Every loan program has their individual requirements, but there are some things that are just ‘standard.’ Understanding the basics of each loan can help you be best prepared for your loan in the future. We always say that the earlier you start preparing for your loan (even years before), the better your chances of getting approved become.
Credit Scores are Important
Credit scores are very important. For most lenders, it’s the first impression they have of your financial responsibility. The higher your credit score is, the more likely you are to qualify for the best loan programs out there. You are also more likely to get the best interest rates available.
Just what is a ‘good’ credit score? It can range between 580 and 680, depending on the loan program you are discussing. Conventional loans, for example, require a credit score of at least 680. In fact, if you have a credit score in the 700s, you’ll be in even better shape.
FHA loans allow credit scores as low as 580. While you’ll get the better interest rates and terms if you have a credit score higher than that, but knowing that you can get by with a 580 score is helpful. Your credit scores/history is one area that we recommend working on as early as possible. If you have negative credit information reporting about you or you know you are behind on your payments, it takes time to clear up your credit. Sometimes it can take as long as a few months for your credit score to change. The earlier you start working, the better your chances will be of getting approved.
Debt Ratios Play a Vital Role
Another important factor in any loan is the debt ratio. This is the comparison of your outstanding debt to your gross monthly income. Lenders want to know that you have enough money available to cover the mortgage. They also want to make sure that you have plenty of residual income or money left to help you cover the daily cost of living.
Each loan program has their own requirements, but in general, you should not have a total debt ratio higher than 43%. This is across the board. Your total debt ratio is the total of your new mortgage payment (including taxes and insurance) plus your credit card payments, installment loan payments, and student loan payments. You’ll also likely face a maximum housing ratio, which can vary. For example, conventional loans allow a 28% housing ratio and FHA loans allow a 31% housing ratio.
You Need Stable Employment
Across the board, lenders usually look for a 2-year employment history at the same job. This shows lenders that you are stable and reliable. You don’t hop from job to job and you don’t run the risk of being unemployed. Of course, you can’t control that 100%, but you have shown stability by having a solid two years of employment at the same company.
Now if you need/want to change jobs, don’t think you won’t be able to get a loan, it just might take a little more work. Some lenders require you to wait at least six months so that they can see the pattern of your income at the new job. Others will allow you to get a loan after just one month of employment as long as you have proof of some type of experience or training in the industry that will allow you to succeed at the new position.
A Down Payment is Usually Required
Finally, you’ll need a down payment. There are two exceptions to this rule – the USDA and VA loans. These two programs provide 100% financing. All other loans require a down payment that ranges from 3.5% (FHA loans) to 5% (conventional loans).
Most loan programs do allow you to accept gift funds from a relative or employer for your down payment. You’ll have to inquire with your individual lender to see what rules apply to your situation. In some cases, 100% of the down payment can be a gift, while in others, you need to put some of your own money into the transaction as well.
The down payment gives you equity in the home and makes the lender feel as if you’ll pay your mortgage back on time. If you don’t have your own money invested, you become a higher risk of default. If you can’t make your mortgage payments, you probably think you don’t have much to lose since you didn’t put your own money into the home. That’s why most lenders require at least some type of down payment.
These basic mortgage requirements will help you as you navigate the world of mortgages. Finding the right mortgage can be just as hard as finding the right home. Remember, you could have this loan for the next 20 – 30 years. Make sure that it’s a loan that suits you and that costs you the least in the long run.