Purchasing a home is a major milestone, but it can also be an intimidating process. It’s not as complicated or scary, however, when you know what lenders expect, and when you understand the requirements for a mortgage. So, what do you need to qualify for a home loan?
Here’s how a lender decides if you’re the right candidate for a mortgage.
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Getting approved for a mortgage involves more than completing a home loan application and providing details about your employment and income. Lenders must verify all information listed on your application, so be prepared to provide a stack of supporting documentation.
1. Paycheck Stubs
You’ll need to hand over your paycheck stubs for the past 30 to 60 days. This is proof that you’re currently employed, plus your stubs contain details about take-home pay which helps your lender calculate how much you can realistically spend on a house payment.
2. W-2s or Complete Tax Returns
A mortgage approval normally requires at least 24 months of consecutive employment, either with the same company or in the same field.
You’ll need to provide your W-2s for the previous two years, or your complete tax returns for the past two years, if you’re a self-employed worker. Mortgage lenders also use tax returns to verify supplemental income, overtime pay, commissions and rental income.
3. Year-to-Date Profit and Loss Statement
Self-employed borrowers must jump through a few extra hoops to prove that their income is regular and consistent. So along with submitting your complete tax returns, you must also provide a year-to-date Profit and Loss statement prepared by an accountant or a tax preparer.
This statement discloses your business earnings for the year thus far, and lenders need this document to ensure your company remains profitable.
4. Divorce Decree
Being asked to provide a copy of your divorce decree might come as a surprise. But this document is sometimes needed to verify court awarded alimony and child support payments, which can be used when qualifying for a mortgage.
You don’t have to include this income, but you’re allowed to if payments are scheduled to continue for at least three years from the date of the mortgage application.
If you’re applying for an FHA home loan, you must provide proof of on time support payments for at least six months, and at least 12 months with a conventional home loan.
5. Bank Statements
Mortgage lenders must also confirm the source of a down payment. Borrowers are required to provide bank statements for the previous two or three month’s (checking and/or savings), as well as statements for investment and retirement accounts.
If a family member plans to cover the cost of your down payment, this person must write a gift letter, which you’ll present to your lender. The letter explains the amount of the gift, and confirms that you don’t have to repay funds.
Along with the above documentation, your lender will pull your credit report to evaluate your credit history and current debts.
Once you have a signed purchase agreement, the lender will then prepare a Loan Estimate which explains the details of your mortgage, such as your estimated monthly payment, interest rate and downpayment/closing costs.
Of course, it isn’t enough to give a mortgage lender documentation. They must review these documents to see if you’re an ideal candidate for a mortgage.
They take the following factors into consideration:
- Credit score. Mortgage programs have minimum credit score requirements. You don’t need perfect credit to get a home loan, but you do need a minimum 620 score for a conventional loan, and a minimum score of 500 to 580 for an FHA home loan.
- Income stability. Job hopping or recent employment gaps can hurt your odds of a mortgage approval. Be prepared to explain gaps longer than a year and recent employment changes. Some lenders will overlook a job change if it resulted in a promotion with higher pay or better benefits.
- Housing ratio. A mortgage payment should not exceed 28% to 31% of your gross monthly income. Some lenders allow borrowers to spend a greater percentage of their income on a payment, but only when there are compensating factors. These include a history of successfully paying a similar amount each month, or having a sizable cash reserve or excellent credit.
- Debt-to-income ratio. Your total monthly debt payments — including the mortgage — cannot exceed 36% of 43% of your gross monthly income. High credit card, student loan and automobile payments can significantly reduce your purchasing power, and you might not qualify for a particular mortgage amount. Pay off some of your debts before applying for a mortgage to increase your pre-approval amount.
After underwriting reviews your credit, application and supporting documents, you might receive the green light to proceed with the mortgage process — better known as a pre-approval or a conditional approval.
Keep in mind that a mortgage isn’t a done deal until closing. Therefore, don’t do anything that could jeopardize your mortgage approval. This includes quitting your job or charging up your credit cards.
Of course, circumstances beyond your control can happen. So if there’s any change to your income, employment or credit before closing, notify your lender immediately to keep closing on schedule.