When you apply for a mortgage, lenders take into consideration a number of factors, including your income and job history, credit score, debt-to-income ratio, assets and property type.
There is no minimum amount of money you need to earn each year to buy a home, but your lender does need to know that you have a steady income source. Your lender will look at your pay stubs and W-2s from the previous two years to see if you have a stable job and consistent income.
Credit Score
There are many things to consider when applying for a mortgage, but one of the most important is your credit score. It determines whether you qualify for a loan, and how much you will pay in interest. A higher credit score means you may be able to get a lower interest rate and better terms.
Your credit score is a three-digit number that lenders use to assess your risk of defaulting on a debt payment. It’s based on information in your credit reports from the three main consumer reporting agencies — Equifax, Experian and TransUnion. These credit bureaus collect information from your creditors, including mortgage lenders and credit card issuers.
These lenders report your credit history to the credit bureaus, which then make use of credit scoring models to calculate your credit score. FICO and VantageScore are two common scoring models used by lenders, but there are other types as well.
The credit scoring model that a lender uses depends on the type of account being considered, and your specific financial situation. For example, if you’re looking to buy a car, a credit score that considers your payment history more than your total amount owed could be more appropriate than one that looks at how much of your available credit you’ve used so far.
In general, a credit score ranges from 300 to 850, and where you fall within that range represents your perceived credit risk. It’s important to note that there’s no “magic” number that guarantees you’ll be approved for a credit account or receive a particular interest rate. However, a higher credit score typically suggests that you have demonstrated responsible credit behavior in the past, which may help potential lenders and creditors evaluate your request for credit more confidently.
Several other factors can also affect your credit score. These include the types of accounts you’re carrying, the length of your credit history and your current balances and credit utilization ratio (the percentage of your available credit that you’re using).
Your credit report is a document that details every aspect of your credit history, from the date you opened a new credit account to the date you closed it. It also includes public records such as bankruptcies, judgments, tax liens and wage attachments.
If you want to boost your credit score, be sure to pay all of your bills on time and stay below your credit limit. This shows a positive record of paying your debts and helps lower your credit utilization, which is another important factor in your credit score.
Additionally, if you have old debt that’s hanging around on your credit report or high credit card balances, be sure to pay those off as soon as possible. Keeping your debt-to-income ratio low will help you secure the best interest rates and terms on your mortgage, as it shows lenders that you’re not overly risky as a borrower.
You can check your credit report for free from each of the three major credit bureaus — Equifax, Experian and TransUnion–at least once a year. You can also take a free credit score simulator test online to see how your credit score might change.
Income
When you apply for a mortgage, you’ll need to show lenders that your income is stable and regular enough that it will cover the loan payments. This is an important part of the process because lenders will look at your income to determine whether you can handle a mortgage and pay back the loan over time.
Your lender will want to see a two-year history of your income, especially if you’re self-employed or have fluctuating income. This includes tax returns and other documentation that shows a consistent flow of earnings over the past couple years.
For most people, their primary source of income is their salary, but it’s not always the only source of money that will qualify for a mortgage. There are a number of other income sources that can be used to meet the requirements, including tips, commissions, retirement income and alimony, among others.
If you’re self-employed, your lender will want to see a minimum of two years of business tax returns and W-2 forms for the previous two years. These must be filed on time and must show a consistent stream of earnings over that period.
Many mortgage lenders will also require a complete financial statement or a cash flow analysis. These tools are designed to help lenders understand a borrower’s finances and predict how much he or she can afford to repay the loan.
A stable income is the most important aspect of qualifying for a mortgage. Most mortgage lenders will not consider an applicant’s salary if it is volatile or has not been stable for several years.
For example, if a person has recently moved into a higher-paying job, the lender may take into account that income when assessing whether to approve the applicant’s mortgage application.
Likewise, an applicant with a large alimony payment will need to demonstrate that it is consistent over the course of the year or for the entire life of the mortgage.
You’ll need to document any other types of income you receive, such as child support and disability. Lenders are allowed to count income from these non-taxable sources as more than 25% more than your gross monthly income, which can add up to a significant amount of extra income for mortgage qualifying purposes.
Another source of income that can be used to qualify for a mortgage is rental property. The lender will study your rental income on your yearly tax return to determine whether it has been consistent and rising over the last couple of years.
If you receive a bonus, overtime or commission from your job, the lender will need to see documentation of that income as well. This might include pay stubs, tax returns or bank statements.
The lender will then subtract your income from any taxes that you might owe on this income, and use the result to calculate your gross income. Then, the lender will divide your debts by your income to determine your debt-to-income ratio.
This ratio is the most important factor in determining how much you can afford to pay for a mortgage, as it is used to calculate your front-end DTI, which is the amount of your housing expenses (mortgage, property taxes, homeowner’s insurance) divided by your pre-tax income. Typically, your front-end DTI should not exceed 30 percent of your gross income. However, some lenders have flexible rules that can allow you to qualify for a mortgage even with an excessively high front-end DTI.
