Whether you’re just plain fed up with renting or you’re looking for a place to put down roots, buying a home is one of the most complex (and expensive) transactions that you’ll ever make in your life. Buying a home can also be an intimidating process if it’s your first time and difficult to know where to begin when preparing your finances.
Before you even get started looking at homes and going to open houses with your realtor, it’s crucial that you understand what you need to do in order to qualify for a mortgage. If you’re not qualified or if you need to work on a certain aspect of your finances, then it might be a good idea to revisit homeownership at a later period when you’ve paid down some debt or are able to make a bigger down payment.
Let’s take a look at everything you need to know about qualifying for a mortgage and how you can improve those factors to get within the range of qualifying.
What Credit Score Do I Need to Qualify for a Mortgage?
You may know that a good credit score is a generally good thing to have, but you may not know that a credit score is one of the key factors on whether or not a lender will accept you or reject you when you’re applying for a mortgage.
What exactly is a “good” credit score? And what score do you need to have to qualify for a loan?
A “good” credit score on the FICO scale is anywhere above 700 (the highest it can be is 850). When you’re between 580 and 700 your credit score is considered “fair,” and when you’re 300-579, your credit score is considered “very poor.”
So what are lenders looking for on a scale of 300-850? Typically, when you’re applying for a conventional loan, your lender is going to want to see a credit score of at least 620 to qualify. However, there are exceptions to this rule of 620.
If you are a veteran who has met a length of service requirement, are a surviving spouse of a deceased veteran, or are a reservist or National Guard member, you can qualify for a VA loan, which does not have a minimum credit score required. Instead, the VA requires that lenders look at a veteran’s entire lending profile to be considered for a loan.
But what if you’re not a veteran and aren’t quite at 620? You’re not out of luck, either. If you have a FICO score of 580 or higher, you can qualify for an FHA (Federal Housing Administration) loan. If you have a score between 500 and 580, you can still qualify for an FHA loan, but you’ll be required to have a 10% down payment on the home instead of just 3.5%.
Bottom line? Your credit score needs to be in good shape before you start shopping for a home or a lender.
What DTI Do I Need to Qualify for A Mortgage?
DTI, or debt to income ratio, is also another important piece of the qualifying puzzle. Your DTI ratio is a comparison of your debt and how much you earn so that lenders can see what kind of risk they’re taking on when they lend you money for a home.
There are two different kinds of DTI:
Front-end DTI ratio: This number shows what percentage of your income would be going toward paying for your prospective house, including your monthly mortgage payment taxes, insurance, and any HOA fees that would be associated with your home.
Back-end DTI ratio: The back-end ratio is all about what kind of debt you bring to the table before you buy the house, including credit cards, student loan debts, personal debts, etc. Lenders want to know exactly how much money it takes to cover all of these monthly debts.
When you’re applying for a mortgage your lender is going to focus heavily on your back-end ratio, which most conventional lenders prefer to be lower than 36%. It is still possible to get financed if your debts are more than 36%, but the highest ratio that they will likely accept is 43%. So for example, if you had gross income of $5,000 per month, your debts ideally wouldn’t exceed $2,150.
As far as front-end ratios go, conventional lenders prefer that your housing expenses not be higher than 28%. This means that if you make $5,000 per month, your housing costs wouldn’t exceed $1,400.
If you are seeking out an FHA loan, however, your front-end ratio shouldn’t exceed 31% and your back-end ratio shouldn’t exceed 41%.
What Kind of Down Payment Do I Need?
You may have heard from financial blogs (and your parents) that the preferred down payment percentage is 20% of the total cost of the home. While it would be great if everyone could put down 20%, it’s just not possible for many who are buying a home—especially for first-time home buyers.
What kind of down payment is required then?
If you’re a veteran who is applying for a VA loan, you may qualify for a zero down payment scenario.
However, if you haven’t served in the military, there are still low-cost options for you. Many first-time home buyers seek out FHA loans specifically because they only require a 3.5% down payment (or a 10% down payment if you have a credit score lower than 580).
There are also conventional home loans that have low down payment options, such as Fannie Mae’s 97% Loan to Value options or Freddie Mac’s Home Possible Mortgages, which only require a 3% down payment for qualified buyers.
Keep in mind, however, that if you put down less than 20% on your home, you will be required to pay private mortgage insurance until you have a loan-to-value ratio of 80%.
What Do I Do if I Don’t Meet Those Numbers?
If you’re looking at your credit score, DTI numbers, and amount of money set aside in your bank account for a down payment and the numbers simply aren’t where they should be—don’t panic. You may just need to take a step back, regroup, and figure out how you can improve all of your numbers.
Let’s take a look at some tips and tricks to get you there.
Improving Your Credit Score
There are all sorts of blogs out there that can give you specific advice on how to improve your credit score, but here are the simplest ways to raise it:
- Pay your bills on time. This is the simplest and one of the most effective ways to ensure that your credit score is raised. Be a responsible borrower and make sure that you’re paying everything on time each month. Set a reminder on your phone, write it down on a calendar, and do everything else you can to remember to pay your bills.
- Limit your applications. Sure, that 10% off at TJ Maxx when you get a store card sounds great, but applying for new credit cards constantly is going to give you a ding on your credit score. Lay off applying if you’ve already accumulated quite a bit of credit.
- Watch your balances. You may have a credit limit of $10,000 but that doesn’t mean you should actually be using that much. Try not to use more than 30% of your available credit, especially when applying for a mortgage.
- Eliminate credit card balances. Remember that credit card you opened your freshman year of college that has $300 on it? And what about that department store card that still has a balance of $100? Pay all those small balances that you have off, and you should see a rise in your score.
- If you have no credit history, get some. You may not be a huge fan of credit cards or debt, but your lender is going to need to see that you can be a responsible borrower before they lend you any money. You simply have got to start your credit history if you don’t have any.
Improving Your Debt to Income Ratio
Improving your DTI is simple: You either need to earn more money, or you need to tackle some of your debt.
Here are a few ways to accomplish that:
- Don’t take on any more debt. We mean it. Just don’t take on any more if you can help it.
- Refinance your debt. If you’re struggling with high interest rates, read up on how to do a balance transfer so that you can potentially combine your debt and get a lower APR.
- Once you pay off one card, start paying off another. It may be nice to have that extra money after you pay off a credit card, but pretend like it’s not even there and use it to pay off more debt when you can.
- Increase your income. Apply for a promotion, search for a new job that has a higher salary, or take on a side hustle that will generate some extra income.
Increasing Your Down Payment
Of course, the most obvious thing to do here is save, save, save. Don’t spend money going out to lunch, cook dinner at home, cancel any memberships you’re not using. Sacrifice that vacation you were going to do this year. Whatever you can do to save some money, do it. (And join the Down Payment Movement for motivation!)
In addition to saving, you could also check into grants and city programs that might be available in your area. Finally, don’t forget that the Unison HomeBuyer program can actually match your down payment funds to give you a larger down payment.
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