In this video, we’re going to talk about the basics of getting qualified for a loan if you’re a homebuyer. Your lender can go more into detail and answer more specific questions about the loan process since they’re the expert.
But having been a real estate agent for a while and helping many different buyers get qualified, I’ve learned the ins and outs of financing. I’ve also gone through the qualifying for a loan process as well when I’ve purchased own properties.
So let’s share some tips for getting a home buying loan!
Starting off with some of the basics, as you go to get qualified for a loan, a lender is going to ask what your current income is. They’re going to look at your current debts that you have, your credit score, and your employment history. These 4 items all play a role together during the loan qualifying process.
Income vs Debts
Starting off with your income and your debts. These two factors are going to be big on the importance scale as far as how much house you can afford.
If you currently have a high income and low debt, then you can qualify for a larger mortgage payment as compared to somebody with a lower income and lots of debt.
Debt to Income Ratio
A lender looks at a metric known as the debt to income ratio. It is a ratio they set a max limit at around 0.40 to 0.45.
This means that your debt can only be about 40% to 45% of your total income.
Lenders don’t like to see debt get higher than that because they know you need to use any additional income to still pay for your bills like your food, your gas, etc. These cost of living expenses take priority usually for most people.
The lender wants to make sure that they don’t get put in the back stop paying the debt payments because you’re more worried about making these other payments for food, for gas, for clothes first.
This is why banks will set the debt to income limit allowed at about 40% to 45% of your income each month.
How Much House Can You Afford
To keep math simple, let’s just say you’re making $10,000 a month. If that’s the case, then you can go up as high as about $4,500 per month in total debt payments before you can no longer qualify for a housing loan.
Again, key word here is “total.” This is is total debt payments. So any debt you currently have gets factored in and subtracted from what you could then qualify for a new mortgage.
For example, if you already have credit card debt payments, or if you already have student loan payments, or a car loan payment, then these are going to factor into that total $4,500 per month amount that you’re allowed to have based on a $10,000 monthly income.
In the case that you don’t have any debt, then you could qualify up to a mortgage payment of $4,500 a month which probably puts you somewhere around an $800,000 house. This would be a pretty nice sized home you could qualify for.
Now, if your income, let’s just say, was cut in half to where you’re only making $5,000 a month.
In this case, if you have no debt, you could probably qualify for a $2,200 per month payment on your mortgage, which would probably get you into about a $350,000 house. Maybe up to a $400,000 house depending on down payment amount and interest rates.
But if you already have existing student loans or a car payment, again, that will reduce the amount of mortgage your can qualify for.
For example, the bank sees this other debt and so they qualify you up to a maximum payment of $1,500 for a mortgage. In this case, you’ll be restricted to about a $200,000 to $250,000 house.
So you can see how debt can affect your max mortgage amount and how it changes how much home you can afford to purchase through a bank loan.
Next, let’s talk about the interest rate. Interest rate has to do with your credit score, so when you go to get a loan, you want to have the best credit score possible. This is going to help you qualify for the lowest interest rate being offered currently by the bank.
If the bank’s offering a 6% interest rate, then you want to make sure that you’re in that top tier credit to get that 6% interest rate.
If you happen to be in the middle tier credit or low bottom credit tier, then you’re going to end up probably getting offered 6.50% or even 7% for having a lower credit score.
So credit score does matter.
It helps you to be able to qualify for the lowest interest rate possible that the bank’s currently offering. The lower you can get that interest rate, the less you’re going to pay each month in interest. You’re going to save more money over the long term.
How to Increase Your Credit Score
What things can do to boost your credit score?
#1: Pay off existing debt
#2: Make sure you’re making your payments on time
#3: Lower your credit utilization ratio
Credit utilization is important because they look at how much credit you spend each month relative to your limit.
For example, if you have a $5,000 credit limit, try to only use like $500 or $1,000 a month of your $5,000 credit limit. That way, you’re using a low amount of your credit and this will bring down your utilization rate. helping your credit score.
If you have $4,000 in credit card bills every month and your limit’s $5,000, then you’re almost maxing out your credit limit every month. That’s a high utilization rate and that’s not good for your credit score.
In addition to credit score, the lender is going to look at your employment history. They want to make sure that you are employed and that you have good employment history so they can feel comfortable that you’ll have consistent income coming in.
The bank only cares about one thing and that is getting paid back for the money they loan out.
A borrower with good employment history appears to the lender as a quality and reputable potential buyer who is going to make their payments on time.
Usually two years employment history is required by the bank.
Overall, those are the important things a lender will look at when you begin the loan qualifying process.
For the Debt to income ratio, you should work on increasing your income, and lowering your debt. This is going to help your debt to income ratio reduce so that you can qualify for a bigger mortgage payment and afford a bigger home if that’s important to you.
Also, make sure you’re working to boost your credit score so you can qualify for the lowest interest rate possible.
Lastly, make sure you have steady employment history so that you can qualify for a loan. If you don’t have a long enough employment history then you might get denied for the loan outright.
Thanks for reading
Realtor Nick Foy
RE/MAX Oak Crest Realty Elkhart
Northern Indiana Real Estate Agent