Many first-time homebuyers run into unexpected issues when applying for a mortgage. Specifically, it's a common misconception that if you have good credit, a job, and a down payment, that's all you need to get approved.
However, the reality is a little more complicated.
For example, did you know that the source of your down payment matters, and that you'll need more cash in savings than you may think? Here are five things lenders look for, and what you need to do to ace the process.
Good credit is a start
Obviously; a good credit score can determine whether or not you'll qualify for a mortgage and what your interest rate will be. So, how "good" does your credit need to be?
There is no easy answer to that question, but most lenders use the FICO scoring model, which ranges from 300-850. If you're going for conventional financing, aim for a 760 or higher for the best rates, although it's possible to get approved with lower scores. Check this chart to see how your credit score can affect your interest rate.
An FHA loan is more expensive, but less restrictive, and a 640 credit score should be sufficient. Some lenders will take lower scores, as the FHA guidelines allow low down payment loans with as low as a 580 FICO score.
To check your actual FICO score, as well as the interest rates you can expect, go to myfico.com. It's well worth the $20 or so it'll cost you, and you can examine your entire credit report for errors.
Down payment and other funds
As mentioned earlier, simply having your down payment isn't enough. You need to be able to document where it's coming from.
If the funds come from savings, your bank statements will be closely examined, and any unusual or suspicious deposits will need to be explained. If you are receiving a gift from relatives for your down payment, your lender will most likely want them to sign a form stating they gave you the gift, as well as to provide copies of their bank statements to prove where they got the money in the first place.
And, you'll need substantially more cash available than your down payment. You'll need to have enough available money to cover your down payment, any closing costs, as well as a few months of mortgage payments in reserve. This varies by lender, but having six months' worth of payments in reserve should make pretty much any lender happy.
Not surprisingly, you'll need enough income to cover your mortgage, and you'll need to document any income you want considered in the approval process.
Lenders have rules regarding the maximum mortgage payment you're allowed to carry relative to your income, and 28% is a pretty common percentage. In other words, no more than 28% of your pre-tax income can go toward your mortgage payment. Some lenders are willing to stretch this in high-cost areas, or if your credit is especially strong, but most are very strict about their limits.
And, when calculating this amount, don't forget to include taxes and insurance in your mortgage payment amount. Depending on where you live, this can severely limit the amount of "house" you can qualify for.
Even if your income is more than sufficient to keep your mortgage payments under the maximum level, if you have a whole lot of other debt, it can become a problem.
Banks use two different percentages when calculating your ability to qualify for a mortgage. First is the maximum percentage of your income represented by your mortgage payment, which I've already discussed. This is known as the front-end ratio.
The back-end ratio is the total amount of your income that can go to paying down your debts, including your mortgage payment. 36% is a very common back-end ratio limit, but just like with the front-end ratio, this varies by lender and geographical area.
So, if your student loan, credit card, and car payments account for 20% of your income, your maximum housing payment might be limited to just 16% of your income. Banks use whichever of the two ratios produces a lower maximum payment, so be aware how your other debts will affect your ability to qualify.
And, if your other debts are prohibitively high for the house you want, it may be a good idea to put your home-buying plans on hold for a bit and concentrate on paying down your other debts.
So, you have a job and earn enough to qualify for a mortgage based on debt and income. Not so fast. In order to qualify, the lender will thoroughly examine your employment history as well.
When they do this, they're looking for stability and consistency. They'll want to see a minimum of two years at either the same job, or at different jobs in the same field with no break in employment. If you didn't work for part of that time because you were still in school (common for first-timers), that's ok, but you'll need to document it.
Self-employed individuals can expect even more scrutiny here. If you have a history of erratic earnings or an unstable record of finding work, you can bet it'll be an issue that, at very least, will require a lot more documentation.
Whatever you do, make sure your documentation is in order
The most important thing when qualifying for a mortgage is your ability to document everything. If you received a gift from your parents toward your down payment and can't prove it, for example, it could easily derail your mortgage application. So, make sure you can back up everything on your application. It's not uncommon for a mortgage file to grow into hundreds of pieces of paper before the loan closes.