Once you’re ready to become a homeowner, it’s time to start the process of securing a mortgage. Careful planning is required, so you need to know how mortgage qualification works.
Though getting approved for a mortgage can be complex, there are some basic steps you should follow. They won’t guarantee approval, but you’ll be much more prepared and confident about the homebuying process.
1. Calculate Your Debt-to-Income Ratio
One of the most important factors that mortgage lenders will consider is your debt-to-income ratio. It is generally expressed as a percentage, and represents how much of your income goes toward paying off debt each month.
Here’s an example: Say you earn $6,000 per month before taxes. You have a $500 student loan payment, $300 car payment, and $100 credit card payment due every month. That means you’re on the hook for $900 in monthly debt payments. If you divide $900 by your gross monthly income of $6,000, you get a DTI of 15%.
Specific DTI requirements depend on the loan you’re applying for, though they aren’t set in stone. The underwriting process for conventional loans — as well as loans backed by the Federal Housing Administration, Department of Veterans Affairs, and the U.S. Department of Agriculture — allows for higher DTIs in some cases. In fact, it’s possible for lenders to approve applicants with a DTI of 45% to 50%.
“That’s mainly when there are ‘compensating factors’ on the loan, such as high credit scores, large down payments, and large cash reserves,” says Tony Grech, a senior mortgage loan originator with Luxury Mortgage Corp. in Newport Beach, California.
How to lower your DTI
If you’re concerned that your DTI is too high, how do you qualify for a mortgage? There are a few things you can do to lower your DTI:
- Try to pay down some of your existing debt. This will reduce the amount you owe each month in relation to your earnings, which can give your mortgage application a boost. Of course, it’s easier said than done.
- Increase the amount you’re earning. You could ask for a raise at work or take on a side hustle. How you attempt to increase your income will depend on your job situation, lifestyle, and other considerations.
- Take all of your income into account. Alimony and child support payments can factor into your regular income.
2. Improve Your Credit Score
Creditworthiness is an important factor when applying for a mortgage. It’s often measured by your credit score, a three-digit number that represents how trustworthy you are as a borrower. Though there are many different scoring models, lenders usually look at your FICO score. It’s based on the information contained in your credit reports, such as account balances and payment history.
The higher the score, the better credit you have. If you want to know where you stand, some banks and credit card companies allow customers to get their monthly FICO scores at no additional cost.
It’s also a good idea to request your credit reports from the three major credit bureaus: Equifax, Experian, and TransUnion. You can get free copies of your reports from annualcreditreport.com and review them for any errors that could be dragging down your score.
Credit score requirements can vary
The minimum credit score needed to get a mortgage varies depending on the loan type and lender.
“Lenders look at the middle of your three credit scores and all borrowers on the loan must meet the credit score requirement,” Grech says.
For most conventional loans — i.e., mortgages that aren’t insured by the government — the minimum credit score is 620. A credit score above 740 allows you to qualify for the best interest rates and terms.
For other loans, such as FHA and VA loans, the credit score requirements can be lower or nonexistent, though Grech noted that most banks and lenders impose a minimum requirement. For example, it’s possible to qualify for an FHA loan with a credit score of 500, as long as you meet additional requirements. You can learn more about mortgage requirements using this table.
How to improve your credit score
While meeting the minimum credit score helps you qualify for a loan, your credit can also affect the interest rates you’re offered, how much you’re required to put down, and more.
If you want to improve your credit before applying for a mortgage, there are certain steps you can take:
- Pay your bills on time. Payment history makes up 35% of your FICO score, meaning it’s the most heavily weighted factor. Missing just one payment can knock many points off your score, while paying every bill in full and on time will help you build good credit.
- Pay off overdue debts. If you’ve missed payments in the past, paying off any past-due debts or accounts in collections can help improve your score. However, keep in mind that late payments can stay on your report for up to seven years.
