Buying a home is one of the most significant investments most people make in their lifetime, and, for a great part of Americans, taking out a mortgage makes this achievement possible: According to recent data from the United States Census Bureau, approximately 61.5% of the homeowners had a mortgage on their property.
As you can see, securing a mortgage is a crucial part of the process for most homeowners, making it accessible for common people to own a place of their own. If this is your case and you’re interested in applying for a mortgage, it’s essential for you to understand how it works.
Understanding how to qualify for a mortgage in the US can make the journey smoother and more successful. That is why we have assembled this comprehensive guide that will walk you through the key steps, requirements, and tips to help you qualify for one and achieve your dream of homeownership. So let’s take a look.
Step 1: Understand the Basics of Mortgages
We’re sure you have heard the word mortgage before -probably many times in your life-, but let’s break down the concept to specify the different types there are. A mortgage is a loan specifically designed for purchasing real estate. The lender provides funds to the borrower to buy a home, and the borrower repays the loan over time, typically with interest.
It’s seen as a secured loan, meaning the lender can foreclose on the property if the person defaults the debt. Like we were saying, there are different mortgage types and they vary on the requirements, benefits, and drawbacks they can have. These are some common options:
- Conventional Loans: Ideal for borrowers with good credit and a larger down payment.
- FHA Loans: Designed for first-time buyers or those with lower credit scores.
- VA Loans: Available to eligible veterans and active-duty military members with no down payment.
- USDA Loans: For low-to-moderate-income buyers in rural areas.
Among the different types, you can also find fixed-rate, adjustable-rate, which we will explain later in this article. Understanding the differences will help you choose the best option for your particular needs.
Step 2: Review Your Credit Score
Your credit score plays a key role in qualifying for a mortgage. Lenders use this score to assess your creditworthiness and determine the interest rate you’ll be offered. The best offers go to borrowers with high scores, since they can demonstrate they can possibly manage their debt. If your credit score is low, you’ll likely pay a higher interest rate. The minimum scores for qualifying for a conventional loan require a credit score of 620 or higher, while FHA loans may accept scores as low as 500 (with a larger down payment). On the other hand, achieving a score of 760 or above typically qualifies you for the best interest rates and loan conditions.
How can I strengthen my credit score?
If your credit score is lower than required, you can still try to improve it before applying for a mortgage. Focus on paying off debts, correcting errors on your credit report, and avoiding new credit inquiries. We recommend you to read some additional tips for strengthening your cs if that is your case.
Step 3: Calculate Your Debt-to-Income Ratio (DTI)
Lenders assess your debt-to-income ratio to determine your ability to manage monthly mortgage payments. This ratio compares your monthly debt obligations to your gross monthly income.
- Ideal DTI: Most lenders prefer a DTI of no more than 43% or lower, though some may allow higher ratios with compensating factors.
- Improving Your DTI: Reduce your outstanding debts or increase your income to improve your ratio and strengthen your mortgage application.
Step 4: Save for a Down Payment
The down payment is the upfront cash you pay toward the purchase of your home. Lenders require this initial payment upfront to minimize the risk of lending money, since it shows the buyers’ capacity for investing in a desired property and their commitment to this purchase.
The down payment requirements for conventional loans are typically 5-20%, while FHA loans may need as little as 3.5%. VA and USDA loans often don’t require a down payment.
We recommend opening a dedicated savings account for this purpose and cut unnecessary expenses to grow your down payment fund. Here you can find some additional advice for this saving fund.
Step 5: Gather Financial Documentation
Lenders require detailed documentation to verify your financial stability and ability to repay the loan. Be prepared to provide:
- Recent pay stubs or proof of income.
- W-2 forms and tax returns for the past two years.
- Bank statements for all accounts.
- Documentation of assets like retirement accounts or investments.
- Information about outstanding debts.
Step 6: Choose a Mortgage Lender
When choosing a lender, your primary goal should be securing the best rates and terms, but it’s equally important to consider aspects like fees and the lender’s reputation. These are some things you might want to consider for comparing lenders and making this relevant decision:
Fees: Loan closing costs vary widely between lenders, typically ranging from 2% to 5% of the loan amount, which can add up to thousands of dollars. If you have strong credit, you may be able to negotiate certain fees, such as the origination fee, to lower your overall expenses.
Annual Percentage Rate (APR): The APR represents the total borrowing cost and it includes both interest and fees. Comparing APRs from multiple lenders can help you strike the ideal balance between rates, terms, and overall costs.
Reputation: Research the reliability of potential lenders by reading reviews, checking ratings, and seeking recommendations from friends or family. A trustworthy lender is essential for providing accurate pre-approval details and ensuring a smooth process, especially since you may work with them for many years.
Finally, after you have considered all these aspects, you can ask your lenders prospects questions to compare what conditions they can offer you and which ones suit you the best. Consider asking questions like:
- What are your mortgage qualifications?
- Is the origination fee negotiable?
- How much will I need for a down payment?
Also, you might want to consider the closing costs and ask your possible lender about them. Closing costs are fees associated with finalizing the mortgage, typically ranging from 2-5% of the home’s purchase price. These costs include appraisal fees, title insurance, and lender fees. Ask your financial entity if these closing costs can be negotiated so you can reduce your expenses.
Step 7: Understand Mortgage Insurance
Mortgage insurance protects the lender in case you default on the loan. It’s typically required for down payments under 20%.
- Private Mortgage Insurance (PMI): Applies to conventional loans.
- FHA Mortgage Insurance Premium (MIP): Required for FHA loans.
- Eliminating PMI: You can request to remove PMI once you reach 20% equity in your home.
Step 8: Get Pre-Approved for a Mortgage
A mortgage pre-approval is a letter from a lender indicating how much you can borrow based on your financial information. This shows your sellers that you’re a serious buyer and helps you understand your price range.
For getting pre-approved, submit your financial documents to the lender you have selected, so they will evaluate your creditworthiness and issue a pre-approval letter. Keep in mind that a pre-approval for a mortgage is not a final approval, so once you come to an agreement with your seller, you’ll have to formally check for the final approval with your lender, supporting all remaining documents needed for underwriting your loan.
During this process, we recommend you to be ready for the home appraisal too. Lenders require a home appraisal to ensure the property’s value matches the loan amount. If the appraisal comes in lower than the purchase price, you may need to renegotiate or increase your down payment.
Step 9: Avoid Major Financial Changes
During the application process, avoid making significant financial changes, such as taking on new debt; changing jobs or becoming self-employed. Making large, untraceable deposits into your bank account is also a bad idea. The banks and financial entities value if you offer a built sense of stability, so these changes might seem like unpredictable behaviour, which is related to risk.
Step 10: Finalize Your Application
Once you’ve found your dream home, submit your mortgage application with the necessary documentation. The lender will perform a thorough underwriting process to evaluate your eligibility.
The closing process can take several weeks as the lender reviews your application, conducts a title search, and ensures all requirements are met. During this time, stay in communication with your lender and follow the process. Sooner or later, you’ll get your answer.
When considering all these aspects, there’s no doubt that qualifying for a mortgage in the US requires careful planning, financial discipline, and a full understanding of the process. But, after all, you might experience the reward that, if everything turns out right, you’ll be able to celebrate your achievement and enjoy the rewards of owning a place of your own.
References:
https://www.fha.com/fha_requirements_mortgage_insurance
https://www.consumerfinance.gov/ask-cfpb/what-is-private-mortgage-insurance-en-122/
