Just so you know everything you need to bring to the table when you need to qualify for a mortgage, here's a guide on how to please the lending gods so they deem you worthy of receiving a huge pile of cash and a great mortgage rate—and what to do if you haven't covered these bases quite yet so you'll pass muster soon enough.
Let's jump in! First off, you need to gather a mess of paperwork from bank statements to pay stubs to tax returns and W-2s. But in addition to paperwork, you need a few other items to get a mortgage loan. Here are the essentials:
When you apply for a mortgage, lenders will check your credit score to assess whether you’re a low- or high-risk borrower. The higher your score, the better you look on paper, and the better your odds of landing a great loan.
While a perfect score is 850, research suggests that only about 0.5% of consumers hit that coveted mark. As a result, scores of 760 and higher are considered to be in the best range from a mortgage lender’s perspective. It means you’d qualify for the best (that is, lowest) interest rates, says Richard Redmond, mortgage broker at All California Mortgage in Larkspur and author of “Mortgages: The Insider’s Guide.”
A good credit score is 700 to 759; a fair score is 650 to 699. If you have multiple blemishes on your credit history (e.g., late credit card payments, unpaid medical bills), your score could fall below 650. If that’s the case, you’ll likely get turned down for a conventional home loan—and will need to mend your credit in order to get approved (unless you qualify for a Federal Housing Administration loan, which requires a 580 minimum credit score).
Your first step, therefore, should be to check your credit report, says Beverly Harzog, consumer credit expert and author of “The Debt Escape Plan.”
You’re entitled to a free copy of your full report at AnnualCreditReport.com. The report does not include your score—for that, you’ll have to pay a small fee—but just perusing your report will give you a ballpark idea of how you're doing by laying out any problems such as late or missing payments. Some credit card companies, including Discover and Capital One, also offer customers free access to their scores and reports.
You should also check to make sure you're actually the person responsible for any black marks that appear on your report. It's more common than you might think—one study by the Federal Trade Commission revealed that 1 in 4 Americans spotted errors on their reports.
How much income you need to get a mortgage home loan boils down to your debt-to-income ratio; this figure compares your earnings on your tax returns with your outstanding debts. To qualify for a home loan, your job’s income must be high enough to offset your debts, including your possible mortgage payments.
To calculate your DTI ratio, figure out how much you’re paying in debt per month—by tallying up things like car payments, student loans, and credit card bills—and divide that amount by your monthly income on your pay stubs.
Let’s say, for example, that every month you’re paying $250 in debts and pulling in $5,000. Divide $250 by $5,000, and you have a DTI ratio of 0.05, or 5%. That’s well below the recommended rule of 36%, says David Feldberg, broker and owner of Coastal Real Estate Group, in Newport Beach, CA. Keep in mind, though, you don't own a home yet, which will push up your DTI.
Once you know your income and debt, you can use an online home affordability calculator to see how much you can shell out for a new house, while still remaining below that 36% DTI ratio threshold.
Let’s take the aforementioned example where you make $5,000 a month and pay $250 in debts. Now let’s assume you have around $30,000 for a down payment and can get a 30-year mortgage at a fixed interest rate of 5%. Enter these numbers into a home affordability calculator, and this will put you in the ballpark of affording a home worth $243,100.
In addition, lenders like to see at least two years of consistent income history, says Todd Sheinin, mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD.
This creates a roadblock for many workers who are just starting their careers or are self-employed. If you're in the latter situation and have variable income, you may need additional assets such as a higher down payment (more on that next) in order to qualify for a mortgage.
Most mortgage lenders like to see that you have enough in the bank to make a 20% down payment—which amounts to $50,000 on a $250,000 home. (And they will be looking at your bank statements.) So if you don't have that much saved up, it's time to start pinching some pennies so you can start making those mortgage payments! But there are other options as well.
FHA-backed loans let borrowers make down payments as low as 3.5%. If you’ve served in the military, the Department of Veterans Affairs loans require no down payment at all. Only eligible for a conventional loan? Expect to need at least a 10% down payment, says Sheinin. However, if you put anything less than 20% down on a conventional loan, you'll need to pay private mortgage insurance—a monthly premium that can range from 0.3% to 1.5% of the total loan amount.
