The Modern Mortgage: How to Qualify for a Loan
Qualifying for a home mortgage has become quite difficult, whether you are buying your first house or tenth. After weathering the storm of foreclosures and bad loans, banks have been forced to be strict about to who and how they will lend. Following the steps below will help ease the headache of getting financing in spite of uncertain economic times.
1. Pay Off Long Term Debts
Instead of saving up for your down payment right away, if you have credit card debt, school loans, car loans, etc. you should use any extra income to pay them off. Paying off debt will allow you greater financial freedom with an ability to save and spend more on a monthly basis, as well debt limits the amount you can borrow. You should keep your credit to debt ratio at 30% or lower to maintain a good credit score.
2. Save Money For a Down Payment.
A large part of getting financing is having a big enough down payment. Generally you need to make a down payment of between three and twenty percent of the purchase price of the home you are buying. The bank should only loan you out what you can afford and when you have a sizable down payment it can cut back on your monthly mortgage payment. Getting on a budget will help you save money most efficiently, the budget should include everything from groceries and rent to entertainment and clothing costs. Moving savings to a separate bank account or savings account, will encourage you to save more and prevent spending on miscellaneous item.
3. Document Your Income.
Lenders will look at your housing ratio, which compares housing expenses to before-tax income in order to qualify for a home loan. They typically look for a ratio of 28% or lower, meaning that your home’s mortgage, taxes and insurance should not exceed 28% of your gross income. A good rule of thumb for this is to know that you will need to be earning between 2 and 3 times more money than what your mortgage payment will be. Documenting all of your income streams with W2’s, 1099’s, pay stubs and other tax forms can help to prove to lenders what you can afford.
4. Keep a Steady Job.
Working the same job for two or more years looks great to lenders because they see that you have a reliable source of income. If you’ve been between jobs, changed fields or frequently changing jobs, lenders may be concerned that you’ll become unemployed, and unable to continue to make mortgage payments. If you’ve been in between jobs, you may need to take on a permanent source of income for a while before you try to take out a loan.
5. Fix Your Credit Score.
The higher your credit score, the less risky you will look to the lender, and the more likely you will qualify for the loan. Banks will only lend to those they believe will be able to pay them back, and typically look for a score of ~660+ or higher. In addition to general approval your credit score also affects the interest rate that you receive on your loan, you can save thousands with a few percentage points. For a full list of how to improve your credit score read our credit score improvement checklist.
6. Get Creative!
If you know you can’t qualify for a traditional home loan or at a particular price point, there are still other ways you can purchase a home. Using alternative purchase techniques like owner financing, rent to own, short sales, and bank owned homes can be a great way to own a house that fits your family and financial situation.