What You Need to Get a Mortgage: Do You Have It All?
What you need to get a mortgage is by no means obvious: Do you just show up at a bank with a checkbook and a smile? Hardly! Mortgages aren't handed out to just anyone, but require a lengthy screening process. Just so you know everything you need to bring to the table, here's a guide on how to please the lending gods so they deem you worthy of receiving a huge pile of cash...and what to do if you haven't covered these bases quite yet so you'll pass muster soon enough. Let's jump in! Here are the essentials:
1. A good credit score
When you apply for a mortgage, lenders will check your credit score to assess whether you’re a low- or high-risk borrower. The higher your score, the better you look on paper, and the better your odds of landing a great loan.
While a perfect score is 850, research suggests that only about 0.5% of consumers hit that coveted mark. As a result, scores of 760 and above are considered to be in the best range from a mortgage lender’s perspective—meaning you’d qualify for the best (meaning lowest) interest rates, says Richard Redmond, mortgage broker at All California Mortgage in Larkspur and author of “Mortgages: The Insider’s Guide.”
A good credit score is 700 to 759; a fair score is 650 to 699. If you have multiple blemishes on your credit history (e.g., late credit card payments, unpaid medical bills), your score could fall below 650. If that’s the case, you’ll likely get turned down for a conventional home loan—and will need to mend your credit in order to get approved (unless you qualify for a Federal Housing Administration loan, which requires a 580 minimum credit score).
Your first step, therefore, should be to check your credit report, says Beverly Harzog, consumer credit expert and author of “The Debt Escape Plan.”
You’re entitled to a free copy of your full report at AnnualCreditReport.com. The report does not include your score—for that, you’ll have to pay a small fee—but just perusing your report will give you a ballpark idea of how you're doing by laying out any problems such as late or missing payments. Some credit card companies (like Discover and Capital One) also offer customers free access to scores and reports. Because a 2013 Federal Trade Commission survey found that one in four Americans said they spotted errors on their reports, you should check to make sure you're actually the person responsible for any black marks that appear on your report.
If you have poor credit, it may take you several months to raise your credit score into a range where you can qualify for a mortgage. (Here's advice on how to improve your how to improve your credit score.)
2. Substantial—and stable—income
How much income you need to get a mortgage boils down to your debt-to-income ratio; this figure compares your earnings to your outstanding debts. To qualify for a home loan, your job’s income must be high enough to offset your debts.
To calculate your DTI ratio, figure out how much you’re paying in debt per month—by tallying up things like car payments, student loans, and credit card bills—and divide that amount by your monthly income.
Let’s say, for example, that every month you’re paying $250 in debts and pulling in $5,000. Divide $250 by $5,000, and you have a DTI ratio of 0.05 or 5%. That’s well below the recommended rule of 36%, says David Feldber, broker/owner of Coastal Real Estate Group in Newport Beach, CA. Keep in mind, though, you don't own a home yet, which will push your DTI through the roof.
Once you know your income and debt, you can use an online home affordability calculator to see how much you can shell out for a new house, while still remaining below that 36% debt-to-income threshold.
Let’s take the aforementioned example where you make $5,000 a month and pay $250 in debts. Now let’s assume you have around $30,000 for a down payment and can get a 30-year mortgage at a fixed interest rate of 5%. Enter these numbers into a home affordability calculator, and this will put you in the ballpark of affording a home worth $243,100.
In addition, lenders like to see at least two years of consistent income history, says Todd Sheinin, mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD. This creates a roadblock for many workers who are just starting their careers or are self-employed. If you're in the latter situation and have variable income, you may need additional assets in order to qualify for a mortgage, such as a higher down payment (more on that next).
3. A sufficient down payment
Most mortgage lenders like to see that you have enough in the bank to make a 20% down payment—which amounts to $50,000 on a $250,000 home. So if you don't have that much saved up, it's time to start pinching some pennies! But there are other options as well.
FHA-backed loans let borrowers make down payments as low as 3.5%. If you’ve served in the military, the Department of Veterans Affairs loans require no down payment at all. Only eligible for a conventional loan? Expect to need at least a 10% down payment, says Sheinin. However, if you put anything less than 20% down on a conventional loan, you'll need to pay pribate mortgage insurance-a monthly premium that can range anywhere from 0.3% to 1.5% of the total loan amount.
By: Daniel Bortz
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