Many aspiring homeowners are making the leap from renting to owning a new home. One of the biggest first steps every homebuyer needs to make is applying and qualifying for a new mortgage.
According to the National Association of Realtors, 87% of recent buyers financed their home purchase1. But one of the largest pitfalls borrowers face when applying for a new home loan is not knowing if they will qualify ahead of time.
Getting approved for a new mortgage can be simple, but it’s important to understand a few underlying factors that play a role in the qualification process.
Here are a few of the basic concepts that will help to ensure a quick and easy approval when the time comes for you to submit your mortgage application:
INCOME | ASSETS | Collateral | Credit
It seems obvious but one of the biggest considerations for qualifying for a new mortgage loan is verifying you earn enough money to cover the monthly payment. Everyone works in a variety of fields and occupations, so income can look different from borrower to borrower.
Your lender is concerned with your gross income (before taxes) that can be verified against documentation including paystubs, W-2 statements, and even your federally filed tax returns.
If you earn other income from sources outside your primary employer, those could potentially be used for qualification as well. Some other sources include spousal or child support payments, military allowances, or even retirement income (i.e., social security, pensions, etc.).
The main thing to keep in mind is that any income used to qualify you for your mortgage needs to be documented and consistent. It should also be expected to continue for the foreseeable future. Most lenders look for 2-3 years expected continuance.
Understand that the amount of income you claim and that can be verified by your lender will have a tangible impact on the size of the mortgage you can take out and, subsequently, the price of homes you can afford.
Equally important to income when qualifying for a new mortgage loan is demonstrating to your lender that you have sufficient funds to cover your down payment (if a purchase) and closing costs.
In some cases, you may also need to provide documentation showing you have assets to cover any required reserves or payoff other outstanding liens, judgements, or debt at closing. Most lenders differentiate funds used for a mortgage transaction between liquid and non-liquid assets.
Traditionally, liquid assets are those considered to be cash or cash equivalents (meaning the asset can easily converted into cash). Non-liquid assets are other assets (often long-term tangible assets or real property) that cannot be converted into cash quickly.
An example of liquid assets includes funds in deposit accounts (i.e., checking, savings, money market, certificates of deposit, etc.), mutual funds, retirement savings, and even net equity proceeds from real property being sold on or before closing.
Conversely, non-liquid assets might be jewelry, vehicles, or other personal property. While you can use the proceeds from the sale of non-liquid assets to qualify for a new mortgage, typically they need to have already been sold with specific documentation to support the sale.
The type of property you own or are looking to purchase also plays a factor when opening a new mortgage. Residential real estate is typically limited to 1–4-unit properties, such as traditional single-family homes, condominiums, and even townhomes.
How you indicate the subject property will be occupied will also be a major determining factor in how your mortgage will be priced and underwritten.
For example, if you are looking to purchase or refinance a property you claim as your primary residence, there are less hoops to jump through than if you were buying a new vacation rental property.
Overall, primary residences are considered less risky for lenders because you’re more likely to pay and prioritize your home payment and expenses. Typically, you can also borrow more money against your primary residence than second homes or investment properties.
Rental properties and second homes may require you to meet higher eligibility and credit requirements. This may include providing evidence of additional funds you have on reserve to cover the mortgage payment should an unforeseen event occur.
Your credit profile will have a tangible effect on your ability to qualify for a new mortgage and what credit terms your lender can offer you. Lenders look at a variety of factors when analyzing your credit from your payment history to the credit mix your carry.
An important credit factor to be especially mindful of is your FICO credit score. Your credit score is used by lenders as an indicator of your ability and willingness to pay your bills and monthly obligations.
Lenders like to see higher credit scores because that means you can qualify for better credit costs and terms. While most conventional mortgages require you have a 620 FICO score or better, don’t get discouraged if your credit score is less than pristine.
Some mortgage financing solutions have lower credit requirements which are offset by other eligibility criteria. In some cases, you may need to provide a larger down payment or meet certain special income requirements.
Lastly, while demonstrating your ability to sufficiently manage credit is essential, it’s also equally important not to have excessive outstanding obligations.
Generally speaking, to qualify for a new mortgage your total monthly credit obligations should not exceed 50% of your total qualifying gross income, better known as your debt-to-income ratio.
1 National Association of Realtors Research Group. (2021, March 16). 2021 Home Buyers and Sellers Generational Trends Report (Rep.). Retrieved June 14, 2021, from National Association of Realtors Research Group website: https://www.nar.realtor/sites/default/files/documents/2021-home-buyers-and-sellers-generational-trends-03-16-2021.pdf