The real estate market is dismal these days, which means bargains-a-plenty for first-time home buyers. Problem is: the real estate market is suffering because so many homeowners took out loans they can’t repay. In turn, mortgage lenders have tightened their purse strings, making qualifying for a home loan a challenge.
That’s not to say getting a mortgage today is impossible. Could you qualify for a mortgage? Here are the three numbers that hold the answer.
CAN YOU QUALIFY FOR A MORTGAGE?
When you apply for a mortgage, the bank looks in three areas: your credit score, your down payment, and your debt-to-income ratio.
To qualify for a mortgage, you must be strong in at least two out of three.
Credit scores, most commonly your FICO score, range from 300 to 850; the higher the better. It used to be that borrowers with FICO scores of 700 or more would qualify for the best rates and terms.
Today, consider a 700 FICO score the minimum needed to grab a first-time mortgage.
Lenders want to see that you will be able to afford your current monthly debt obligations and your new mortgage and home ownership costs, and still have some cash left over each month. To determine this, they use the debt-to-income ratio, or the percentage of your monthly income that goes to existing debts.
You’ll want your debt-to-income ratio must be under 20% before applying for a mortgage, and less than 10% is best.
For example, if you earn $36,000 a year and you have two credit cards with minimum monthly payments totaling $50, a student loan with a $120 monthly payment, and an auto loan with a $200 monthly payment, your debt-to-income ratio would be 12.3%.
You can also use this principle to determine how much house you can afford to buy. A common rule of thumb is the 28/36 rule. Your monthly housing payments (including your mortgage, insurance, and property taxes) should not exceed 28% of your gross monthly income.
Furthermore, your total debt should not exceed 36% of your gross monthly income. Therefore, if you have a 12.3% debt-to-income ratio, expect a housing payment that is no more than 23.7% of your income. In the example above, that payment would be $711.
A higher down payment doesn’t just reduce the amount of money you need to borrow to afford a particular home, it also reduces the risk your lender must assume, and can actually increase your chances of getting approved.
If your down payment is less than 20%, you will need to pay private mortgage insurance (PMI), which can up your monthly housing costs by a few hundred dollars. Hence, it pays to start saving now!
Ready to go house-hunting? Save time, money, and aggravation by lining up your financing first with a mortgage pre-approval. Get mortgage pre-approval online.