Whether you’re a first time home buyer needing your first mortgage or if you’re an experienced home buyer ready for your next home, knowing how the mortgage process works and how to qualify for a new mortgage is an important first step in the process of buying a home.
You’re obviously not expected to know the various acronyms and details involved in how to qualify for a mortgage, but having some general understanding of the process and expectations will put you in the best financial position for buying a new home. It’ll also simplify the process for you.
Credit scores required for a mortgage
Your credit score is really the starting point that most mortgage lenders look at in determining your mortgage qualification. While credit scores are certainly not an indicator of wealth, they do provide a baseline for lenders to determine your creditworthiness. It’s also the tool that determines all of the other ratios we’ll look at below and the interest rates which you will qualify under.
The higher your credit score, the lower the costs of getting a mortgage and the lower the interest rates will be. For the most part a minimum credit score of 640 is needed, however there are several programs available for home borrowers with credit scores as low as 580.
Income requirements for a mortgage
Your income shows the ability to repay the mortgage. Income combined with credit score make up a large portion of what a mortgage lender look at when qualifying you for a mortgage. Mortgage lenders are looking at your Gross Monthly Income. They prove this income through your W-2’s from your employer, your paycheck stubs from your employer, and your 1040 tax return from the IRS. They’ll also consider other regular income that isn’t salary based like dividends from stocks or company ownership, child support, or other income that is consistent.
Your income is the starting point in mortgage calculations for how much mortgage you can qualify for.
Qualifying limits for a mortgage
Obviously credit scores and income are important pieces in qualifying for a new mortgage. But they are only the starting pieces of the puzzle mortgage lenders look at when issuing a mortgage.
One of the most important pieces is actually your Debt-to-Income ratio (DTI).
This ratio is calculated by adding up all of your current debts like car payments, student loan payments, minimum monthly credit car payments, and other debt payment plus adding in the future estimated mortgage payment. Then you divide that monthly amount by your provable gross monthly income. This will give you a percentage of debt-to-income.
Depending on your credit score, there are different limits for this DTI ratio. The higher your credit score, then the higher your DTI ratio can be and still qualify for a mortgage. But it is fairly typical for the limit to be around 42% maximum as a good rule of thumb. There are circumstances and loan programs that will allow for this ratio to be as high as 50%.
This is process is how mortgage lenders determine how much house you qualify to purchase as a maximum. They start with your provable income, verify the maximum DTI you are allowed to have based on your credit score, and calculate the maximum amount of monthly payments you can have. Then they subtract out your existing debts, which leave them with the maximum monthly mortgage payment.
House Qualifying Limits
Loan-to-Value (LTV) is another important piece of the puzzle that determines several aspects of your qualifying limits. The LTV is the percentage of mortgage you’re borrowing against the value of the property. Your downpayment helps to determine the Loan-to-value.
An FHA mortgage will allow you to have a minimum down payment of 3.5% of the purchase price. While there are conventional programs that have various down payment options starting as low as 0%, the most common minimum down payment percentage allowed on a conventional loan is 5% down.
The LTV is a risk measure for the mortgage lender. The smaller the down payment you have, then the higher the LTV ratio is which means the higher the risk the mortgage lender is taking by issuing you a mortgage. Therefore they price their loan accordingly to the risk they’re taking.
A 20% down loan will have fewer closing costs, lower interest rates, and no Private Mortgage Insurance, whereas a 3.5% down payment will have higher overall costs associated with the mortgage.
These mortgage costs all factor into the estimated monthly mortgage payment, which ultimately carry into your DTI ratio for qualifying. Remember, your DTI ratio has to be under the maximum allowed limit as determined by your credit score and loan program.
How to Estimate a Mortgage Payment
There are 4 pieces to a monthly mortgage payment: Principal, Interest, Taxes, and Insurance. There’s a 5th piece called Private Mortgage Insurance (PMI) if your LTV is higher than 80%.
You can calculate the Principal & Interest (P&I) portion of your payment using any payment calculator. A 30 year loan (360 months) or 15 year loan (180 months) with the total amount of money you plan on borrowing for the mortgage with an average market mortgage rate. This will give you your fixed monthly payment.
Taxes are fairly simple to calculate, although they can be different for each house on the market. The easiest way is to look up the local tax rates and multiply that percentage by the sales price. Divide by 12 and that’ll give you your monthly tax bill. The more specific way is to go to your county website and find the actual tax bill for each property you want to buy and divide the amount by 12.
Homeowners insurance varies by geographic location, company, type of house, age of roof, square footage of house, and price point. It’s difficult to estimate this annual premium without knowing a specific house and receiving a quote. However mortgage lenders in your market can make an educated guess based on their knowledge of recent loans and housing types in the area. You can always ask your mortgage lender or a Realtor in your area how much you should estimate for homeowners insurance. A good rule of thumb is $200/month, knowing that it could be more or less depending on the house and time.
You take these 4 elements, P&I, taxes, and insurance and add them together for your estimated mortgage payment. If you have less than 20% down payment, then you’ll need to also add in an estimated PMI payment (Private Mortgage Insurance). There are calculators online for this and the actual amount will vary depending on LTV, credit score, and overall amount financed. A general guideline would be $130/month knowing that it could be more or less.
How to qualify for a mortgage
These are all of the primary elements that go into mortgage qualifications. A mortgage lender takes your credit score and provable income to start the process and figure out what loan program may work best for you.
They look at your down payment percentage on a specific house to determine the LTV. Based on your credit score and loan-to-value ratio they then are able to calculate mortgage pricing for origination and interest rate costs as well as PMI.
They use all of that information to determine the estimated monthly mortgage payment including taxes, insurance, and PMI.
They then add that new estimated monthly mortgage payment to your existing debts. If the total of those debts divided by your gross monthly income is under the DTI ratio requirement, then you likely qualify for the mortgage.
What options are available if you don’t qualify for the mortgage?
After all of those elements are reviewed, if you come back not qualifying then the mortgage lender reviews each of those individual elements to see where adjustments could be made.
Maybe, your credit score is 714 which gives you a 45% DTI maximum but at a 720 credit score your qualifying DTI maximum would increase to 48% under some circumstances. If you have revolving debt like credit cards that have a high utilization rate, then paying down those credit cards would increase your credit score enough to get into the better pricing bracket.
Maybe you have enough cash available for down payment to get to 20% down instead, which eliminates PMI from your calculations and would get you under the maximum DTI limits.
Maybe there’s other income you forgot to include in your application that would increase your Gross Monthly Income enough to get under the maximum DTI limits.
Maybe you have a retirement account or savings reserves that give you 6+months of reserves the lender can use to increase your qualifying ratios.
There are dozens of different things mortgage lenders can do to adjust and help you in mortgage qualifying.
Should you get a new mortgage?
Just because you may technically qualify for a mortgage doesn’t mean you should rush out to buy a home. There are guidelines out there that would allow you to buy a house where the monthly mortgage payment is 50% of your gross monthly income. There’s not a financial advisor in the world that would say that is a wise decision, even though you could technically qualify for that loan.
Your first step is to make sure your financial house is in order, that you have your consumer debts eliminated or super limited, and that you have enough cash in the bank for a down payment. Then determine how much you personally feel comfortable budgeting each month for your housing costs (20%-33% is a realistic and understandable amount for most families in the US.)
From there, you should meet with a professional Realtor to help you start narrowing in on all of the details in purchasing a home and helping you navigate the process. Your professional agent will have several mortgage lenders that will help you qualify for a mortgage and get the process started. If you’re in the DFW area, our team would love to help you get qualified for a mortgage and buy your new home. Learn more about our team and how we help home buyers here!
We made a catastrophic mistake in the name of “protecting property values.” We did it too well! Over the last 50+ years or so we’ve slowly and unintentionally made it illegal to live somewhere other than in large single family homes or in luxury apartments.
During that time period we have created entire zoning ordinances that require minimum square footage homes on minimum sized lots with minimum setbacks from neighbors and streets. We’ve prohibited generational living such as building a mother-in-law suite and guest homes are prohibited from having someone occupy them full time. We’ve let HOA’s and municipalities put ordinances in place that restrict our ability to let our aging parents live in a small apartment in our backyard. How crazy!!?!?!
We did all of this just so we could “protect our investment” into our single family neighborhoods by keeping out any other development (and people) that doesn’t look exactly like our own. God forbid someone might allow a newlywed couple to live in an over the garage carriage house while they save for a down payment! The world may literally end if our single family home sits adjacent to a really beautiful duplex where a family owns one unit and rents out the other unit to help offset the cost of their mortgage! I think the sky may actually fall if a quadplex even shares the same air as a Country Club neighborhood.
We have protected property values so well that we now have increasingly expensive single family neighborhoods all over the country. We’ve refused to build anything near those single family homes that doesn’t meet some subjective standard of quality that changes over time. And they’re now getting to the point where homes are flat out of reach for a new generation of homebuyers.
If real estate is one of the best ways to build generational wealth, to break generational poverty, and provide financial stability for families… which I believe it does… then EVERYONE DESERVES THAT OPPORTUNITY!
Accessory Dwelling Units help to solve this home affordability crisis by providing new options for renters and property owners.
An ADU is simply a secondary dwelling unit that is built on a single family lot and occupied/rented by someone else. They’re sometimes called carriage homes, garage apartments, granny flats, mother in law suites, backyard cottages. Sometimes they’re attached to the single family house or even a finished out basement. Other times they’re a detached structure on the side or in the backyard. 150 years ago it was uncommon that anyone but the extremely wealthy could afford a single family home without putting the land to use. It was a sign of extreme wealth to have a front lawn that’s only purpose was to grow grass that had to be mowed every week. The average family had to utilize as much of their land as they could to help financially pay for their home.
ADU’s help average property owners build wealth, but they also provide an affordable home option for a variety of people that live in a community. Maybe your aging parents need a little assistance from time to time and want to maintain their independence without owning their own single family home. Perhaps your college graduate just moved back home while they’re starting out in their first career and can’t quite afford the rent at one of the luxury apartments in town, but wants to be out living on their own. The recent high school graduate that’s working full time in the restaurant around the corner while they figure out what’s next in life likely can’t afford the rent at an apartment complex with tons of amenities, but they also need to be out living on their own instead of with family for whatever reason.
Building Accessory Dwelling Units on your single family property creates unique housing options within your community to address home affordability options while also creating wealth building opportunities for you. It’s literally a win-win scenario.
Yet for the vast majority of single family property owners that live in the United States, they are illegal to build. The zoning in your community most likely doesn’t allow for them. And if the zoning does allow for them and you live in an HOA, then your HOA likely prohibits them.
We could almost overnight change this home affordability conversation. We could create opportunities for you and your neighbors to build a she-shed in the backyard and rent it out for a few hundred dollars each month to someone needing a different housing option. It’d generate income for you as well as help you grow your equity in your property. It’d give someone else in a different life stage than you a housing option other than splitting luxury apartment rent with 3 other people. It’d let new homeowners find ways to generate extra income to help offset the rising mortgage costs.
We can solve this problem. It just takes your local governing body to quit making it illegal for you to build a small apartment for your kids grandmother to live in your backyard.
In a sellers market it can certainly be tempting for you to sell your home For Sale By Owner and save the money on the Realtor commission. But in almost every case I’ve come across it will cost you more money, a lot more time, and cause a significant amount more stress in your life versus hiring a professional.
Okay. So I’m a licensed, practicing Realtor. I sell a bunch of houses in Texas and refer real estate agents around the country. I’m supposed to say this, right?
For a minute though, set that fact aside and lets just look at some logical reasons why selling your house For Sale By Owner is a bad idea.
1. Time: There’s a lot more to selling a home than just putting a sign in the yard, taking pretty pictures, holding an open house, and waiting for a buyer. When you show your home, someone has to let the buyer in, allow them to walk through the house, spend time with them, and answer any questions about the home or neighborhood. There are all of the calls that come in off of the sign in your yard. There are all of the other real estate agents calling you to ask you about your house. If you show your home to 15 buyers at 30 minutes each you’ve personally invested 8 hours of your life into just showing your home.
And all of this is before you even get an offer. Then there’s the time to negotiate, time to go through inspections, time to coordinate closing with lenders and title companies.
2. Preparing Your Home: No offense here, but you aren’t necessarily unbiased about your home. When you hire a Realtor to come in they will point out the dirt on your baseboards that you’ve stopped noticing or the kids finger prints and scuffs on your kitchen cabinets. I don’t care how great of a decorator you think you are, your home is not ready to sell.
