Qualifying For A Mortgage: The Basics

Are you ready to make the jump from renting a home or an apartment to owning a home? The first step is applying for a mortgage, but how can you tell ahead of time if you'll qualify?

This article will introduce you to some of the factors that lenders look at when they consider mortgage applications and share a few tips to make your application stronger.

Let's begin by looking at the major factors lenders first consider when they decide whether you qualify for a mortgage. Your income, debt, credit score, assets and property type all play major roles in getting approved for a mortgage.

Income

One of the first things that lenders look at when they consider your loan application is your household income. There is no minimum dollar amount that you need to earn to buy a home. However, your lender does need to know that you have enough money coming in to cover your mortgage payment, as well as your other bills.

It's also important to remember that lenders won’t only consider your salary when they calculate your total income. Lenders also consider other reliable and regular income, including:

• Military benefits and allowances
• Any extra income from a side hustle
• Alimony or child support payments
• Commissions
• Overtime
• Income from investment accounts
• Social Security payments

Lenders need to know that your income is consistent. They usually won't consider a stream of income unless it's set to continue for at least 2 more years. For example, if your incoming child support payments are set to run out in 6 months, your lender probably won't consider this as income.

Property Type

The type of property you want to buy will also affect your ability to get a loan. The easiest type of property to buy is a primary residence. When you buy a primary residence, you buy a home that you personally plan to live in for most of the year.

Primary residences are less risky for lenders and allow them to extend loans to more people. For example, what happens if you lose a stream of income or have an unexpected bill? You're more likely to prioritize payments on your home. Certain types of government-backed loans are valid only for primary residence purchases.

Let's say you want to buy a secondary property instead. You'll need to meet higher credit, down payment and debt standards, since these property types are riskier for lender financing. This is true for buying investment properties as well.

Assets

Your lender needs to know that if you run into a financial emergency, you can keep paying your premiums. That's where assets come in. Assets are things that you own that have value. Some types of assets include:

• Checking and savings accounts
• Certificates of deposit (CDs)
• Stocks, bonds and mutual funds
• IRAs, 401(k)s or any other retirement account you have

Your lender may ask for documentation verifying these types of assets, such as bank statements.

Credit Score

Your credit score is a three-digit numerical rating of how reliable you are as a borrower. A high credit score usually means that you pay your bills on time, don't take on too much debt and watch your spending. A low credit score might mean that you frequently fall behind on payments or you have a habit of taking on more monthly debt than you can afford. Home buyers who have high credit scores get access to the largest selection of loan types and the lowest interest rates.

You'll need to have a qualifying FICO^® Score of at least 620 points to qualify for most types of loans. You should consider a Federal Housing Administration (FHA) loan or Department of Veterans Affairs (VA) loan if your score is lower than 620. An FHA loan is a government-backed loan with lower debt, income and credit standards. You only need to have a credit score of 580 in order to qualify for an FHA loan with Rocket Mortgage^®. You may be able to get an FHA loan with a score as low as 500 points if you can bring a down payment of at least 10% to your closing meeting. Rocket Mortgage doesn’t offer FHA loans with a median credit score below 580 at this time.

Qualified active-duty service members, members of the National Guard, reservists and veterans may qualify for a VA Loan. These government-backed loans require a median FICO^® Score of 580 or more.

Debt-To-Income Ratio

Mortgage lenders need to know that homeowners have enough money coming in to cover all of their bills. This can be difficult to figure out by looking at only your income, so most lenders place increased importance on your debt-to-income ratio (DTI). Your DTI ratio is a percentage that tells lenders how much of your gross monthly income goes to required bills every month.

It's easy to calculate your DTI ratio. Begin by adding up all of your fixed payments you make each month. Only include expenses that don't vary. Debt that’s considered when applying for a mortgage can include rent, credit card minimums and student loan payments.

Calculating Your DTI

Do you have recurring debt you make payments toward each month? Only include the minimum you must pay in each installment. For example, if you have $15,000 worth of student loans but you only need to pay $150 a month, only include $150 in your calculation. Don't include things like utilities, entertainment expenses and health insurance premiums.

Then, divide your total monthly expenses by your total pre-tax household income. Include all regular and reliable income in your calculation from all sources. Multiply the number you get by 100 to get your DTI ratio.

The lower your DTI ratio, the more attractive you are as a borrower. As a general rule, you'll need a DTI ratio of 50% or less to qualify for most loans.

Lenders will often use your DTI ratio in conjunction with your housing expense ratio to further determine your mortgage qualification.

The factors lenders look at during the mortgage loan process aren't the only things you need to consider before you submit an application. Make sure you consider your principal, interest, taxes and insurance (PITI) in your calculations. Include private mortgage insurance and closing costs along with your PITI when you calculate how much buying a home will cost you.

PITI

PITI acts as a rough estimate of how much you can afford to purchase a home. Many lenders will use your PITI estimate to determine if you qualify for a mortgage, as it provides an idea of whether you can afford to pay back the loan. You can calculate your PITI yourself if you have an idea of what you’ll owe in each category. That way you’ll know how much house you can afford before you fall in love with one you can’t.

