How to Qualify for a Mortgage?
If you’re ready to buy a home, applying for a mortgage is the first step you need to take. However, before you take that first step, you need to make sure that you qualify for a mortgage.
According to Statista, a mortgage is the largest component of total debt owned by consumers in the United States, accounting for $9.44 trillion out of $13.95 trillion (over 67%).
A mortgage is a type of loan that takes decades to pay off and can cost thousands of dollars in interest. However, for most people, taking out a mortgage is the only way to buy a home.
That being said, not everyone who wants to purchase a home can qualify for a mortgage. That’s because mortgage lenders set strict requirements for getting a mortgage to make sure that borrowers will be able to pay back their debt.
How Can You Qualify for a Mortgage?
Minimum requirements to qualify for a mortgage vary from one lender to another and depend on the loan type. However, some of the basic requirements to be approved for a mortgage are:
- A stable source of income.
- An acceptable debt-to-income ratio.
- A good credit score.
- A down payment or up-front fee, depending on the type of loan.
Let’s take a closer look at each of these basic requirements to explain what you need to qualify for a mortgage.
1. Source of Income
Your monthly income is one of the most crucial things lenders review before approving your mortgage application. A lender needs to be certain that you have the capacity to pay back the loan. That’s why having a steady and stable source of income is critical if you want to qualify for a mortgage.
Any of the following can count as a steady source of income:
- Bonuses and commissions
- Social Security income
- Income from self-employment
- Investment income
- Rental income
Most mortgage lenders require borrowers to demonstrate proof that they received income for the past two years to be counted as a qualifying source of income. If a source of income cannot be verified, the lender will not consider it when determining whether you qualify for a mortgage.
2. Debt-to-Income Ratio
While having a steady source of income brings you one step closer to qualifying for a mortgage, your income isn’t the only thing a lender will consider when reviewing your application for a mortgage. Lenders also consider your debt-to-income ratio (DTI).
The higher your debt-to-income ratio, the riskier you appear to mortgage lenders. The rationale behind this is that you’re likely to struggle to pay back the loan if you already have a lot of debt. Lenders calculate your DTI ratio by adding up all your monthly debts and dividing the sum of your monthly debt payments by your gross monthly income.
For example, if the total sum of your monthly debt payments is $1,500, and your gross income is $3,000, your debt-to-income ratio is 50%. “What debt-to-income ratio do you need to qualify for a mortgage?” you may wonder. It depends on the type of loan.
Ideally, your front-end ratio should be 28% or less, and a back-end ratio should be 36% or less to be approved for a mortgage. This is also known as “the 28/36 rule” that lenders use as a standard for determining mortgage rates.
3. Credit Score
A borrower’s credit score is also a major part of a mortgage lender’s equation. Your credit score is determined based on a combination of factors:
- Your history of making payments on time
- Whether there were any judgments for unpaid bills, bankruptcies, or foreclosures
- Your credit utilization ratio or the amount of debt you are carrying on all of your credit cards
- The number of different types of loans that you have
- The number of hard inquiries on your credit report
You may have different credit scores depending on which consumer credit-scoring model is used by a lender to determine the score. The vast majority of mortgage lenders use FICO and VantageScores. Both models have credit scores that range from 300 to 850.
Typically, your credit score must be at least 580 to get a mortgage loan. While it may be possible to qualify for a mortgage with a score below 580, don’t expect favorable rates and terms. As a rule of thumb, the higher the credit score, the better the rates and terms.
4. Down Payment
Last but not least, you will have to make a down payment to qualify for a mortgage. Depending on your mortgage loan type, you may be required to pay a one-time up-front insurance premium or an up-front fee. The minimum down payment ranges from 0% to 20% for most mortgage loans.
Most mortgage lenders require borrowers to prove a source of funds for a down payment. Some of the acceptable sources of funds are:
- Retirement accounts, including IRAs and 401(k)
- Checking or savings accounts
- Trust accounts
- Investments or stocks
- Gifts from family members or friends
- Proceeds from the sale of personal property
Other Requirements to Qualify for a Mortgage
You may also need to meet other requirements to qualify for a mortgage, including but not limited to:
- Perform a home appraisal to determine the value of the home you want to buy.
- Conduct an inspection of the home.
- Buy title insurance.
- Demonstrate proof of homeowner’s insurance.
- Show proof that you have the funds to cover closing costs.
For most people, getting a mortgage is the biggest financial decision in their lives. You need to make sure that you are financially prepared to take out a mortgage.