Home buyers that view your home will also walk through a similar home in a similar price point as yours that a professional pointed out all of the little details that need fixed before listing the home. That seller took care of those things. When you sell your home For Sale By Owner you miss those details and they hurt you by either not generating an offer or an offer comes in below list price because the house wasn’t perfect.
3. Risk: If you sell your home For Sale By Owner you are taking on all of the risk that your transaction was done legally and that you’ve disclosed everything you needed to disclose about your home to the buyer. Did you forget about that plumbing leak from 5 years ago that you thought dried out but in fact caused mold to grow between the drywall of your home? Well, when your buyer rips open that wall for their renovation project they will find that and sue you for non-disclosure and you will be responsible. By hiring a professional they will make sure you’ve disclosed all of the important facts about the home and make sure the transaction is handled correctly.
4. Negotiating: Who do you think is better at negotiating a real estate contract? You after you’ve read several articles on the internet and received a little bit of advice from your friends who sold their home For Sale By Owner? Or a professional that has negotiated 70 or 80 real estate contracts recently? When you sell your home For Sale By Owner you will likely be negotiating with a buyers real estate agent that negotiates contracts for a living. They are better than you at this.
There’s a lot more to a real estate contract than the sales price. There are exclusions, financing options, earnest money deposits, seller closing costs, timelines for surveys and HOA addendums, buyers objection timelines, notices required to be delivered to the buyer, inspection periods, closing dates, home warranty’s, possession dates, settlement expenses, mediation, option periods, and more.
Once you execute on a contract as the seller, you no longer have control of how your home will be sold. The buyer and that contract dictate everything about the sale from that point forward. If you’re not familiar with real estate contracts and don’t put everything in writing prior to signing, your entire deal can fall apart and often does just before you were supposed to close on the sale.
5. Price: This is usually one of the major reasons homeowners choose to sell their home For Sale By Owner in the first place. They think that they’ll be able to save on the real estate agent commission and pocket that money. In reality they almost always sell their home for a lower price and still pay a realtor.
Over 90% of home buyers have hired a Realtor to represent them in a home sale transaction. So with that, most Realtor’s will only show their buyer a home that is listed in the MLS or that has agreed to pay them a buyers agent commission. This amount is typically 1/2 of the total commission that a listing agent charges to the seller.
For example, if a seller hires me to sell their home for them at a 7% commission then I will earn that full 7% commission if I bring a buyer to the seller. However if another agent brings that buyer, then I earn that 7% commission but agree to pay the buyers agent 3.5% (or 1/2) of my total commission.
So if 90% of homebuyers have already hired an agent to represent them, those agents will only show their buyer a home in which they will receive a commission. So if you’re selling For Sale By Owner and 90% of buyers have a Realtor, you must pay a decent Realtor commission in order to get those agents to show your home. For this example, let’s assume 3% commission.
Now as far as listing agents are concerned, a really good one will typically have a sales price vs. list price ratio of 100% or higher. This means that they will typically sell a home near the list price or higher and that they fight in negotiations to get that price.
If you list your house For Sale By Owner for $200,000 and a professional buyers agent brings a buyer to you, they will negotiate with you and you will likely settle on a price around $190,000 to $195,000. Remember, these are professionals that negotiate for a living. You still have to pay them 3%. Did you really save any money or make any more money by doing this on your own? Nope. And you get to add all of the stress that goes into the process to not even make any more money.
This example doesn’t even account for the situation where a professional has better access to comps than you do and can possibly price your home higher than you expected. It doesn’t take into account the situation where an appraisal comes in below your contracted price and you need access to comps to fight for a higher appraisal. It doesn’t factor in that a professional knows how to negotiate contracts up over the list price.
Even if you are able to sell your home for the exact same price that a professional would be able to sell it for, which is highly unlikely, it doesn’t factor in all of the other costs working with a Realtor are able to save you, like marketing costs, time, and negotiating a beneficial contract for you.
