Home ownership is a core component in establishing and living the American Dream.
For most people, the ambition to acquire their own home is their most important goal, surpassing all others, and it is the primary influence and motivation for how they conduct their business, financial, and personal lives.
Most people will have to finance their home ownership by obtaining a home mortgage from a lending institution especially first-time home buyers.
We're going to guide you through all the steps which must be taken in order to qualify for a home mortgage loan.
QualifyING for A Home Mortgage Loan
Before a prospective homeowner can begin the quest towards purchasing a home, there are many factors to consider, most of which are determined by some basic facts and assumptions.
- How big is your family?
- What neighborhoods are you willing to consider?
- Are schools a factor?
- Is a single-family home a requirement or is a condo an option?
- Based on your income and assets, what kind of home can you afford?
For some home buyers, living in a specific neighborhood takes precedence above all else, whereas, for others, the home itself is more important.
In a perfect world, you’d find the ideal home, in your neighborhood of choice, at a price you can afford; but, realistically, most people will have to make some compromises.
Make a list of the features you want in a home–the number of bedrooms, a fenced yard, granite countertops, a garage, etc.–and then rank them according to priority.
Decide whether the house or the neighborhood matters more to you, or whether you’re willing to make a longer commute to own a home with a larger lot.
These kinds of decisions need to be made before beginning the search for your new home.
Saving for a Down Payment
Nearly all mortgage loans and lenders require some amount of cash as a down payment.
The amount you've set aside for this will determine the kind of mortgage you qualify for. It will also impact how much you can afford to borrow for a home.
Most lenders prefer a down payment of 20% or higher to qualify for a conventional loan, but there are loan options where you can put down less.
However, you should be aware that with a smaller down payment, you’ll likely be required to pay for mortgage insurance, and your loan application will be subject to greater scrutiny.
Types of Mortgages
There are two types of mortgage lenders in the United States:
- private, or
- government
Private lenders offer conventional loans with each financial institution or agent having their own loan eligibility criteria or underwriting guidelines.
A conventional loan can also be a conforming or GSE-backed loan, meaning the loans are made available for purchase by Fannie Mae or Freddie Mac.
Conventional loan requirements typically include:
- income verification, which is usually two years of employment (W-2's)
- a credit score of 640 or higher, though, typically 740 or higher is the desired target
- a minimum down payment of 5%, except with Fannie Mae or Freddie Mac, which requires 20%
Government loans are based on established federal regulations that ensure these types of loans are made available to subprime borrowers who meet the agency’s loan eligibility requirements.
Government loans can offer lower interest rates and other benefits, but you will have to adhere to federal guidelines that can introduce stricter standards on home inspections and appraisals, and increase processing time of the loan.
Here are several government-backed loan types that allow a smaller down payment amount:
FHA Loans
The Federal Housing Administration offers 3.5% down payment mortgages through participating lenders. FHA loans are also easier to qualify for and have slightly lower rates than conventional mortgages.
The FHA loan requirements include:
- a credit score of 500-579 or higher, with lower interest rates offered with credit scores above 580
- a steady income and proof of employment
- a debt-to-income ratio of 43% or less
- mortgage insurance premium, or MIP, and
- the property must be your primary residence only
>>Click here for a list of top rated FHA lenders.
GSE-Backed Loans
Fannie Mae and Freddie Mac are both currently insuring 97% loan-to-value loans.
In other words, this enables lenders to offer 3% down payment mortgages to qualified buyers.
USDA Loans
Home buyers in rural and suburban areas may be able to qualify for home loans offered by the U.S. Department of Agriculture.
USDA loans offer low rates and 100% financing.
The USDA loan requirements include:
- proof of U.S. citizenship or permanent residency
- credit score of 620-640 or higher
- the property location
- income limits based on a 4-person or 5-8 person household
- debt-to-loan ratio of 41%
- a monthly mortgage payment no more than 29% of income, and
- you must work with a USDA-approved lender
VA Loans
Eligible veterans, as well as active duty service members and their families, can qualify for Veterans Administration loans.
A VA mortgage requires no down payment or mortgage insurance.
To be eligible for a VA loan, military members must have served 90 consecutive days of active service during wartime, 181 days of active service during non-wartime, or served more than six years in the National Guard or Reserves.
Additionally, a spouse of a service member who died in the line of duty or as a result of a disability suffered during active service is also eligible.
The VA loan requirements do not set a credit score limit; however, each VA lender may have its own credit score requirements, and the VA does not have a specific debt-to-income ratio.
There is a maximum loan limit of $453,100, and the borrower must pay a VA Funding Fee.
>>Click here for a list of the best VA Loan lenders.
Fintech VS. Traditional Lenders
You may have heard the term before, but Fintech is the combination of financial and technology and represents companies that offer online lending services including a simplified and faster loan approval process and broader underwriting guidelines.
