TV commercials and Internet ads make applying for a mortgage loan look quick and easy. While it makes for good advertising copy, it doesn’t necessarily square with reality. Unless you know the mechanics of how to qualify for a mortgage, you can easily join the millions of homeowners who have their own mortgage “war” stories.
Familiarize yourself with the requirements presented below, and be proactive throughout the application process, and you should enjoy a stress-free mortgage experience.
What You Need to Qualify for a Mortgage
There are six basic criteria involved in qualifying for a mortgage:
Mortgage lenders look for borrowers to provide a minimum of two years of continuous employment. Those who have left the military or graduated from college within the last two years, will generally be given favorable consideration as long as they are currently employed in an occupation related to either their college course of study or relevant military experience.
Short periods of unemployment will normally be accepted, as long as the borrower has been successfully reemployed within the same line of work for a reasonable amount of time.
Self-employed borrowers will need to prove consistent income for at least the previous two years. In some cases, less than two years will be accepted if the new business is in the same field as the previous occupation. However, that will still require at least one year of self-employment.
Income can be included from any member of the household who will live in the subject property and meets the required employment criteria. You can also use income from alimony, child support, pensions, and Social Security to qualify.
Debt-To-Income Ratio (DTI)
Debt-to-income-ratio is a calculation in which the borrowers’ total fixed monthly obligations – including proposed housing expense – is divided by their stable gross monthly income.
For example, if a borrower earns $5,000 per month, has a proposed house payment of $1,300, and $500 and other obligations, DTI be calculated as follows:
($1,300 + $500) = $1,800 divided by $5,000 = 36%
Lenders will typically calculate two versions of DTI. The first is the total DTI, which is presented above.
The second is the housing DTI. The proposed monthly income will be divided by the stable monthly income. The calculation will be as follows:
$1,300 divided by $5,000 = 26%
Though the lender will calculate the housing DTI, it’s the total DTI that’s given the greatest weight.
Other obligations included in the calculation are payments on student loans, car loans, credit cards, child support or alimony. It does not include variable expenses, like groceries, utilities, non-housing related insurance and other recurring expenses.
As is the case with most loans, lenders will obtain your credit score to make the loan decision. But unlike many other loan types, mortgage lenders will obtain your credit score from all three major credit bureaus, Experian, Equifax and TransUnion.
The credit score that will be used for the purposes of the loan will be the middle of the three provided by the bureaus. For example, if your Experian credit score is 692, Equifax comes in at 727, and TransUnion is 712, your credit score will be considered 712 as the middle of the three.
Credit score minimums are based on the type of loan you apply for. We’ll cover those minimums under each of the loan types in the next section.
In addition to credit scores, lenders also consider any major derogatory information that appears on your credit report. These include recent bankruptcy, foreclosure, collections, charge-offs, and late payments, especially those on a current or previous mortgage.
You won’t automatically be declined for major derogatory information. But it will depend on how recent the event was, and your ability to prove it was caused by circumstances beyond your control.
For example, a 5% down payment lowers the lender's exposure to 95% of the property value. A down payment of 20% lowers it to 80%. For that reason, a larger down payment makes approval more likely, as well as a lower mortgage rate.
Because of the risk associated with making low down payment mortgages, loan programs require mortgage insurance. This is frequently referred to as private mortgage insurance (PMI), but the actual description will vary by loan type.
Mortgage insurance is not to be confused with homeowner’s insurance. While a homeowner’s insurance policy provides reimbursement for damage to the home itself, mortgage insurance
provides coverage to the lender for part of the loan amount should the borrower default.
Like all insurance policies, mortgage insurance requires payment of premiums. Those premiums will be paid by the borrower. They can take the form of either upfront mortgage insurance – paid at closing – or monthly mortgage insurance.
Some loan types charge only upfront mortgage insurance, some charge only monthly, and some charge both. On conventional and Jumbo mortgages, mortgage insurance will only be required if the loan exceeds 80% of the property value. On other loan types, it’s required regardless of the amount of the down payment or equity.
When you apply for a mortgage you’ll complete a standard mortgage application, as well as a large number of other forms. You’ll need to support information you’ve provided in the application, especially financial information.
Common documentation requirements include:
- Your most recent pay stub.
- W2s for the most recent two years.
- Income tax returns for the past two years if you’re self-employed, or earn at least 25% of your income from bonuses and/or commissions.
- Evidence of receipt of Social Security, pension, disability, alimony or child support payments.
- Copies of bank statements for the last two months (though this information is increasingly being obtained online).
- A fully executed copy of the contract on the property being purchased.
- Other documentation may be required by the lender, such as credit explanations, divorce decrees, or evidence of gifts from family members.
Minimum Mortgage Requirements – by Loan Type
In this section, we’re going to cover what you need to qualify for each of the five most common types of mortgages. Though qualifications are roughly similar for each type, there are some significant differences you’ll need to be aware of in applying for each.
Documentation requirements won’t be covered in this section because they’re standard for the industry. Nor will income since there is no minimum income requirement on all but USDA loans.
Conventional loans are issued by banks, credit unions, and mortgage companies, and funded by either Fannie Mae or Freddie Mac. They’re considered to be “conventional” because mortgage insurance is provided by private insurance carriers, rather than by government agencies.
Maximum loan amounts for a single-family home in 2022 range from $647,200 to as much as $970,800 in areas designated as high cost. Higher loan limits are available on two-to-four unit homes. Conventional loans are available for primary residences, second homes, and investment properties.
- Debt-To-Income Ratio (DTI): Total DTI should be lower than 45%, but lenders will go to at least 50% if you have a particularly strong borrower profile (like excellent credit and a large down payment).
