First-time homebuyers are often perplexed by the process of applying for a loan and finding out whether they can qualify for a mortgage. They want to know how much they'll have to finance, how much they need for a down payment and the amount of personal assets they need to land an affordable monthly payment.
The first step in the process should be to give up any misconceptions about how difficult it is to qualify. A better use of time for the prospective homeowner is to determine how much they can reasonably afford to spend on a home.
Meeting Income Requirements for a Mortgage
Lenders evaluate the borrower's debt-to-income ratio (DTI) in determining worthiness. They examine income tax returns and pay stubs to calculate a gross monthly income. The income is counterbalanced by liabilities – how much the borrower has in monthly living expenses, existing debt in installment or revolving accounts, and other scheduled payments.
In math terms, a borrower should divide the liabilities by the gross monthly income to determine their DTI. Each lender will establish the minimum requirements for DTI based on potential risk. Borrowers can use LendingTree's Loan Calculator to determine their DTI. Customarily, lenders will shy away from applicants where the monthly payment exceeds more than 28% to 44% of their gross income.
Sweating the Down Payment
Lenders will pre-qualify borrowers based on their credit score, cash reserves, job history, and how much they can afford for a down payment. Among the mistakes first-time borrowers make is assuming they won't be able to afford the down payment on their first home. Not all loans to first-time borrowers take out a pound of flesh in the form of a down payment. For example, there are FHA and VA loan products requiring only five percent down or less.
A 2015 market survey by Wells Fargo found that more than 40 percent of millennials buying homes put down less than 10 percent. The survey said 21 percent of respondents gave up on applying for a loan at all, thinking they couldn't afford the down payment.
Look into Credit Requirements
In the same study, Wells Fargo found that nearly half of millennials thought that lenders considered only FICO scores above 780 as acceptable. In reality, the survey said, the average credit score on approved loans in 2014 was 689. The bank advised consumers that the credit score is not the sole determinant of whether an applicant can qualify for a home loan. Everyone considering a mortgage should pull a current credit report and check for errors.
Buy an Affordable Home
First-time buyers should run the numbers to estimate to the best of their knowledge that the house payments will remain affordable, especially if income changes or the interest rate goes up on an adjustable mortgage. A cash reserve can help in negotiating the down payment and interest rate, as can other collateral. Be sure to include calculations for additional monthly expenses associated with the home, such as mortgage insurance, home insurance, taxes and upkeep. In all cases, if the total loan amount exceeds the property value, the lender will walk away.