by Christy Bieber | Jan. 1, 2019
Will you be able to qualify for a mortgage? Here are the factors that determine if you'll be eligible for a loan.
If you want to buy a home, chances are good you'll need a mortgage. Mortgages can come from banks, credit unions, or other financial institutions -- but any lender is going to want to make sure you meet some basic qualifying criteria before they give you a bunch of money to buy a house.
There's variation in specific requirements from one lender to another, and also variation based on the type of mortgage you get. For example, the Veterans' Administration and the Federal Housing Administration (FHA) guarantee loans for eligible borrowers, which means the government insures the loan so a lender won't face financial loss and is more willing to lend to risky borrowers.
In general, however, you'll typically have to meet certain criteria for any lender before you can get approved for a loan. Here are some of the key factors that determine whether a lender will give you a mortgage.
Your credit score is determined based on your past payment history and borrowing behavior. When you apply for a mortgage, checking your credit score is one of the first things most lenders do. The higher your score, the more likely it is you'll be approved for a mortgage and the better your interest rate will be.
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With government-backed loans, such as an FHA or VA loan, credit score requirements are much more relaxed. For example, it's possible to get an FHA loan with a score as low as 500 and with a VA loan, there's no minimum credit score requirement at all.
For a conventional mortgage, however, you'll usually need a credit score of at least 620 -- although you'd pay a higher interest rate if your score is below the mid 700s.
Buying a home with a low credit score means you'll pay more for your mortgage the entire time you have the loan. Try to raise your score as much as you can by paying down debt, making payments on time, and avoiding applying for new credit in the time leading up to getting your loan.
Your debt-to-income (DTI) ratio is the amount of debt you have relative to income -- including your mortgage payments. If your housing costs, car loan, and loan payments added up to $1,500 a month total and you had a $5,000 monthly income, your debt-to-income ratio would be $1,500/$5,000 or 30%.
To qualify for a conventional mortgage, your debt-to-income ratio is usually capped at around 43% maximum, although there are some exceptions. Smaller lenders may be more lax in allowing you to borrow a little bit more, while other lenders have stricter rules and cap your DTI ratio at 36%.
Unlike with credit scores, FHA and VA guidelines for DTI are pretty similar to the requirements for a conventional loan. For a VA loan the preferred maximum debt-to-income ratio is 41% while the FHA typically allows you to go up to 43%. However, it's sometimes possible to qualify even with a higher DTI. The VA, for example, will still lend to you but when your ratio exceeds 41%, you have to provide more proof of your ability to pay.
If you owe too much, you'll have to either buy a cheaper home with a smaller mortgage or work on getting your debt paid off before you try to borrow for a house.
Lenders typically want you to put money down on a home so you have some equity in the house. This protects the lender because the lender wants to recoup all the funds they've loaned you if you don't pay. If you borrow 100% of what the home is worth and you default on the loan, the lender may not get their money back in full due to fees for selling the home and the potential for falling home prices.
Ideally, you'll put down 20% of the cost of your home when you buy a house and will borrow 80%. However, many people put down far less. Most conventional lenders require a minimum 5% down payment but some permit you to put as little as 3% down if you're a highly-qualified borrower.
FHA loans are available with a down payment as low as 3.5% if your credit score is at least 580, and VA loans don't require any down payment at all unless the property is worth less than the price you're paying for it.
If you put less than 20% down on a home with a conventional mortgage, you'll have to pay private mortgage insurance (PMI). This typically costs around .5% to 1% of the loaned amount each year. You'd have to pay PMI until you owe less than 80% of what the home is worth.
With an FHA loan, you have to pay an upfront cost and monthly payments for mortgage insurance either for 11 years or the life of the loan, depending how much you initially borrowed. And a VA loan doesn't require mortgage insurance even with no down payment, but you typically must pay an upfront funding fee.
All lenders, whether for a conventional mortgage, VA loan, or FHA loan, require you to provide proof of employment.
Typically, lenders want to see that you've worked for at least two years and have steady income from an employer. If you don't have an employer, you'll need to provide proof of income from another source, such as disability benefits.
Finally, lenders want to make sure the home you're buying is in good condition and is worth what you're paying for it. Typically, a home inspection and home appraisal are both required to ensure the lender isn't giving you money to enter into a bad real estate deal.
If the home inspection reveals major problems, the issues may need to be fixed before the loan can close. And, the appraised value of the home determines how much the lender will allow you to borrow.
If you want to pay $150,000 for a house that appraises only for $100,000, the lender won't lend to you based on the full amount. They'll lend you a percentage of the $100,000 appraised value -- and you'd need to come up with not only the down payment but also the extra $50,000 you agreed to pay.
If a home appraises for less than you've offered for it, you'll usually want to negotiate the price down or walk away from the transaction as there's no reason to overpay for real estate. Your purchase agreement should have a clause in it specifying that you can walk away from the transaction without penalty if you can't secure financing.
While these factors are considered by all mortgage lenders, different lenders do have different rules for who exactly can qualify for financing.
Be sure to explore all of your options for different kinds of loans and to shop around among mortgage lenders so you can find a loan you can qualify for at the best rate possible given your financial situation.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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