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COURTESY of Realtor.com
By Jamie Wiebe | Jan 5, 2016
It's easy to fall in love with the idea of buying a home. You've got it all planned out: a five-bedroom home in your favorite neighborhood with a manicured lawn and—why not?—a nice pool.
Well, if you really want to land that dream home, you'd better get started now!
Step 1 is to clean up your credit score, also called a FICO score—a simplified calculation of your history of paying back debts and making regular payments on loans. If you're borrowing money to buy a home (as most do), lenders want to know you'll pay them back in a timely manner, and a credit score is an easy estimate of those odds.
Here's your crash course on this all-important little number, and how to whip it into the best home-buying shape possible.
There are three major U.S. credit bureaus (Experian, Equifax, and TransUnion), and each releases its own credit scores and reports (a more detailed history that's used to determine your score). Their scores should be roughly equivalent, although they do pull from different sources. For example, Experian considers on-time rent payments while TransUnion has detailed information about previous employers.
To access these scores and reports, financial planner Bob Forrest of Mutual of Omaha recommends using AnnualCreditReport.com, where you can get a free copy of your report every 12 months from each credit-reporting company. It doesn't include your credit score, though—you'll have to go to each company for that, and pay a small fee.
Or check with your credit card company: Some, including Discover and Capital One, offer free access to scores and reports, says Michael Chadwick, owner of Chadwick Financial Advisors in Unionville, CT. Once you've got your report, thoroughly review it page by page, particularly the “adverse accounts" section that details late payments and other slip-ups.
It's simple: The better your credit history, the higher your score—and the better your opportunities for a home loan. The Federal Housing Administration requires a minimum credit score of 580 to permit a 3.5% down payment, and major lenders often require at least 620, if not more. So what can you do if your credit report is in less than shipshape? Don't panic, there are ways to clean it up.
A 2013 Federal Trade Commission study found that 5% of credit reports contain errors that can erroneously ding your score. So if you spot any, start by sending a dispute letter to the bureau, providing as much documentation as possible, per FTC guidelines. You'll also need to contact the organization that provided the bad intel, such as a bank or medical provider, and ask it to update the info with the bureau. This may take a while, and you may need documentation to make your case. But once the bad info is removed, you should see a bump in your score.
So you've made a late payment or two—who hasn't? Call the company that registered the late payment and ask that it be removed from your record. “If you had an oopsy and missed just a payment or two, most companies will indeed tell their reporting division to remove this from your credit report," says Forrest. Granted, this won't work if you have a history of late payments, but for accidents and small errors, it's an easy boost for your score.
One no-brainer way to increase your credit standing is to simply pay off your debt. Not an option right now? Here's a cool loophole: Ask your credit card companies to increase your credit limit instead. This improves your debt-to-credit ratio, which compares how much you owe to how much you can borrow.
“Having $1,000 of credit card debt is bad if you have a limit of $1,500. It isn't nearly as bad if your limit is $5,000," Forrest says. The simple math: Although you owe the same amount, you're using a much smaller percentage of your available credit, which shines well on your borrowing practices.
If you're often late with payments, now's the time to change. Commit to always paying your bills on time; consider signing up for automatic payments so it's guaranteed to get done.
Unfortunately, negative items (such as those habitually late or nonexistent payments) can stay on your report for up to seven years. The good news? Changing your habits makes a big difference in the “payment history" segment of your report, which accounts for 35% of your score. That's why it's essential to start early so that you're sitting pretty once you're shopping for homes and find one that makes you swoon.
Once you've set your credit on a better path, it's time to tackle the next major hurdle: saving for a down payment.
Check out our First-Time Home Buyer Resource Center for more tips to help you through your home-buying journey.
Jamie Wiebe writes about home design and real estate for realtor.com. She has previously written for House Beautiful, Elle Decor, Real Simple, Veranda, and more.