If you’re in the market for a new home, you’ve probably spent some time thinking about mortgages. Whether you’re a first time home buyer or you’ve been around the block a time or two, this part of the process can be intimidating. Changing requirements, loan options, credit scores, assets, pre-approval...have you checked out already?! It’s understandable, which is why we wanted to take some time to break it down so you don't have to (break down, that is).
Let’s begin with the basics. There are 5 major players that lenders consider when deciding if you qualify for a loan:
The lender will look at your income to be sure you can afford the mortgage, bills, etc. Income includes your salary and all other forms of steady money coming in (ie. commissions, side gigs, social security, etc).
Assets, or things you own that have value, are also considered as good back up: stocks & bonds, IRA, 401(k)s, checking & savings accounts, etc.
Your FICO credit score usually reflects how responsible you are when it comes to paying back loans in a timely manner. The required credit score varies with which type of loan you apply for. Most loans require a minimum score of 620, but some government-backed loans (like FHA or VA) require a median score of 580. It’s best to check with your lender for their requirements.
Debt-To-Income Ratio (DTI)
Your DTI reflects what percentage of your monthly income goes toward steady monthly expenses. These are typically “fixed” expenses like rent, credit card payments, or student loans. It does not include expenses that vary greatly month to month. A low ratio reflects a healthy balance; the lower your ratio, the better your chances at qualifying. Generally speaking, most lenders require a DTI of 50% or less for approval, but this also varies depending on the loan type so be sure to check with your lender. You can calculate your DTI using this formula: (Total monthly debt) ÷ (Gross monthly income) x 100 = DTI.
Type of Property
The three main types of properties are primary residence (the home you plan to live in), secondary residence (vacation home, etc) or investment property. The easiest loan to qualify for is for a primary residence. These tend to be less risky for lenders and require a smaller down payment. In fact, some government loans are only available for primary residence purchases. If you’re looking to purchase a secondary or investment property, you can expect qualifications and the required down payment to be higher.
Let’s move on to loan options. There are several choices when it comes to what type of loan you’re applying for, each with their own requirements. Conventional loans are the most common and have average minimum requirements. Jumbo loans are more common in high-cost areas and have more restrictive requirements. Currently, any loan above the mid $500,000s is considered a jumbo loan. Mortgages including FHA, VA, and USDA have lower requirements but are only available for primary residence purchases. Max purchase prices on these loans can change year to year and vary by county.
Now that we have the basics covered, let’s look at two other costs to plan for before applying:
The minimum down payment depends on what type of loan you are applying for. Some mortgages have no minimum requirement while others require a minimum of 3-6%. The more you put down, the better off you’ll be in the long run. In some cases, a higher down-payment can help offset a lower credit score.
If you’re unable to put a lot down, you will need private mortgage insurance (PMI). PMI’s provide an extra layer of protection for the lender in the event you were to default on the loan and are required for those with less than 20% down. The upside is a PMI can get you in the door, and it can be canceled once you acquire 20% equity in your home.
Closing costs are the processing fees paid to the lender including appraisal, escrow and attorney and mortgage broker fees. These typically come out to 3-6% or your total loan value, so be sure to factor in these costs before applying for a loan!
In summary, let’s recap the “to do list” before applying for a mortgage!
- Save! Start setting money aside for your down payment and closing costs.
- Improve your credit score and DTI! When possible, pay down debt, increase your income, and reduce your bills.
- Explore loan options so you know which one is right for you.
- Determine what you can afford. To help you do this, we’ve provided a handy mortgage calculator that can estimate your monthly payment. You can change loan details like purchase price, mortgage term, down payment, annual taxes, interest rate, etc to run your specific scenarios.
Phew! We know this is a lot to take in, but don’t worry--you’re not alone. Our agents are equipped and ready to help guide you or answer any questions you may have! For any and all of your real estate-related inquiries, we are here for you and #ReadyToServe!