- Reduce your outstanding debt. How much you owe in relation to the total amount of credit available to you is called your credit utilization ratio, and it makes up 30% of your score. It’s best to keep your credit utilization below 30% — the lower, the better.
- Build your credit history. At 15% of your credit score, your credit history is another important factor. If you don’t have much experience using credit — also known as having a thin credit file — you can ask to be added as an authorized user on the credit card account of a trusted family member or friend. This allows you to share that person’s positive credit history.
- Avoid applying for new credit. When you’re in the process of applying for a mortgage, it’s important to avoid making any new changes to your credit profile. That includes applying for other loans or credit cards, which will result in a hard credit inquiry on your report — a potential red flag to lenders.
Note that companies promising to improve your credit score quickly or remove items from your report are almost certainly scams. It can take three to six months of active credit use to establish a score — and it’s something you can do yourself, for free.
3. Save For a Down Payment
When taking out a mortgage, you’ll usually need to pay some money upfront toward the cost of the home. This is known as the down payment.
With most loans, it’s possible to put down as little as 3%. Conventional loans, for example, usually require a 3% down payment at minimum, and FHA loans require at least 3.5% or more, depending on your credit score.
Other types of loans, such as VA and USDA loans, might not require you to put down any money at all if you meet certain criteria. Conversely, higher-risk loans, such as jumbo loans, may require you to put down more than 20% to be approved.
If you can afford to make a larger down payment, doing so means you’ll need to borrow less, and you can avoid the additional expense of private mortgage insurance. For conventional loans, you must pay PMI if you put less than 20% down, and you’ll continue paying it until you reach an 80% loan-to-value ratio — meaning you have 20% equity, or ownership, in your home.
How to save for a down payment
If you don’t have enough saved for a down payment yet, there are different ways you can boost your savings:
- Cut discretionary spending. It could be lucrative to review your budget and look for expenses that can be temporarily cut. This may include dining out, subscriptions, memberships, and other spending on other nonessentials.
- Automate your savings. By setting up a regularly occurring transfer from your paycheck or checking account to your savings, you won’t have to overthink the process of saving money.
- Look for down payment assistance programs. There are many government and nonprofit organizations that provide financial assistance to homebuyers for down payments and closing costs. To find out what programs you qualify for, start by looking up your state in the Department of Housing and Urban Development’s directory.
4. Gather the Necessary Documents
Once your finances are in order, it’s time to get ready for the actual application — and you might be asking yourself, “How much of a home loan do I qualify for?” Your lender will be able to tell you based on the information that you provide. This step involves gathering a large amount of paperwork, and it can feel overwhelming, so it’s a good idea to prepare all the documentation as soon as possible.
Below is a breakdown of the common types of documents that your lender will request. Keep in mind that the mortgage application process varies by lender, so you may be asked to provide additional or different documentation.
Documentation of income
Be prepared to provide one to two months’ worth of paystubs, as well as the past two years of tax returns. You might need to provide other documentation if you receive income from sources other than a traditional job, like if you’re self-employed or earning passive income from investments.
“Regarding income, lenders look to determine if your income is stable, verifiable, and likely to continue,” Grech says.
If your income fluctuates a lot or comes from many unconventional sources, you may need to opt for manual underwriting or a lender that specializes in working with nontraditional borrowers.
“A specialty lender is better equipped to deal with, for example, a self-employed social media influencer whose income varies from month to month or someone whose primary income comes from stock options,” says Tabitha Mazzara, director of operations at MBANC, a mortgage lender based in Manhattan Beach, California. “We do a more in-depth analysis of your investments, bank statements, and whatever it takes to get a thorough understanding of the big picture of your finances.”
Documentation of assets
In addition to sufficient and stable income, lenders also want to know that you have enough money in reserve. You’ll need to provide a list of assets, which are anything of value that can be converted into cash — such as stocks, bonds, vehicles, and so on.
“For assets, we are looking to see that you have enough funds for closing, whether or not there is anything left over in reserve after closing, and that all your funds come from acceptable sources,” Grech says.
Documentation for your assets may include three to six months of bank account statements — including checking, savings, certificate of deposit, and money market accounts — as well as statements for retirement accounts such as a 401(k) or an individual retirement account.
There could be other areas of your financial situation that you’ll need to verify. For example, if you’ve made any large deposits or withdrawals recently, your lender may want to see a paper trail. If the funds for your down payment were a gift from a family member, you may need to provide a gift letter that describes where the money came from.
5. Understand the Minimum Requirements for Your Loan
When shopping around for a mortgage, you’ll find that every lender has its own standards for loan approval. However, there are some basic requirements that apply to different types of mortgages.
Below is a closer look at some of the main loan types and the minimum requirements to qualify:
Mortgage Types and Requirements
|Requirement||Conforming Loan||FHA Loan||VA Loan||USDA Loan||Jumbo Loan|
|Minimum down payment||3%, or 20% to avoid PMI||3.5% with a 580-plus credit score, or 10% with a credit score between 500 and 579||0% for qualifying borrowers||0%||10%, or 20% to avoid PMI (can vary by lender)|
|Minimum credit score||620||500||None (up to lender)||None (640 is recommended)||680 (can vary by lender)|
|Fees||Closing costs (can vary by lender)||Upfront mortgage insurance premium of up to 1.75%, annual premium of up to 1.05%, and closing costs||One-time VA funding fee of 1.65% to 3.6%, plus closing costs||Upfront guarantee fee of up to 3.5%, annual fee of up to 0.5%, and closing costs||Closing costs|
|Maximum DTI||45%||43%||41%, or additional requirements if higher||41%||45% (can vary by lender)|
Keep in mind that there are many factors at play, so you might not qualify for a loan or the best interest rates even if you meet the minimum requirements. Before applying, be sure to talk with the lender about their eligibility requirements.
Additionally, the Fair Housing Act prohibits lenders from discriminating against borrowers based on race or color, religion, national origin, sex, familial status, or disability. If you believe you’ve been a target of discrimination, it’s important to file a complaint with the HUD.
6. Compare Different Mortgage Lenders — and Take Your Pick
When applying for a mortgage, it’s important to shop around for the best offer from a reputable lender. That means getting quotes from different lenders to compare interest rates, terms, and fees.
When choosing a lender, consider the following factors:
- Type of lender: Many different financial institutions provide mortgages. For example, you can choose a major bank, which can be a quick and convenient option. However, if you have a relationship with a community bank or credit union, you may receive personalized service and be more likely to get approved.
- Mortgage rates: The interest rate you pay on your loan will make a big difference in the total cost. Even half of a percentage point can equal thousands of dollars spent or saved over several years. It’s also important to know if the loan is a fixed or adjustable-rate mortgage, which can change the size of your payments in the future.
- Loan requirements: Again, every mortgage lender is different, so you’ll want to consider the requirements set by each lender — including the minimum down payment, the minimum credit score, and other factors that will influence your ability to get the best deal possible.
- The fine print: Watch out for certain conditions that might be attached to the loan, such as prepayment penalties, extra fees, or how long the interest rate will be locked in. Be sure to go through all the details of the contract before agreeing to anything, and ask questions.
- Types of loans offered: Not every lender is approved to provide every type of loan. For example, if you want an FHA loan, you’ll need to work with an FHA-approved lender. If you’re borrowing beyond the conforming loan limits, you’ll need to find a lender that specializes in jumbo loans.
“Generally, I recommend gaining a referral from someone you trust,” Grech says. “You could also check with your bank or credit union if you feel you have a good relationship with that institution.”
Once you’re found the right lender for you, you can go ahead and apply for a mortgage.
The Bottom Line on Qualifying For a Mortgage
Going through the process of buying a home and securing financing might seem intimidating, but as the buyer, you have control over your choices. By arming yourself with knowledge of the process and preparing in advance, you’re laying the groundwork to get a good mortgage for your new home.