There are 4 standard components of qualifying for most mortgages:
Each mortgage program has its own requirements for each component, and may be more lenient on some while being stringent on others.
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.
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 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 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.