Buying a home is a significant investment and, for most people, the largest made in a lifetime. So, naturally, questions about financing will arise, and one of the most common is – how much can you afford to invest? The answer depends on each individual’s financial situation, which a lender measures during the first step of the lending process – the mortgage (a.k.a., home loan) application.
The lending process can be daunting, so it’s helpful to understand the financial expectations before investing the time. Everything begins with the home loan application when a loan officer will measure your financial fitness based on specific criteria. Although each lending situation is unique, the financial qualifications vary little. So let’s discuss these four factors and why they are critical to approval decisions.
Your debt-to-income ratio (DTI) is essential to determine how much home you can afford or how much they might be willing to lend. Debt-to-income calculations compare the amount of money you earn each month to the amount you spend on recurring debts, such as car payments, student loans, insurance, etc. – including the projected house payment.
Here’s how it looks. Let’s say these fixed recurring expenses add up to $4,000 a month, including the house payment, and you have a $6,000 monthly income. Then your debt-to-income ratio is $4,000/$6,000 or about 66%. Most lenders set the DTI limit somewhere around 43% (although this is variable) for a conventional home loan, so a 66% DTI probably would not be acceptable.
Your credit score affects the mortgage application because it indicates your past payment history and borrowing behavior. A credit score will influence the officer’s decision to approve the loan and help determine the interest rate assigned to the loan. High credit scores are better and may help the loan get approved.
Conventional mortgages typically require a credit score of at least 620; however, you may pay a higher interest rate if your score is well below. In the case of government-supported home loans, like an FHA or VA loan, the credit score requirements are looser. A lending officer can discuss this option with you and help you determine eligibility.
A down payment is always favorable when purchasing a home because it can help build equity. Currently, most lenders offer conventional financing with as little as 3% – 5% down. Not everyone will qualify for these programs, but it’s important to know that they exist and might help you achieve the dream of homeownership.
The more money you have available to put down when buying a house, the better. A larger down payment will lower your monthly payments. A smaller down payment might also increase your interest rate. Also, if you aren’t able to put 20% down on a conventional mortgage, your lender will require Private Mortgage Insurance (PMI), which you can pay monthly or at the time you obtain your loan with a single premium payment.
Proof of employment is a must when applying for a home loan. In most cases, lenders prefer to see a work history with a steady income for at least two years. However, if you don’t have an employer, you’ll need to provide proof of an income from another source, such as disability payments, investment distributions, trust income, etc.
Hopefully, this article lent some insight into the home loan application process and strengthened your mortgage education – especially if you’re grappling with the question of when is the best time to apply for a mortgage? If your financial situation meets the criteria explained here, perhaps now is the time to find out if your financial situation meets the criteria for becoming a homeowner.
As community-focused mortgage lenders, we strive to be trusted mortgage educators for our clients and beyond. As evidenced by our core values of taking care of our clients, team members, and communities, we place our client’s needs first. The lending process is ever-changing and consistent all at the same time, so the Directors Mortgage team will always work to help others learn mortgage processes with confidence to better understand how they affect personal situations.