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Are you planning to buy a new home soon but aren’t quite sure how to qualify for a mortgage? Sure, you need money. But how much money? And are there other eligibility criteria to be mindful of when preparing to apply for a home loan?
Here’s an overview of the financial requirements you’ll need to secure financing and steps you can take to simplify the process. In a nutshell: what you need to buy a home.
What do you need to buy a house?
Before you apply for a mortgage, there are some general guidelines to be aware of.
1. Credit score / debt-to-income ratio
To get a home loan, you’ll need to meet the lender’s credit score and debt-to-income ratio (DTI) criteria. But you’ll want to do better than just meet the minimum requirements. The best interest rates are generally reserved for borrowers with high credit scores, since the risk of them defaulting on their loans is lower.
Lenders also want reassurance that you can afford your monthly mortgage payments and pay them on time. Hence the importance of your DTI, which expresses as a percentage the amount of income you have versus the amount you owe. This indicates to a lender if you can handle more debt or are already overextended. There are two types of DTI ratios:
- Front-end (or housing) ratio: This ratio focuses on your income vis-à-vis your housing-related costs — everything that might be paid out of an escrow account. It’s calculated by dividing the monthly mortgage payment, plus homeowners insurance premiums, property taxes, mortgage insurance and HOA fees (if applicable), by your monthly gross income.
- Back-end ratio: This ratio compares your income to your overall obligations: mortgage payments and the other housing expenses, plus other regular bills like car or student loans, credit card payments, child support and so on.
The credit score and DTI thresholds vary by lender and loan type. Furthermore, some lenders have overlays, which are more rigid requirements, to help minimize the risk they assume when funding your home loan. So, when actually applying, you may need a higher credit score or DTI than federal guidelines might indicate.
Here are the typical credit score and DTI requirements by loan type:
|Loan Type||Minimum Credit Score||Debt-to-Income Ratio (DTI)|
|Conventional Loan||620||45% (front-end/back-end combined)|
|FHA Loan||580 (3.5% down payment)500 (10% down payment)||Front-end: Up to 31%
Back-end: Up to 43%
|USDA Loan||640||Front-end: Less than 29%
Back-end: Less than 41%
|VA Loan||620||Less than 41% (recommended)|
|Jumbo Loan||700||43% (maximum)|
2. Proof of income / job history
Most lenders also want to see 24 months of consistent, steady income before approving you for a mortgage. The amount of income you’ll need depends on the loan amount you’re seeking and your current debt load. Your income is computed based on the pay stubs and W2s you provide to the lender.
You’re not required to have a full-time job to qualify for a mortgage; if you’re self-employed, you could be eligible. Still, you’ll likely need to provide alternative income documentation, such as tax returns, 1099 forms and bank statements, and proof that you have an income-producing business. But you should know that the lender will likely calculate your average earnings for the past 24 months to come up with an income figure to use with your mortgage application.
If you’re starting a new job soon, an offer letter — attesting to your salary — may suffice. However, it must be signed for the lender to consider the income. Your new job should also be in the same industry you’ve worked in for the past two years.
3. Down payments / closing costs
Unless you opt for a mortgage that offers 100 percent financing (a rare breed, outside of certain government-backed products), you’ll need to make a down payment to get a home loan. Below is a list of the minimum down payment requirements by loan type:
|Loan Type||Minimum Down Payment|
|Conventional Loan||5% – 20%|
|FHA Loan||580 (3.5% down payment (580 credit score)10% down payment (500 credit score)|
|Jumbo Loan||10 – 20% (varies greatly by lender)|
Closing costs are another expense to consider when buying a house. They’re generally between 2 and 5 percent of your loan amount and include the cost of the appraisal and credit check, the loan origination fee, application and underwriting fees, attorney’s fees, title search and insurance, and transfer taxes (if applicable).
The amount you pay will vary depending on the loan program, the amount you borrow and your state of residence. According to ClosingCorp, the national average for closing costs on a single-family home in 2021 was $3,860 or $6,905 with property taxes.
4. Mortgage lender
Once you understand the financial requirements of taking out a home loan and are ready to apply, you’ll need to start shopping for the right lender. You have several options to choose from, including direct lenders like banks, credit unions or mortgage companies; mortgage brokers, independent, licensed professionals who serve as matchmakers between lenders and borrowers; and hard money lenders, private investors who finance loans.
Ask around for recommendations and check with your bank or credit union to see if they can assist. You’ll also need to gather the necessary documentation to get preapproved for a mortgage — a key step in being able to make offers on a home that sellers will take seriously.
Here’s what you’ll need to apply for a mortgage preapproval:
- Asset documentation: two to three months of recent investment income and retirement statements, a down payment gift letter (if applicable) and correspondence regarding any real estate you currently own (if applicable)
- Debt documentation: the last 60 days of statements for any loans you currently have
- Credit documentation: proof of rent payments and the name and phone number of your landlord if you’re currently renting
- Employment documentation: contact information for any employers you’ve had in the past two years
- Income documentation: two to three months of your most recent bank statements, 30 days of your most recent pay stubs and tax returns from the past two years
If you’re self-employed, you’ll also need a CPA letter certifying you’ve been in business for two or more years and a copy of your business license from the state.
The mortgage preapproval process involves undergoing a hard credit check and submitting the documentation you gathered for the lender to review. If you’re a good fit for a home loan, the lender will issue a loan commitment, usually in the form of a letter.
Consider getting prequalified with several lenders before getting preapproved for a mortgage. Doing so allows you to view potential loan terms from different lenders and compare quotes to decide which is most suitable for your financial situation.
A word of caution: It may not be in your best interest to accept the maximum amount a lender offers — if you can’t afford the payments. Consider using a new house calculator to run the numbers and determine how much you can realistically afford to borrow.
Next steps: Finding a house
With a preapproval, you’re ready for the final requirement for buying a house: The dream home itself.
Shopping for the perfect home can be the most enjoyable part of the process. But before you begin showing up to open houses or scouring online ads, consider hiring a real estate agent to help you. Not only will they help navigate the house-hunting process, they can advise on making offers, advise on the terms of the purchase and sale agreement, and help overcome any challenges that may come up before closing.
Finding the right real estate agent to purchase a home doesn’t have to be stressful. Start by asking for recommendations and researching potential candidates to learn more about their experiences with past clients. Also, be sure to interview at least three agents and check references. This helps ensure the agent you select is reputable and the right fit to assist you as you embark on your homebuying journey.