Home Qualifying Series Part 2
How to become pre-approved for a mortgage loan?
Now that you have a foundation after reading Part 1 “What are 5 things to do before buying a home?” Let’s talk about the pre-approval process.
Securing a pre-approval letter is your first step towards homeownership.
This involves you to complete a 15–20-minute credit application and uploaded necessary documents to support income and assets: 2 most recent paystubs, 2 most recent years of W2, 1099, or 1040 tax returns, fixed income documents such as social security or pension, 2 most recent bank statement for ALL accounts, recent mortgage statements, and any other pertinent information your mortgage lender asks of you.
What Credit Score do I need to buy a house?
Credit scores play a crucial role in a mortgage approval. While a score of 580 is often the minimum requirement, there are other tiers of credit.
This information is accurate as of January 2024. Please consult with a mortgage lender for updated information.
580 will qualify for FHA and VA Financing (See blog post for more information on FHA/VA)
600 will qualify you USDA Financing (See blog posts for more information on USDA Financing)
650 will qualify you for most down payment assistance programs.
680 although Conventional guidelines say they will go down to 620 most situations will require 680+. Every situation is different when it comes to Fannie Mae and Freddie Mac. (Please see blog posts for more information on Conventional Financing)
Along with your credit score your credit report will show your lender the debts that you have against you: Car payments, student loans, credit cards, installment debts, child support, collections, etc.
We will add up all monthly debts and divide it by the gross monthly income found on your income documents to find your debt-to-income ratio.
What is a debt-to-income ratio?
The debt-to-income ratio is the determining factor for your qualifying budget or buying power in a home. Different loan programs have different debt to income levels.
USDA Financing will max out at 42%,
Conventional financing will typically max out at 45%,
FHA is at 54%
VA Financing is based off a residual income calculation that you typically can qualify for more with.
These percentages are based on your gross monthly income.
For example, if you’re making $75,000 per year in gross income or $6,250/month * 45% = $2,812.50.
We then must subtract your credit debts stated in the above credit section.
For example: $500 car payment, $100 student loan, and $25 credit card =- $650.
This leaves us with $2,162.50 left over for your mortgage payment.
How to know if a house is too expensive?
A common rule of thumb is to not spend more than 30% of your gross monthly income on your monthly mortgage payment. With the current interest rate environment and with rental amounts on the rise some analysts have increased this amount to 40% of your gross monthly income, but it’s always good to be on the conservative side and not to be house broke.
There is a tight rope that you may need to walk comparing your mortgage payment and being realistic in the options you have in the house.
If you need 3 or 4 bedrooms for kids, which is the difference of 40% of your gross monthly income you may need to overreach.
If you feel that it’s still expensive the next plan is to try to reduce debt so you can snowball savings or try to go for that promotion you deserve to increase your income.
It’s never a good idea to bank on a refinance, but it’s pertinent to note that you can save money through a refinance if rates come down while you live in the home.
How much money should you have before buying a home? How much to put down?
The last order of business before our decision on a pre-approval letter are assets. What is our plan for the down payment?
When you’re buying a home there are other costs besides the down payment such as closing costs, inspection costs, earnest money, home warranty, and other costs that we will discuss here.
A common myth in the mortgage industry is that you must put a 20% down payment. You can read my mortgage insurance blog to learn more, but it in a nutshell PMI allows investors to offer options for lower than 20% down. With home prices on the rise in the past decade, it is difficult for most families to come up with such a big chunk of money. Therefore, it is common to see 15% or 10% of the purchase price as a down payment. The minimum with Conventional Financing is 5% down unless you’re a first-time home buyer that meets the area income limits then it is 3%. The FHA minimum is 3.5% and both USDA and VA Financing have options for 0% down.
It's important to research any state, county, city, and even neighborhood assistance and grant programs to help with the upfront cost of the down payment and closing costs.
How much money should we expect for closing costs?
Closing costs consist of Title Fees, the Appraisal, Underwriting costs, and escrow (property taxes and home insurance). On average these fees amount to an additional 3% of the purchase price considering an average $431,000 purchase price in 2023. Closing costs are negotiable with the sellers of the home. Depending on the leverage position of the sellers we can ask the sellers to pay for the buyers closing costs. This will overall weaken your offer with the sellers, which will hinder you from negotiating other items such as a price drop. In most situations the sellers will want to increase the purchase price to incorporate the closing costs into their net proceeds.
Are there are any other costs when buying a home?
There are a few other optional costs to mention and to consider when buying a home. The two most common items are a home inspection and a home warranty.
A home inspection is a preventative measure to know what the home needs before buying it. We will send a certified inspector out to do a full report on all of the repairs the home is in need of.
Home warranties come in all shapes and sizes, but it’s more of an insurance measure in case major appliances break in a certain time frame of owning the home.
Another common misconception is that earnest money is an additional cost when buying a home. Earnest money essentially holds the contract in place and puts a monetary value towards the purchase agreement. Upon closing, this earnest money will be a credit towards your down payment.
It’s important to consider your lifestyle spending habits while buying a home. You’ll still have to pay your current bills, grocery bills, gas bills, etc. on top of paying moving expenses, new utilities, and furnishings for the new home. This isn’t considering a growing family cost either.
It’s always safe to have a 3 – 6-month emergency fund while going through the home buying process.
What is my qualification amount for buying a home?
To wrap this up, your qualification consists of 3 sections: Credit, Income, and down payment.
The more income you have, the more assets you have, and the less debt you have the better your qualification and success for buying a home will be. This is not only in the price of the home, but also the interest rate and programs. If a borrower has a low DTI, has a solid emergency fund, and is overqualified for the home they will have an easier time than a person that is maxing out DTI and the down payment.
Many people will speculate what they will qualify for, but the one true way is to have a mortgage professional review these credentials. Reach out to us today to discuss.
See you at part 3 of this series:
