Qualifying For A Mortgage: The Basics
Let's begin by looking at the major factors lenders first consider when they decide whether you qualify for a mortgage or not. Your income, debt, credit score, assets and property type all play major roles in getting approved for a mortgage.
One of the first things that lenders look at when they consider your loan application is your household income. There is no minimum dollar amount that you need to earn to buy a home. However, your lender does need to know that you have enough money coming in to cover your mortgage payment, as well as your other bills.
It's also important to remember that lenders won’t only consider your salary when they calculate your total income. Lenders also consider other reliable and regular income, including:
- Military benefits and allowances
- Any extra income from a side hustle
- Alimony or child support payments
- Income from investment accounts
- Social Security payments
Lenders need to know that your income is consistent. They usually won't consider a stream of income unless it's set to continue for at least 2 more years. For example, if your incoming child support payments are set to run out in 6 months, your lender probably won't consider this as income.
The type of property you want to buy will also affect your ability to get a loan. The easiest type of property to buy is a primary residence. When you buy a primary residence, you buy a home that you personally plan to live in for most of the year.
Primary residences are less risky for lenders and allow them to extend loans to more people. For example, what happens if you lose a stream of income or have an unexpected bill? You're more likely to prioritize payments on your home. Certain types of government-backed loans are valid only for primary residence purchases.
Let's say you want to buy a secondary property instead. You'll need to meet higher credit, down payment and debt standards, since these property types are riskier for lender financing. This is true for buying investment properties as well.
Your lender needs to know that if you run into a financial emergency, you can keep paying your premiums. That's where assets come in. Assets are things that you own that have value. Some types of assets include:
- Checking and savings accounts
- Certificates of deposit (CDs)
- Stocks, bonds and mutual funds
- IRAs, 401(k)s or any other retirement account you have
Your lender may ask for documentation verifying these types of assets, such as bank statements.
Your credit score is a three-digit numerical rating of how reliable you are as a borrower. A high credit score usually means that you pay your bills on time, don't take on too much debt and watch your spending. A low credit score might mean that you frequently fall behind on payments or you have a habit of taking on more debt than you can afford. Home buyers who have high credit scores get access to the largest selection of loan types and the lowest interest rates.
You'll need to have a qualifying FICO® Score of at least 620 points to qualify for most types of loans. You should consider an FHA or VA loan if your score is lower than 620. An FHA loan is a government-backed loan with lower debt, income and credit standards. You only need to have a credit score of 580 in order to qualify for an FHA loan with Rocket Mortgage®. You may be able to get an FHA loan with a score as low as 500 points if you can bring a down payment of at least 10% to your closing meeting. We don't offer FHA loans with a median credit score below 580 at this time.
Qualified active-duty service members, members of the National Guard, reservists and veterans may qualify for a VA Loan. These government-backed loans require a median FICO® Score of 580 or more.
Mortgage lenders need to know that you have enough money coming in to cover all of your bills. This can be difficult to figure out by looking at only your income, so most lenders place increased importance on your debt-to-income ratio (DTI). Your DTI ratio is a percentage that tells lenders how much of your gross monthly income goes to required bills every month.
It's easy to calculate your DTI ratio. Begin by adding up all of your fixed payments you make each month. Only include expenses that don't vary. Debt that’s considered when applying for a mortgage can include rent, credit card minimums and student loan payments.
Do you have recurring debt you make payments toward each month? Only include the minimum you must pay in each installment. For example, if you have $15,000 worth of student loans but you only need to pay $150 a month, only include $150 in your calculation. Don't include things like utilities, entertainment expenses and health insurance premiums.
Then, divide your total monthly expenses by your total pre-tax household income. Include all regular and reliable income in your calculation from all sources. Multiply the number you get by 100 to get your DTI ratio.
The lower your DTI ratio, the more attractive you are as a borrower. As a general rule, you'll need a DTI ratio of 50% or less to qualify for most loans.
Lenders will often use your DTI ratio in conjunction with your housing expense ratio to further determine your mortgage qualification.
Other Mortgage Qualification Factors
The factors lenders look at during the mortgage loan process aren't the only things you need to consider before you submit an application. Make sure you consider PITI, private mortgage insurance and closing costs when you calculate how much buying a home will cost you.
PITI stands for principal, interest, taxes and insurance, and acts as a rough estimate of how much you can afford to purchase a home. Many lenders will use your PITI estimate to determine if you qualify for a mortgage, as it provides an idea of whether you can afford to pay back the loan. You can calculate your PITI yourself if you have an idea of what you’ll owe in each category. That way you’ll know how much house you can afford before you fall in love with one you can’t.
Private Mortgage Insurance
Many people believe that it's impossible to buy a home if they don't have at least 20% down. This actually isn't true. You can buy a home with as little as 3% down, depending on your loan type. Some government-backed loans can even allow you to buy a home with $0 down. However, you will need at least a 20% down payment if you want to avoid paying for private mortgage insurance (PMI).
PMI is a special type of insurance that protects your lender in the event that you default on your loan. Despite the fact that PMI affords you no protections as the buyer, most mortgage lenders require that you pay it if you bring less than 20% down at closing. You have the option to cancel your PMI once you reach 20% equity in your home by paying down your principal each month.
You also need to factor in closing costs when you apply for a mortgage. These are processing fees you pay to your lender in exchange for finalizing your loan. The specific closing costs you'll pay depend on where you live and the type of mortgage you're getting. Some common closing costs include appraisal fees, attorney fees and escrow fees. You can expect your closing costs to equal around 2% – 6% of your total loan value. Make sure that you have enough money to cover these costs before you apply for a loan.