Purchasing a Home with a Mortgage – Part 2 of 4

Prepare for Pre-Approval

The lender will take an initial look at your personal financial situation to determine if you are pre-approved for a loan. The core items the lender will collect and evaluate are: income, debt, and credit score. Let’s take a look at each of these in more detail.

Income is based on what you file on your annual tax returns. Lenders are looking for income documentation that shows your financial ability to pay back a mortgage, and will ask for current pay stubs as well as state and federal tax returns for the past two years.

You may also be able to use overtime and commissions as part of your income calculation, but these also need to be documented and have been in place for the past two years. If you have seen a change in pay recently, such as a raise, you will also need a statement from you employer explaining that this change is permanent.

Other sources of income you may be able to use to qualify for a mortgage include:

  • Social Security Income
  • Non-taxable Income
  • Rental or Property Income

These sources of income can only be used if the lender approves them as part of your mortgage qualification calculations.

Debt includes car payments, credit card payments, personal loans – any debt you have where you make a monthly payment. The total of the monthly payments, plus the proposed mortgage payment, will be divided by your average monthly income to identify your Debt-to-Income (DTI) ratio. Lenders rely on the debt-to-income ratio (DTI) calculation to assess your ability to pay for a loan.

Here is an example of a debt to income ratio calculation.

  • Gross monthly income = $4,500
  • Monthly Debt Payments = $1,785
    • $75 Credit Card Payment
    • $285 Car Payment
    • $1,425 Proposed Mortgage including PITI
  • Debt-to-income Ratio = $1,785/$4,500 = 39.6%

Lenders generally look for a DTI of 45% or below; however, Federal Housing Authority (FHA) lending programs can go as high as 56.9% DTI.*

*NOTE: Lending guidelines are constantly changing and these examples used at the time of publication are subject to change.

A Federal Housing Administration (FHA), a part of the Department of Housing and Urban Affairs, provides mortgage insurance on loans made by FHA-approved lenders. An FHA loan is designed for low-to-moderate-income borrowers for single-family homes and multifamily

properties; they require a lower minimum down payment and lower credit scores than many conventional loans.

NOTE: While student loans can demonstrate your ability to pay on debt over time, many lenders do not use them as part of the DTI. You will need to disclose the loan amount and payment to your lender.

Your credit score determines your creditworthiness to the lender. While each credit reporting agency determines credit score a little differently, there are common factors that impact your score with each agency including:

  • outstanding debt
  • timeliness of payments
  • amount of debt
  • age of debt
  • type of debt

To qualify for the best interest rates, lenders typically look for a credit score of 740 or above. FHA programs can approve credit scores as low as 580. The higher your credit score is, the more likely you are to be able to obtain credit and receive the best interest rate on your borrowed money:

  • 300-629 – Bad Credit makes it difficult to qualify to borrow money
  • 630-689 – Fair Credit may qualify for a loan, but you’ll likely pay a higher interest
  • 690-719 – Good Credit qualifies you for most loans, and gives you lower interest rates
  • 720-850 – Excellent Credit gives you access to lowest interest rates offered on loans

 

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