Qualifying for a mortgage is not a mysterious nor a random process. Lenders actually look at a number of factors when determining if you qualify for a home loan and how large of a loan you qualify for. Good credit is extremely important when trying to qualify for a mortgage, but so is your income and other assets you may have. You will need employment verification as well as proof of your income and assets – much like getting a loan for a car. When applying for a home mortgage, it is important to know that the bank will look at your overall financial picture in deciding whether or not to offer you a loan. All banks have different underwriting guidelines, but we will go over the main points that your lender will be looking at.
Here, we go through each aspect of your financial profile that is considered when applying for a mortgage. Whether for a new purchase or a re-finance of your existing mortgage, these “financial health” items are critical in determining whether you are worthy of a home loan or not.
How Important Is Good Credit For A Mortgage?
Good credit goes a long way when applying for a mortgage. If you have excellent credit it may allow you to qualify for a larger loan, or, lower the requirements for a down payment. Mortgages are a risk for the lender and they want to ensure that they minimize their risks by checking on your credit history. It takes a long time to correct credit mistakes, so if you plan on applying for a mortgage make sure that you credit is in good order. Always pay your bills on time and avoid having large amounts of debt when you apply.
What exactly is “good” credit you may ask? Well, the table below shows the range of acceptable and non-acceptable credit scores. Where do you fit?
Credit Score Ratings
| Credit Grade: | Credit Score: |
|---|---|
| Excellent | 780 to 850 |
| Good | 660 to 779 |
| Fair | 600 to 659 |
| Poor | 500 to 599 |
| Bad | Below 500 |
Keep in mind that there really is no “good” or “bad” credit. Those are labels that we use. Every lender who handles mortgage loans has their own guidelines and no two lenders are the same. Your lender will have mortgage loan underwriting guidelines that they will follow and your credit score will be part of that decision matrix. Also, credit is only one part of your loan application so if you find you are a little lacking in this area, perhaps your income or assets can make up for it.
Given how important your credit score is to a mortgage, you should definitely pull your credit from each of the three major credit bureaus (Experian, TransUnion & Equifax). Once yearly you can request a free credit report, or you can use a paid service like MyFICO to both produce a FICO score from the major bureaus, and monitor your credit. You can read our review of MyFICO here.
Your Income Is A Factor On Any Mortgage Application
In the past, there was such a thing as “no verification” and “no documentation” loans. While these types of home loans are still available, the more common way to qualify for a mortgage is to provide proof of your income. You are extremely unlikely to qualify for a mortgage if you do not have a reliable source of income, even if you have a great credit score. Lenders want to be able to count on you to make your payment, not only based on your credit, but based upon your employment status. Lenders will want to see your W-2s, pay stubs, and oftentimes a few years of tax returns. You can count on the lender to verify your employment via a phone call or other means. Income will be verified via a two-step process:
Employment Verification
The mortgage lender is going to look at your employment history, as well as your current employer. They need to verify you have a stable income source and do not shift from job to job. An acceptable stable employment history is about 2 years on the job. Again, your employer WILL be contacted in order to verify that you are truly an employee as you claim to be.
Income Verification
Once they have verified your current employer and employment background, they will check on your actual income. Your employment income must be verifiable. If you are self-employed, there are more records you would have to give the lender to prove your income. Your income must be enough to cover not only the mortgage loan but also your current monthly debts.
Your lender could look at variable income, if you can prove it is reliable. Variable income would be from working overtime, commissions, and bonuses. It’s important to bring your W2’s, prior 3 years tax returns, and past 3 months’ worth of paycheck stubs. Other income factors a lender would look into are rental income, court verifiable child or alimony support, income from a trust, a second job, and retirement income.
What Is Your Debt-To-Income Ratio?
Your lender will review your housing expense ratio and total expense ratio. Most lenders do not want you to have a debt-to-income ratio higher than 36 percent. Further, most lenders recommend that you limit yourself to spending only 28% of your monthly income on a mortgage. Some lenders will ask for documentation regarding your long-term debts such as student loans. If you are in a forgiveness program or in a forbearance program, it is possible they could exclude that from your debt ratio.
- To calculate your housing expense ratio, you need to add your monthly mortgage payments, the mortgage insurance, hazard insurance, and property taxes. Divide that by your monthly income.
- To calculate your total expense ratio, add all your monthly debts into your mortgage calculations and divide that by your monthly income.
The key here is that the lower your debt to income ratio is the better. Your lender will definitely look favorably on you if your ratios are low as this is how they determine that you are not biting off too large of a mortgage.
What Are Your Assets?
Relevant assets are typically cash reserves as well as saved money in the bank. Assets could also include other real estate (as long as it has equity), stocks, bonds, and other non-liquid assets. This is used to determine if you can make an initial down payment, and also provide the lending bank with an idea of how much money you have available should you hit hard times. Depending upon the loan program your down payment can be as low as 3.% of the total home cost or as much as 20%. Documentation proving your assets are items like bank statements or other proof of owning the asset. If a friend or family member will be assisting you in the down payment you will need a letter stating that the money they give you is not a loan.
Are Your Seen as a Risk?
Finally, the lender is going to evaluate how high of a risk factor you are. They will look at your credit report, employment, and income to determine your overall financial health. The lender will check your bank statements to verify if you have had accounts closed or over the limit withdraws. The bottom line is that they will want to determine if you are risky person to lend a substantial amount of money to.
Summary
Obtaining a home loan, whether it be for a new purchase or a refinance of your existing loan, is a lengthy and thorough process. Patience is definitely a virtue as you will likely be asked to provide substantial documentation, as well as endure endless forms and questioning. However, in the end obtaining a home loan starts a new chapter in your life. An exciting chapter as a homeowner!
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