If you buy a house in the United States, you usually must apply for a mortgage. This is one of the most important decisions you’ll ever make with your money. It may sound like just any other type of borrowing to get your home improvements paid for with a credit card, but behind the scenes, there can be many more nagging problems–affecting approval, APR rates, and total potential costs. Knowing what lenders value ahead of time and being organized can speed up the process of obtaining a mortgage. It will also make that process much less painful. It may even save you money, as well.
If you start in California, a broker who helps buying property in California can make the process easier: They will know how to guide buyers through the region’s requirements and common pitfalls. So here I’ll guide you through the necessities every borrower needs to know for a mortgage in the U.S., from credit score expectations and income checks to down payment options and types of loans.
Understanding How Credit Scores Affect Your Mortgage
Your credit score is among the first things that lenders check when you apply for a mortgage in the United States. This three-digit number shows the degree of responsibility that you have had with credit in years past. On a range of 300 to 850, credit scores are divided. Any score over 740 is considered excellent. The higher your credit score, the more likely you are to qualify for a loan with lower rates. For instance, over the lifetime of a 30-year loan, a high score can save borrowers tens of thousands of dollars.
Credit scores are used by lenders to predict the risk of lending to you. If it’s low, lenders could potentially reject your application or lend you money at a higher rate of interest. That’s why many financial advisers suggest pulling yours months before you apply. You are entitled to one free report from each of the three major bureaus — Equifax, Experian, and TransUnion — per year. Reading the reports will help you catch mistakes, pay off debt, and establish a better history of on-time payments.
And it’s also a good idea to know how different types of debt impact your score. Among other factors, credit card balances, student loans, and car payments — even medical bills — can all be part of the equation. Your credit utilization ratio–how much credit you are using compared to how much is available to you–– should generally be under 30%. Moreover, don’t open too many new credit accounts shortly before you apply for a mortgage, as this can lower your score–temporarily–by causing a series of hard inquiries.
In other words, a strong score doesn’t just get your application approved; it dictates the affordability of your mortgage. One of the smartest things you can do before an application is to get ready early by improving your credit health.
Debt: What Lenders Evaluate
Mortgage lenders are looking to ensure that you have a regular and consistent means of repaying the loan. And that’s why your income, employment history, and overall debt load are major factors in whether it is approved. Many banks and mortgage companies look for borrowers to have a minimum of two years of employment within the same field. Payments that arrive always on time create financial stability, reducing the lender’s exposure. If you’re self-employed, expect to provide two years of tax returns to prove your income.
Then there’s your debt-to-income ratio (DTI). This ratio looks at the sum of all your monthly debts versus your gross monthly income. For instance, if you earn $6,000 a month before taxes and already pay $2,000 each month to other lenders as debt payments, your DTI ratio is around 33%. Generally, 36% is the sweet spot, but certain lenders will go up to 43%. In other cases, approval can be received with the DTI up to 50%. A lower DTI tells lenders that you aren’t stretched too thin and can readily handle a mortgage payment. Income is not all created equal:
- Straight up normal salary or hourly wage – you got this.
- Bonuses and commissions – could require further documentation.
- Self-employment or gig income — need tax returns and, in some cases, profit-and-loss statements.
- Other sources of income – including rent income – must be verified to be taken into account.
Lenders aim to minimize risk. Once employed with little debt and some money in the bank, you are positioned for approval and to comfortably bear the costs of homeownership.
Other Upfront Expenses
When people consider buying a home, the down payment is probably the first thing that comes to mind. The traditional standard in the United States is 20 percent of the home’s purchase price. On a $300,000 house, that’s $60,000 in cash. And many borrowers can’t afford that much. But the good news is that while boxes obnoxiously stacked on front stoops throughout the country may seem egregiously expensive, there are several loan programs to help homebuyers put less money down. For instance, FHA loans may only require 3.5% down, and VA and USDA loans can sometimes offer no-money-down options for eligible applicants.
Yet a larger down payment typically is in your favor. It can reduce the size of your loan, your monthly payment, and potentially eliminate private mortgage insurance(PMI). PMI is a cost you pay on your mortgage for a loan that represents more than 80% of the value of the property and, because it comes in different forms, is not always as easy to understand. PMI can run from 0.3% to 1.5% of your loan amount annually. Over time, that adds up.