A couple of these, for example, are Rocket Mortgage and LendingTree.
Many FinTech companies are financed by venture capitalists but not all. These companies focus on customer experience and efficiency.
Between 2010 to 2016, FinTech mortgage companies reduced loan processing time by approximately nine days!
Fixed VS. Adjustable
There are two types of mortgage interest rates available on home loans:
- fixed
- adjustable
A fixed rate mortgage maintains the same interest rate for the life of the loan, and, typically is a 30-year loan, but there are 15- or 20-year loans available.
An adjustable rate mortgage, or ARM, is a home loan which has an interest rate that changes based on the adjustable rate and schedule of the loan.
Available ARM rates are 3/1, 5/1 or 7/1, where the interest rate will be fixed for the first period of the ARM. After the initial fixed-rate period, the rate goes up or down based on the current interest rate.
Fixed or adjustable rate mortgages are available through both private and government loans.
Calculating Your Needs
There are all kinds of online calculators that can help you determine what your down payment amount will be based on the type of loan, the price of your house, your location, and credit rating.
>>Here’s one such calculator from SmartAsset<<
Getting Pre-qualified
By this point, you should have a pretty good idea about what kind of home you’re looking for, and the neighborhood you’d like to live in.
You also know how much you've saved for a down payment, which in turn will determine the type of loan you should pursue.
The next step is to get pre-qualified for a mortgage loan.
In order to do this, you will have to select a mortgage lender to work with and obtain your loan.
Essentially, mortgage pre-qualification is a promise from the lender that you’re qualified to borrow up to a certain amount of money at a specific interest rate, subject to a property appraisal and other documentation.
In today’s competitive housing market, it is not uncommon for a seller to receive multiple offers on their home.
Having a pre-qualification letter in hand could be the difference in your ability to purchase the house you desire.
This proves unequivocally to the seller that you are serious and provides you with bargaining power which is likely to give you an advantage over other buyers.
As a potential borrower, you can also take the next step in the loan process by being pre-approved by your lender.
This step is a different process than being pre-qualified although sometimes these terms are used interchangeably.
Becoming pre-qualified is the initial step in the loan application, which can be done over the phone or the internet. The pre-qualified loan amount that you receive is based on your overall financial picture.
Obtaining a pre-approval is a much more complicated process where you as the borrower actually fill out a mortgage application, pay the processing fee, and provide the lender with all the required supporting documentation.
Being both pre-qualified and pre-approved are important steps to take because both show sellers you are a serious buyer, which in turn can be in your favor if there are multiple contracts, including yours, on a property.
Essential Mortgage Documents
Each lender may have a different list of required supporting documentation.
Some of the standard documents required for most mortgage loans are:
- proof of income (W-2's)
- proof of assets to demonstrate that you have enough in savings for the down payment
- closing costs
- a remaining reserve of money
- tax returns
- copy of driver’s license or U.S. passport
- your social security number and signature
- bank statements (3 months)
- investment account statements, including stocks or bonds
Improving Your Chances as a Borrower
Buying a home is a big financial investment for any home buyer.
Here are a few steps you can take to improve your chances of buying that dream home:
- improve your credit score to 640 or higher
- lower your debt to income ratio to 36% or lower
- pay off your recurring credit or loan balances, increase income, or
- make a bigger down payment
COMPARE RATES & GET A PRE-QUALIFICATION LETTER>>
Finalizing a Mortgage Loan
Let’s assume you have found your dream home with a realtor’s assistance, made an offer, and it has been accepted.
Now you must go back to your lender to do what is required to finalize the loan you’ll need to buy the house.
Here are the key areas that a mortgage lender will examine in order to qualify you for a mortgage loan–credit, income, assets, and debt.
Your credit is one of the most important things that will be considered when determining if you qualify for a home loan.
To do this, a lender will look at the length of your credit history, how reliably you’ve paid on your loan accounts, and if you’re maxed out on credit cards or loans.
Another factor is your debt-to-income ratio.
This is simply your fixed expenses, including your new mortgage, as compared to your gross monthly income.
Lenders typically like to see someone who spends less than 50 percent of their gross monthly income on fixed expenses, which include:
- mortgage payments
- property taxes
- association dues
- homeowners insurance
- car loans
- student loans
- credit cards, and
- any other fixed payments that would show up on your credit report
Lenders also verify that the funds you are using for your down payment are in a liquid account, such as a checking or savings account.
They need to know the origins of all the funds that are being used in your transaction.
Finally, lenders will also want to see a stable employment history and will verify your past two years of work.
Qualifying for a mortgage to buy a home can often be a stressful and strenuous process.
In the end, the pride, security, comfort, and freedom that comes from owning your own home makes all the effort worthwhile.