- Credit Score: 620 minimum, but higher scores result in lower mortgage rates.
- Down Payment: 5%, but 3% on certain loans for first-time homebuyers and low-income households.
- Mortgage Insurance: Required with a down payment or home equity of less than 20% of the property value. Mortgage insurance premiums are paid on a monthly basis; upfront premiums are not required. Monthly premiums are determined by a matrix of factors and cannot be generalized.
Jumbo loans are loan amounts that exceed conventional (conforming) loan limits. Some can go as high as several million dollars. Jumbo loans generally work within the same guidelines as conventional loans. However, since they’re funded by banks and other loan sources, guidelines will be specific to each lender and not standard across the loan type.
- Debt-To-Income Ratio (DTI): Maximum total debt ratio of between 40% and 50%, depending on the loan program and lender.
- Credit Score: At least 680, but some programs may require 700 or even higher. There may also be a requirement of no major derogatory events, like bankruptcy, foreclosure, or late mortgage payments.
- Down Payment: At least 20%, but some lenders may go lower on certain loan types, loan amounts, and borrower profiles.
- Mortgage Insurance: Similar to conventional loans.
VA loans are regulated and insured by the Veterans Administration and designed exclusively for active duty members of the US military, eligible veterans, and their families. VA loans are available for owner-occupied primary residences only (no second homes or investment properties).
100% loans are available for up to the conforming loan limit. But VA also insures jumbo loans. A jumbo loan requires a down payment equal to 25% of the amount by which the loan exceeds the conforming amount. For example, if the loan exceeds the conforming limit by $200,000, the borrower will need to make a down payment of $50,000 ($200,000 X 25%).
- Debt-To-Income Ratio (DTI): The stated limit is 41%, but lenders will go higher with a strong borrower profile.
- Credit Score: No credit score requirement, but borrowers are expected to demonstrate responsible credit management.
- Down Payment: VA loans are available for 100% of the purchase price or property value of the home. But making a down payment can reduce the amount of mortgage insurance paid for the loan. Down payments are required on jumbo loans, as discussed above.
- Mortgage Insurance: VA loans require mortgage insurance on all loans. It’s charged through the VA funding fee, which is paid upfront (VA does not impose monthly premiums).
The current VA funding fee schedule is as follows:
|If your down payment is...
|Your VA funding fee is...
Less than 5%
5% or more
10% or more
After first use
Less than 5%
5% or more
10% or more
FHA loans are similar to conventional loans, but offer relaxed credit guidelines. And much like VA loans, they can be available with no down payment when used in conjunction with down payment assistance programs. They are available only for owner-occupied primary residences, not second homes or investment properties. No jumbo option is available with FHA loans. The Federal Housing Administration provides mortgage insurance coverage on the loans.
- Debt-To-Income Ratio (DTI): 43%, but lenders will go as high as 50% with a strong borrower profile (good credit, cash reserves after closing, or a declining house payment).
- Credit Score: 620 with the standard down payment of 3.5%; as low as 500 with a 10% down payment.
- Down Payment: 3.5% minimum, which can be covered by eligible down payment assistance programs.
- Mortgage Insurance: Upfront premium equal to 1.75% of the loan amount. On most loans the monthly premium is equal to 0.85% of the loan amount. Example: $200,000 loan amount will have an upfront premium of $3,500 ($200,000 X 1.75%). The monthly premium will be $141.67 ($200,000 X 0.085% divided by 12).
USDA loans are available for borrowers who don’t qualify for other loan types, due primarily to limited income. They’re sponsored by the US Department of Agriculture, but don’t be fooled by the name. Properties located in the vast majority of counties across the country, including metropolitan areas, are eligible for these loans.
They’re also an excellent choice for low-income borrowers who want to purchase properties requiring extensive renovation. In fact, there are maximum income limits, based on your family size and County of residence. Properties may not exceed 2,000 square feet, and must be primary residences.
Loans are also unique because they have an extended repayment term of 33 to 38 years. Rates are set at 2.50% for 2022, but maybe as low as 1% for very low income borrowers. Loans are fixed rate only.
- Debt-To-Income Ratio (DTI): 41%, can be exceeded with a strong borrower profile.
- Credit Score: From USDA: “The program has no credit score requirements, but applicants are expected to demonstrate a willingness and ability to handle and manage debt”.
- Down Payment: None but may be required if you have more than $15,000 in non-retirement savings. New construction may require 10% down.
- Mortgage Insurance: 1% loan guarantee fee paid upfront, plus annual fee of 0.35% of the loan amount paid over 12 months.
How to Better Qualify for a Home Loan
No matter what type of home loan you’re applying for, advanced preparation will not only improve your chance of being approved, but may also result in a lower rate.
Before making an application for a mortgage, take the following steps:
- Improve your credit score - Get a copy of your credit report and see if there are any entries that are incorrect. If so, dispute them, have them removed, and your score should improve.
- Have your down payment ready before making application - Lenders look to verify recently acquired funds. By having your down payment ready before applying, you’ll reduce the paperwork needed during the application process. It may also help to increase your savings to be ready to make a larger down payment.
- Pay off as much debt as you can - This will not only result in a lower debt-to-income ratio, but it will also make affording your new home easier within your budget.
- Have your loan documentation ready - We’ve listed the typical mortgage document requirements above. Follow that list and have your documents ready at application. This will provide the lender with more accurate information, make it easier to issue a preapproval letter quickly, and minimize documentation requests after application.
If you’ve taken care of each of the above in advance, the loan application process should be easier, and produce better results.