6. Marketing and Tools: In order to sell a house it has to be in the MLS. It just does. That’s what puts your house on Realtor.com, on Zillow, and all of the other buyers and agents radars as the home is for sale. There are some agencies and companies that will list your home in the MLS for a flat fee. Sometimes this is $200. Other times it’s $500. But it is a cost you’d have to pay up front whether your home sells or not in addition to the Realtor commission you’ll be paying a buyers agent.
Also, Realtors in most areas have access to a showing or scheduling service. This is a central company that organizes all of the showing requests to come view your home. That way you don’t have to answer your phone every time it rings from an agent that wants to show your house tomorrow at 9am. They call the showing service, the showing service texts you to ask if that’s okay, and arranges the showing with the other agent.
You’ll also need to put really great photos of the house in your MLS listing. Your iPhone camera just doesn’t cut it. Realtors hire professionals photographers to take listing photos, so if you want to compete on the MLS you’ll need to spend that $200 out of your own pocket to get professional marketing photos taken.
There are tons of other tools, tricks, and techniques that Realtors have access to that brings in buyers, markets your home effectively, and generates offers that you just don’t have access to.
7. Relationships: You need to know at least 2 different lenders and a real estate attorney or title company to assist you in closing your transaction when you’re selling For Sale By Owner. You have to stay on top of them the entire time to make sure the transaction goes smoothly.
Realtors already have these relationships and their vendors like title companies and lenders work incredibly hard to keep Realtors happy. If a title company screws up a transaction they know that the Realtor will never use them again and encourage other agents to not use them again. These relationships are already established so you know that a good Realtor has a good team behind them that make things work smoothly.
I know it’s tempting. I know you think you can do this on your own and that you need that extra money to buy the next house or to pay off some debt or to boost your emergency account. But I promise that when it comes to selling your home For Sale By Owner you rarely get that extra money you want and you bring a lot of extra stress into your life in the process. Hire a professional.
(If you’re looking for a professional real estate agent anywhere in the country, I can help. Check out the real estate page here to find a top real estate agent in your area.)
In a large part of the country, the real estate market is booming. Somehow interest rates are still incredibly low and we’ve finally burned through all that excess foreclosure inventory from the 2008 crash.
It’s created a pretty fantastic dynamic for sellers looking to move up in home and a great opportunity for buyers to get into a house with a historically low interest rate. And this combination has caused home values to rise, homes to sell fast, and sellers getting multiple offers on their listings.
Want to really screw up a home purchase?
Jump into this type of market without a solid financial foundation.
In a real estate world with competing multiple offers there are 2 types of offers that get chosen.
The first is the one that offers near the list price, has a large amount of cash, like 10%, 20%, or 50% as a down payment, has a conventional loan pre-approval and doesn’t ask for much seller assistance. A seller views this offer as a safe bet. As they look over the offer they don’t find any indications that this type of offer will fall apart and not close on the house.
The second type of offer accepted is the buyer that offers a substantial amount over the list price, because they are rolling their closing costs into the loan. Their down payment is the minimum the bank requires for an FHA loan. They need the seller to contribute to their closing costs. They don’t offer up much in the form of earnest money. Basically their offer screams to the seller that they don’t have much money, and barely qualify for the house. The only reason a seller would gamble with this offer is because the buyer is willing to pay $3,000, $4,000, $9,000 more than everyone else is because the buyer is just rolling in all the upfront costs into the loan. If the offer isn’t substantially better than the more stable offers this buyer loses out, so they must overpay in order to get the house.
And that is how you really screw up a home purchase.
You decide to buy a house before you’re really ready to. Sure you can qualify for a loan, and have a little bit of cash for a down payment. But you’re not ready to take on homeownership, and in order to do it in this market you’re going to overpay. Or you’re going to have a ton of heartache and wasted time going from listing to listing and making offer after offer that sellers reject.
So what do you need to buy a house, even if a lender or real estate agent says something different?
You need a good, healthy emergency account.
You need a large down payment.
You need to know you can afford the house.
You need to be out of consumer debt.
Basically, the best way to avoid screwing up a real estate purchase is to get really prepared financially before you even go look at a house.
*Are you finally ready to make a real estate purchase? Maybe you need to sell your house or want to upgrade your home? Check out my Real Estate page for information on how I can help, even if you don’t live in the DFW area.*
Want to really screw up a home purchase?