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How to Qualify for a Mortgage

Wondering how to qualify for a mortgage?

There are 4 standard components of qualifying for most mortgages:

  • Credit history
  • Capacity to pay back the loan
  • Capital 
  • Collateral (the property which will secure the loan)
 

Each mortgage program has its own requirements for each component, and may be more lenient on some while being stringent on others.

We’ll look at each of these pieces more in depth below.
 
 

 

Credit History

A flawless credit history can certainly help ensure that you’ll be approved for a mortgage, but a few credit missteps won’t necessarily stop you from getting a loan.

Most loan programs have a minimum credit score.  For conventional loans, it’s 620.  FHA and VA loans are much more lenient if you can compensate in different areas.

Interest rates, and therefore your monthly payment, will also depend on your credit score.  The lower your monthly payment, the better your chances of qualifying for the amount you’re seeking.

Late payments and recent activity on collections and charged-off accounts will hurt your credit score the most, and should be avoided within the 2 years prior to application if at all possible.  The more recent the delinquency, the more it will hurt your chances of approval.  

Disputed derogatory accounts (accounts with late payments or in collections) are also problematic.  Credit bureaus don’t always include disputed accounts when calculating your credit score, so they typically need to be taken out of dispute before your application can proceed.  This takes time and should be handled well before you start shopping for a home.

Co-signed loans are just as much your responsibility as the person who you helped.  These loans are considered your debt, so any late payments on these will negatively affect your score.  Consider this before putting your credit and your signature on someone’s car or home loan application.

Credit Karma and other free credit scores do not use the same scoring system as mortgage lenders.  While they can give your a general idea of credit history, scores are not reliable to determine whether you’ll qualify for a mortgage.  
 

 

Capacity

Capacity refers to your ability to repay the loan.  Typically this component will depend on how much stable monthly income you receive.  In some cases, having enough liquid assets can also increase your capacity to repay a loan.

Length of employment history, length of time in a particular industry or line of work, and the amount and type of your monthly income are all important in determining your capacity for repayment.

If you receive bonus, overtime, or commission income, lenders will look at the trend of this income to make sure it’s either stable or increasing from year to year.

Capital

Capital is the amount of liquid funds you have available for a down payment, closing costs, and reserves.  Reserves are savings remaining after paying for your down payment and closing costs.

Each loan type has a minimum required down payment.  Conventional loans require at least 3% to 5% of your purchase price or appraised value, whichever is lower, while FHA loans start at 3.5% down.    

Refinances also need to meet minimum equity requirements.  Occupancy and the type of loan will determine how much equity you’ll need.  Equity is the current market value of the home, less any liens against the property.  A $500,000 home with a $400,000 mortgage has $100,000 in equity.

Some purchase loans do not require a minimum out of pocket funds.  These include down payment assistance loans, VA loans, and USDA loans.  Closing costs can be paid by the seller in many cases.  We can advise if you need to structure your purchase this way, because you will need to negotiate for the seller to help pay closing costs in your contract.  Closing costs are typically given as a percentage of the purchase price or a flat dollar amount.

 

 
 

 

Collateral

Collateral refers to the home or property that will secure the loan.  The property itself is important to the lender because of the large amount of money being lent.  In cases of default where a borrower stops making loan payments, the lender may need to foreclose, or take back, the property to repay the loan.  They need to know that the value of the property will be high enough to pay off the loan.

Not only is the property value important, but the condition of the property also needs to be acceptable.  Homes with health and safety hazards, or homes with significant deferred maintenance or non-functioning heating or mechanical systems will be more expensive to fix and more challenging to sell in the event of a foreclosure.  Lenders will not lend on properties unless the current condition meets their standards.

Condos have an added layer of underwriting: the homeowner’s association (HOA).  The HOA needs to meet requirements including budgeting enough for maintenance, having sufficient insurance in place, and the majority of owners within the association need to be current on their HOA dues, among other things.  If the finances of the HOA are not managed properly, or there are ongoing lawsuits against the HOA or the builder, a condo may be ineligible for financing.