How To Qualify For A Mortgage: The Essentials You Need To Know

You’ve been scrolling through Zillow and Redfin looking for the perfect place and now you’re ready to find out what it takes to qualify for a mortgage. 

You know your credit score plays a big part in this but what about your credit history, debt to income ratio, additional assets, and employment status? Find out what you need to get a handle on and what the best mortgage options might be for you. 

The Major Factors Lenders Consider When Considering Mortgage Applications:

Purchasing a home is a very long-term commitment, so lenders consider multiple factors when approving someone for a mortgage. This can include, but isn’t limited to: 

• Credit score
• Income
• Financial assets
• Employment status
• Debt to income ratios
• Property types

The requirements for each of those factors can vary based on the lender, the purchase price, and the type of loan you decide to get. 

Income

Lenders consider your income as one of the biggest factors behind qualifying borrowers for a home purchase. Because how else are they going to make sure you can afford a mortgage payment?

There’s no minimum required income to buy a house. However, your net income has to be enough to cover your new mortgage, in addition to your current obligations and expenses. It also has to be consistent. 

Financial institutions want at least two years of income with documentation in the form of: 

• W2s
• 1099 Forms
• Federal and State tax returns
• Income from investments
• Social security income
• Rental income if it’s been at least a year
• Military benefits
• Child support or alimony payments

Unless the income stated is long-term, it likely won’t be considered when qualifying you for the mortgage loan. That means any money brought in from a part-time job income, or unemployment won’t be counted as part of your qualifying income. 

Credit Score

The credit score requirements depend on which type of loan you choose as well as which lender you decide to work with. 

Government-backed loans such as an FHA, USDA, or VA loan have a minimum score they’ll accept, and we’ll get into more detail on that later. Conventional loans have a minimum score requirement that’s set by the lender. 

Your credit score has a big role to play in determining your mortgage rate. You can take an in-depth look at the difference in mortgage rates by credit score to find out how this impacts you. 

Even with the minimum score requirements, the specifics on your credit report still matter. You want to have a strong payment history and a healthy length of credit history as a good starting point. 

Assets

By this point, we know that buying a home means your lenders review your full financial picture.

Just in case you were to experience a loss of income, they want to make sure that you’ll still be able to meet the mortgage payments in addition to verifying where your down payment is coming from. 

This could mean that they require documentation from various accounts:

• 401k/ retirement balances
• Checking and Savings account balances
• Investment accounts
• Monetary Gifts to help with the downpayment from family or friends 

Lenders also want to ensure you have the ability to cover closing costs which can be 2% to 5% of the purchase price for your home. All of these extra costs can add up quickly. The last thing you want is to make it halfway through the home buying process and run out of funds. 

The best thing you can do to prepare for this big move is to SAVE. 

You can consolidate your debt to save money on interest every month or set up an auto-transfer to your savings account each time you get paid. 

You want to show lenders an appropriate downpayment, closing costs, and additional cash reserves in your financial profile when submitting your mortgage application. It might be wise to save extra money for initial home repairs, new furniture, or unexpected expenses as well. 

Property Type

All of the government-backed loans will only provide funding for properties that will be used as primary residences. Conventional home loans have more leniency where this is concerned. 

Primary residences typically include single-family homes, condos, or townhouses. Specifically, under conventional mortgage loans, primary residences can also include manufactured homes on permanent foundations, and one to four-unit homes within a subdivision or condo project. 

Conventional mortgages can be used for primary, secondary, or investment property purchases. However, you might notice that secondary and investment purchases will have a higher interest rate than a primary residence as this presents additional risk to your mortgage broker. 

If the home loan is meant to purchase secondary or investment properties, you can expect to provide higher down payments, higher credit score requirements, and even proof of additional cash reserves. 

Employment

Similar to the income, mortgage lenders want to see at least two years of consistent employment history within the same company or at least within the same industry. This can be more difficult for people who are self-employed or work off of commission. 

If you’re self-employed, you’ll need to provide consistent proof of your income over at least two years with documents like: 

• Invoices
• 1099 Forms
• Federal tax returns
• Contracts
• Profit and loss statements

For people who are employed, the longer you’ve been employed, the better. If you have any employment gaps, you’ll likely need to explain them formally. 

Debt To Income ratio

Your debt to income ratio is calculated by dividing your Gross Monthly Income by your Total expenses and multiplying the result by 100. 

If your debt to income ratio is too high, it tells potential lenders that you might not have enough monthly income to meet all of your monthly debt obligations. Your monthly debt payments can include car loan payments, credit cards, and installment loans. 

But did you know that mortgage lenders use two different kinds of debt to income ratios? 

1. Front End Ratio: The total of your monthly home expenses divided by your gross monthly income. Home-related expenses would include your mortgage payment, property taxes, and insurance. 

2. Back End Ratio: the total of all your monthly expenses divided by your gross monthly income. Your monthly expenses would include student loan payments, credit card bills, auto loans, and personal loans. 

Depending on the type of loan, there may be two separate underwriting maximums for the front-end ratio and the back-end ratio. Not paying attention to DTI limits could cause a hold-up in the mortgage process especially if your lender requires you to pay off debt before approval. 

 According to The Motley Fool, “A front-end ratio of 28% or less and a back-end ratio of 36% or less is considered ideal and is the standard most lenders use”.

Minimum Loan Criteria For Different Types of Loans:

The minimum loan requirements for each loan type are shown in the table here. The credit score requirements may vary based on which lender you work with. We’ll go into additional detail on each of these loan options below. 

Minimum Loan Requirements for Loan Types

Loan Type	Minimum Down Payment	Minimum Credit Score	Maximum DTI	Mortgage Insurance or similar fees
Conventional	3%	620	45%	PMI: 0.15% to 1.95%
FHA	3%	500	50%	UFMIP: 1.75%& Annual MIP: 0.45% to 1.05%
USDA	0%	none	43	1% Upfront USDA guarantee fee and 0.35% annual guarantee fee
VA Loan	0%	none	41%	.50% to 3.6% Gov. funding fee

Sources: Lending Tree and Credible 

Conventional

Conventional loans are private mortgage loans that fit into one of two categories: 

1. Conforming: A conforming conventional loan fits the requirements set forth by the FHFA. A minimum credit score of 620, DTI of 36%-50%, and a downpayment of 3% are required if your mortgage is backed by Fannie Mae or Freddie Mac. 

This loan type includes a borrowing limit of $548,250 except in Alaska, Guam, Hawaii, and the US Virgin Islands where the cost of living is higher. 

2. Non-Conforming: If you need to borrow more than $548,250, you’ll likely have to go with a non-conforming loan. This is also known as a jumbo loan. We’ll cover more about this shortly. 

FHA

These loans are easier to get a qualified mortgage due to their low credit requirements and lower down payments. This tends to be a favorite for first-time homebuyers, but it’s a common misconception that you have to be a first-time homebuyer to get an FHA loan. 

Here are some of the features for these mortgages: 

• FICO credit scores from 500 to 579 require a 10% down payment
• FICO scores 580 and above only need a 3.5% down payment
• Mortgage insurance premium (MIP) will be included in your monthly payment
• DTI ratio should be below 43%
• You’ll need two years of employment history to qualify 
• Can only be used to purchase a primary residence

Don’t get it twisted. Just because FHA loans have a lower credit requirement than conventional loans doesn’t mean you’ll get approved no matter what. 

FHA lenders still consider the rest of your credit history, not just the number. And your score still plays a part in the interest rate you get approved for. 

So even if you’ve managed to bring your score up to the 500 minimum, you could get denied an FHA loan based on items in your credit history.  

Delinquencies, bankruptcies, and foreclosures could affect your chances of getting approved, but it’s not unheard of. 

Borrowers with bankruptcies and foreclosures have still qualified for this mortgage option. 

Borrowers who choose an FHA loan will only need a 3% down payment in most cases with the addition of Private Mortgage Insurance or PMI. PMI is a type of insurance that’s included in your monthly mortgage payment which protects your lender if you can no longer pay for your loan. 

But that doesn’t mean it’s there for the full 15 or 30-year loan term. When you reach 20% equity by making your monthly payments on time, you can request that your lender remove the PMI. You might have to refinance your mortgage for that to happen. 

Another little-known feature of getting your mortgage with FHA is that the home has to pass a safety inspection before settlement, and it may require the owner to make additional repairs if issues are found. 

This can be a downside for potential sellers, and some of them shy away from working with buyers who have FHA financing. This restricts your housing options as well if a property you’re interested in discloses that the dwelling is not FHA approved. 

VA

VA loans are another government-backed loan program that’s open to veteran and active duty service members. And they have some enviable mortgage requirements. The only cost is a funding fee that’s about 0.50%-3.6% of the total loan amount based on any down payment. 

VA loans have the following features:

• No credit minimum, but it’s suggested to have a 580 to a 620 minimum 
• No down payment required
• No mortgage insurance
• 41% DTI ratio
• Can only be used for primary residences and a safety inspection is required
• No borrowing limits

These loans are available to active duty service members and veterans. You’ll have to provide a Certificate of Entitlement or COE as part of the qualification process. The spouses of those who died while in active duty can qualify, as well as the spouses of Prisoners of War or MIA.  

Since there are no borrowing limits on a VA loan, these can be used to purchase a higher-priced property. Just keep the funding fee in mind as it’s based on the purchase price and your down payment. 

USDA

USDA loans are specifically for people with low-to-moderate income who are looking to buy a home in a rural area. The advantage to choosing this option is there’s no down payment required, and the credit score needed is much lower than a conventional loan.

There are other features that you should know to decide if this is the right loan for you:

• The USDA doesn’t have a set minimum credit score, but their approved lenders usually work with a score of 640 or higher. 
• No mortgage insurance, but you will have two guarantee fees. 
• There are income limits based on the total income of everyone in your household. 
• Front end DTI maximum of 29% with a back-end maximum DTI of 41%. 
• The USDA has a property eligibility check to find out if the house you want is in an eligible area. 

Even though you’re not responsible for mortgage insurance with a USDA loan, you will have to pay two guarantee fees which offsets the cost of the loan to taxpayers. 

The first fee is 1% of the loan amount and is typically included in financing. The second guarantee fee is annual and amounts to 0.35% of the loan which gets divided by 12 and added to your monthly payments. 

Jumbo

A jumbo loan is for consumers who are looking to borrow money towards the purchase of a home that is over the FHFA limit of $548,250. Since this is a much larger loan, the requirements are much higher than a conforming conventional mortgage. 

To qualify for a jumbo loan, you would need: 

• A credit score of 700+
• In most cases, a down payment of 20%, but some lenders may request more or less 
• A strong credit profile and documentation of assets 

Jumbo loans are only offered by private lenders since they’re outside the range of what Freddie Mac or Fannie Mae will buy. The only exception being homes in states and US territories where the cost of living is higher. This includes Alaska, Hawaii, Guam, and the US Virgin Islands. 

How To Improve Your Chances of Qualifying For A Mortgage:

Improve Credit Score

If your score is below the acceptable credit score range for the loan you want, you don’t have to take whatever interest rate you’re handed by the loan officer. Improve your score and take advantage of better loan options and lower monthly mortgage payments. 

You can start by opening accounts that build credit as long as it’s at least six to eight months before you plan to submit your mortgage loan application. 

A very effective account to achieve that boost in your score is to open a credit builder loan. 

Within the first three months of opening the account, the average credit builder loan holder increased their score by over 25 points with Credit Strong. 

Don’t pay extra money in interest if you don’t have to. Credit Strong can help you skyrocket your score by providing expertly developed tools to take your financial journey to the next level. 

The higher you’re able to raise your score, the better repayment terms and interest rate you can take advantage of. 

Unlock your credit potential by finding your perfect Credit Strong plan and start building your score with confidence!

Reduce Your Debt

An effective way to raise your credit score in preparation for applying for a mortgage loan is to reduce your total amount of debt. Here are three major ways to achieve this: 

• Pay off high-interest debt by doing a balance transfer. This can lower your credit utilization ratio and help you pay off debt quicker as most balance transfers offer 0% for a certain period. You may still have to pay a balance transfer fee of about 3%-5% of your balance. 

• Look for options to reduce your monthly bills and redirect the cash flow to pay off debts faster. What reasonable budget cuts can you make to have added money chipping away at your debt?

• Make increased on-time payments every month leading up to your application. Payment history is a huge part of your score and contributing a little extra to your monthly payments as part of your debt reduction plan can pay off in the end. 

• Pick up a part-time job: While you won’t be able to use this additional income to qualify for your home loan, you can use the extra cash to pay down outstanding balances. 

If you have a significant amount of credit card debt, you might consider a balance transfer to help you pay down your debt at a much lower interest rate. 

Well-qualified consumers can even get a 0% interest rate for several months, putting you lightyears ahead with the right repayment plan.

Get a Higher Paying Job

In the planning stages of qualifying for a home, you can find out how much you need to make annually to afford the house you want. If that amount is way over the typical raise you would get at your current job, you may want to find a higher-paying position elsewhere. 

While your employer might not be able to afford the hefty raise to retain you as an employee, other companies know they need to make an enticing offer for you to make the switch. 

Just make sure you’re still able to demonstrate consistent employment and income history so it doesn’t hurt your chances of getting approved.