Private Mortgage Insurance

Private mortgage insurance (PMI) is a special type of insurance that protects your lender in the event that you default on your loan. Most mortgage lenders require that you pay it on conventional loans if you have less than a 20% down payment. You have the option to cancel your PMI once you reach 20% equity in your home by paying down your principal each month.

Closing Costs

You also need to factor in closing costs when you apply for a mortgage. These are processing fees you pay to your lender and third parties in exchange for finalizing your loan. The specific closing costs you'll pay depend on where you live and the type of mortgage you're getting. Some common closing costs include appraisal fees, attorney fees and escrow fees. You can expect your closing costs to equal around 3% – 6% of your total loan value. Make sure that you have enough money to cover these costs before you apply for a loan.

There are a few steps that you can take to strengthen your mortgage loan application and improve your chances of getting an approval.

1. Improve Your Credit

Your credit score significantly affects your ability to get a home loan. Take a few steps to repair your credit to help you qualify for more loan types and unlock lower interest rates. Here are three easy ways to get started on the path to better credit.

• Make all your payments on time. The easiest way to raise your credit score is to build a history of on-time payments. Write down when each of your loan and credit card payments is due and make at least the minimum payment every time. If available, you could also enroll in autopay for some of your loans.

• Watch your credit utilization. Do you put too much money on your credit cards each month? If so, lenders might see you as a riskier candidate. Try to use no more than 30% of your total available credit each month to see the biggest increase in your score.

• Pay down your debt. Paying down debt proves you know how to manage your finances and you don't borrow more money than you can afford to pay back. Create a plan to tackle your debt early and watch your score soar.

2. Lower Your DTI Ratio

Lower your DTI ratio to free up more money to save for a down payment – it makes you a more appealing candidate for lenders. There are two main ways that you can lower your DTI ratio:

• Reduce your bills. Channel all of your extra monthly income into debt reduction and downsize to reduce your living expenses.

• Increase your income. Ask for a raise at work, pick up a side hustle or work toward getting more overtime on each of your checks.

Neither of these methods are easy, but both can significantly improve your chances of success with lenders.

3. Save For A Bigger Down Payment

A larger down payment reduces the amount your lender needs to loan you. This makes your loan less risky for the lender because they lose less money if you default. Saving for a larger down payment can help you become a more appealing candidate for a loan and can even convince a lender to cut you some slack in other application areas. Use these tips to increase your down payment fund:

• Budget for savings. Take a look at your monthly budget and decide how much you can afford to save each month. Hold your down payment fund in a separate savings account and resist the temptation to spend any of it.

• Pick up a side hustle. In the on-demand "gig" economy, it's never been easier to earn extra cash outside of your job. Drive for a ridesharing service, deliver food for local businesses or pick up a few spare tasks on a site like TaskRabbit.

• Sell some of your things. Sites like eBay, Mercari, and Poshmark make it simple to sell old things you no longer use. Search around your home for things you think you can sell and list them.

4. Explore Government-Backed Loans

Government-backed loans are a special class of financing options that have insurance from the federal government. This means that the regulating body covers the bill on behalf of your lender if you default on your loan. Government-backed loans are less risky for lenders and have lower standards for applicants. However, government loans each have their own specific criteria you need to meet before you qualify.

There are three major types of government loans:

• VA loans: VA loans are backed by the Department of Veterans Affairs. Generally, you can buy a home with no down payment with a VA loan.

• FHA loans: FHA loans are insured by the Federal Housing Administration (FHA). FHA loans have looser credit score and income requirements and can allow you to get a mortgage with as little as 3.5% down.

• USDA loans: USDA loans are insured by the United States Department of Agriculture. These loans can allow you to buy a home in a qualified rural or suburban area with no money down. Rocket Mortgage doesn't currently offer USDA loans.

5. Consider Having A Co-Signer

A co-signer is someone who agrees to take financial responsibility for a mortgage should the original applicant fail to make their payments. Having someone co-sign on your mortgage application could strengthen it in the eyes of a lender, as it can assure them that they’ll be repaid even if the borrower defaults.

You can and should calculate your mortgage payment for your prospective home loan yourself, or at least a rough estimate of it, to avoid any surprises down the line. Calculating this estimate can help you figure out what you can afford monthly or if you need to improve your financial situation before applying for a mortgage.

For your convenience, use our mortgage calculator to get an idea of what you can afford.

If you feel you’re ready for a mortgage, the next step is to apply with a lender. This part of the process is often called preapproval. Applying will tell you how much money you can get in a home loan and can help you begin shopping for your perfect property. Create a plan of action and put it into place today if you think you need more time to improve your finances before you apply.

Qualifying for a mortgage involves a lot of pieces coming together. Lenders will be reviewing your income, assets, credit score, debt-to-income ratio and many other qualifying factors. Once you have your finances in order and the necessary documents ready, though, you’ll be one step closer to becoming a homeowner.

Ready to start the process? Start an application today with Rocket Mortgage for approval.