Real life answers to your questions
Mortgage qualification is a crucial process for anyone who needs financing to buy a home.
While mortgage guidelines vary depending on the lender and type of mortgage, the mortgage qualification process is basically the same for all borrowers. A mortgage lender will look at the following items when determining your qualification for a mortgage:
Knowing your credit score can help you choose the right mortgage program. Conventional mortgage lenders typically require credit scores above 740 to offer the best mortgage rates. If you have a lower credit score, you may qualify for a home mortgage with an FHA loan or VA loan.
Stability is the primary concern for a lender. Typically, two years of work history shows a lender that your income and work situation is stable. There are exceptions, particularly if you switched jobs recently, but remained in the same line of work, received a promotion, or switched jobs to advance your career or to get a higher salary.
Income and Expenses
When you apply for a mortgage, you'll need to show your income from the past two years. Usually, your lender will ask for last year's W-2 along with your most recent pay stub. Lenders want to see stability in your income. If a large portion of your income is from unstable sources, like bonuses, commissions, or tips, you'll need to talk with your lender and show how your income is reliable.
Your lender will also want to look at your checking and savings account statements to see your cashflow, as well as any dividend and interest income you've received in the last two years. They'll also want to see what kind of expenses you have, like loans and other debts, including revolving lines of credit, like those on a credit card. Keep in mind that how you use your credit cards can also impact your credit score.
Your personal assets include bank accounts, stocks, bonds, retirement funds, life insurance policies, and personal property. These assets help to assure a lender that you'll be able to take care of yourself if you lost your job or otherwise ran into hard times.
Your down payment amount will depend on the type of mortgage you choose. Typically, your down payment amount will be between 0-20% of the price of the property. For a conventional loan, 20% is typical, while an FHA loan may require less than a 5% down payment, and some vets may be able to secure a home loan with no money down.
Pre-qualification: The First Step
Pre-qualifying for a mortgage begins when you provide basic information about your financial situation to a lender. This information gives the lender an overview of your debts, income and assets. Wages, salary, alimony, Social Security benefits and interest are examples of income. Savings, checking and investment accounts are assets. The lender may pull your credit report and score, but this is not always done at the pre-qualification stage and is never done without your permission.
The main purpose of pre-qualification is to give you and your real estate agent an estimate of what you'll likely be able to afford when you shop for property. Once you've gone through the process, your lender can issue you a pre-qualification letter, which lets real estate agents and home sellers know that you're a serious buyer and not someone just touring houses for decorating ideas.
Pre-approval: The Gold Standard
The difference between loan pre-qualification and loan pre-approval is very important. Pre-qualification is based on preliminary information obtained from you, and the lender runs a few calculations to determine if you superficially appear to be qualified. You can even do this yourself with a pre-qualification tool like LendingTree's Home Affordability Calculator. This first step is helpful for lenders and borrowers.
The problem with pre-qualification is that the lender is taking you at your word, and your information has not been independently verified. In fact, Realtor.com says, "Many REALTORS® and sellers won't consider you as a strong home-buying candidate without a pre-approval letter."
The pre-approval process requires you to submit a mortgage loan application and supporting documentation – pay stubs, tax returns, bank statements, and more. A mortgage underwriter looks at your credit report and analyzes your debts. At that point, if your application package meets the lender's guidelines, you can be granted a pre-approval, also known as a credit approval. The idea is that you as a buyer are approved, and if the property you choose also meets the lender's guidelines, you should be able to close on your purchase.
Qualifying for a Home Loan: By the Numbers
To qualify for a home loan, you must first contact a lender.
That might seem obvious, but many first-time buyers make the mistake of shopping for a home online or at open-house events without ever contacting a lender to find out whether they are qualified for a home loan. This backward approach can result in a lot of disappointment when buyers discover they can't qualify to borrow as much as they'd expected they could.
One of the most important factors in home loan approval is your debt-to-income ratio, or DTI. This ratio compares your gross (before tax) monthly income to your monthly debt repayment obligations to determine whether you can afford the loan you want. Most lenders and programs don't want to see a DTI higher than 43 percent, and many set lower limits than that. If your gross income is $6,000 per month, and your lender allows a maximum DTI of 40 percent, all obligations can't exceed $2,400 a month. If your debt payments come to $1,000 a month, that leaves you $1,400 a month for your house payment, including property taxes and homeowner's insurance.
You'll need to prove that you have enough money for your down payment and closing costs, and you'll need to show where it comes from. Lenders like to see that after you close on your home purchase, you'll still have money to cover your mortgage if you have a financial emergency. These funds are called "reserves," and the more you have, the better your chances of getting approved for your mortgage.
While many loan programs allow credit scores as low as 620, and while FHA allows scores as low as 500 if you put at least ten percent down, most successful borrowers have considerably higher scores. Mortgage tracking firm Ellie Mae reports that the average FICO score for approved loans was 723, while the average score for denied applications was 678!
Don't Blow It!
Neither pre-qualification nor pre-approval is the final step in the mortgage qualification process. The lender will probably require you to update your documents before you can close on your purchase. The underwriter will order a fresh credit check and an appraisal of the property's value prior to closing.
During the home buying process, maintain the status quo with your financial situation. That means you shouldn't open new credit accounts, buy furniture or major appliances on a charge card, buy or lease a car or change employment. Any significant change in the borrower's income, assets, debts or credit can invalidate your mortgage approval.
Being pre-qualified or pre-approved for a maximum loan amount doesn't mean you should spend that much. There are many items that affect a budget that don't necessarily become part of a mortgage application – perhaps you have an expensive hobby or like to save more than the average person. It's up to you to determine your comfort zone and stay in it. The bottom line is that mortgage qualification is a process that starts with a lender and borrower, and ends with a closed and funded new loan.
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