The Qualifying Conundrum: Getting Your First Mortgage

Getting your first mortgage is a rite of passage for many Americans, but in these days of tighter credit regulations, increasing down payments and less free cash for savings, it may seem like an impossible dream. Believe it or not, you can still get a mortgage — even a first mortgage — in today’s real estate market, but it does help to know something about the process. We’re going to walk you through getting your first mortgage right now, so fasten your seat belts.

What to Do Before Applying

In the days, months and years before you even think about applying for a mortgage loan, there are some things you can do to help prime yourself for the process. First and foremost, you need to pay down your debt — but not too much. I know that sounds confusing, but there are three important concepts at work here: your debt-to-income ratio, your credit utilization and your credit history. Each of these items plays a different part in helping you secure a mortgage down the road:

Credit History. Your credit score is computed using several different types of data, but some of the most valuable tidbits revolve around how well you pay off credit and how long you’ve had your accounts. Older credit accounts that are being actively used help you generate a higher credit score, as do on-time payments for those accounts. Payment history and length of credit history together make up half of the credit score calculation, so if you don’t have any credit cards or loans, now is the time to open a small credit line.

Credit Utilization. Another 30 percent of your FICO score is based on how you use your credit. For this metric, the model compares how much credit you’ve been granted against how much you’re using. Although you can safely revolve some debt, try to leave at least half the credit line free at all times. You can achieve this feat by either paying your credit card balance in full each month or by making payments that keep your revolving balances low.

Debt to Income Ratio. Your debt to income ratio is vital to your success at securing a mortgage. No matter who you are or how much of a down payment you have, you will be hard pressed to find a lender that will extend you enough of a mortgage to exceed a 43 percent debt-to-income ratio. They determine this number by adding up the monthly payments for all your credit-reporting debts (including your future mortgage payment) and comparing that number to your monthly income. Your debts must be less than 43 percent of your income for you to stand a chance.

So, in short, to up your chances of landing a great mortgage in the future, have some debt — but just a little bit — to show how responsible you can be with it. The sooner you begin establishing a history of on-time payments and low balances, the better off you’ll be.

A Word About Job History

The other homework you can and should be doing long before you’re ready to apply for a mortgage has to do with your job history. Banks are still really nervous about getting left holding the bag on your home, so they’re going to investigate your job history and determine your prospects for long-term employment. You can set the bank at ease by putting your mortgage dreams ahead of exploring new avenues with your career. This means having a stable job at the same company or at least in the same job title, for several years — two to five is ideal.

Whatever you do, DO NOT give up your suit and tie to go freelance or start a business until AFTER you’ve moved into your new home. You will be expected to produce tax documents and check stubs to prove your employment, rate of pay and job history, but your bank will also call your employer to verify this information as well. Don’t fudge on this, don’t try to get away with anything funny, just be a regular working guy for a few years and like it.

Feel free to take extra work on the side doing whatever it is that is your ultimate career goal, but don’t jump in with both feet just yet. Any sudden career moves, changes in career fields, significant increase or decrease in pay or a history of job-hopping can throw a wrench in the works of the mortgage machinery.

When You’re Ready to Apply

If you’ve kept a steady job and done your pre-mortgage homework, you should be in a pretty good place when you apply for your mortgage. There are basically four things that any lender looks for before they fully approve a loan, no matter what program you use. These are:

Ability to repay. This is where your long, stable job history is going to come in really handy. Proving that you’re making a solid living, aren’t inclined to job hop and your debts aren’t out of control, you’ll pass this check with flying colors. Remember, at least two years on the job is ideal, along with a debt-to-income (including your future mortgage payment) of less than 43 percent.

Likeliness you’ll repay. Just because you can repay the loan doesn’t mean you’ll make it a priority when the going gets tough. This is why it’s so important to have a long established credit file with an excellent payment history. Prove to the bank that you’re trustworthy and your application will sail right through.

The source of your funds. In fact, this is the trickiest part of getting a mortgage. Many loan programs require that you have a certain amount of liquid funding in the bank before they’ll allow you to close. This is typically equal to somewhere between two and six months worth of payments, homeowner’s insurance, mortgage insurance (if applicable) and taxes. These funds must be above and beyond the amount you intend to use for your down payment and closing costs — and they have to be verifiable.

Any deposits that exceed 25 percent of your monthly income must be explained and documented, as will any smaller deposits that don’t have clear sources. That means if you sell a valuable heirloom, accept a money gift from a family member or finally win the lottery, you have to have a paper trail to accompany it if you want that money to count. This can get especially difficult with buyers who are bringing a lot of cash to closing, so clearly explain your liquid money situation to your banker before you even step foot inside the first house your Realtor has in mind.

In addition to all of this, most banks want to see that your funds are seasoned. What that means is that beyond explaining and documenting your deposits in detail, you have to have them in your account for at least sixty days when the bank verifies them in the week or so before closing.

Your future home’s vitals. Of course, the mortgage loan isn’t just about you — the home you’ve got in mind has to meet both the program’s requirements (especially important with an FHA, VA or USDA loan) and the bank’s. Most banks want to see that the house is worth what you’re paying for it and that it’s in an area that isn’t blighted or would otherwise make the property impossible to resell if they’re forced to foreclose.

Just how much value your home has to have will vary between programs, but most banks won’t lend more than 95 percent of the home’s value. Don’t worry about this too much right away, though, you can and should get pre-approved before choosing your new house.

These days, it pays to get a full pre-approval before you start house shopping. Even though this puts a clock on your purchase, you’ll already have the bulk of the paperwork completed when you do finally find that first home of your dreams. You’ll also have a much stronger negotiating position to work from, so a pre-approval could end up saving you money in the long run.

The Bottom Line: Qualifying for a First Mortgage Demands Planning

When you have no existing home to borrow against or significant credit history to support your absolute dedication to paying a mortgage, it can be hard to prove to your friendly neighborhood banker that you’re going to stick around after closing. The amount of paperwork and planning required to buy a home may seem daunting or even excessive, but there are good reasons for so many checks and double-checks.

It was a very different world for borrowers just ten years ago — many lenders didn’t do these sorts of checks and instead would lend to pretty much anyone who wanted to borrow. Home prices were artificially inflated to unsustainable heights, borrowers were overextended and eventually, the whole thing came crashing down. The market was too hot and a lot of people got burned because of a mix between reckless lending practices and shifty Wall Street shenanigans.

In the end, the banks were left with thousands upon thousands of foreclosed homes in every market that they simply could not sell for anywhere near the value of the notes that they secured. Although today’s lending practices may seem overly cautious, the alternative wasn’t any better.

Instead of encouraging people to impulse buy a home, we all should recognize that homeownership is a huge commitment, much like getting married or having a child. If you can’t spend a couple of years getting ready for the biggest purchase you’ll ever make, you’re probably not really serious about owning — and that’ll matter when you’ve got to deal with a leaky roof or other major and unexpected repair after the new has worn off.

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