Do you want to qualify for a mortgage? Here’s what you need to know

There’s an industry framework for qualifying for a mortgage. These are the elements that you should know about if you want to qualify for a mortgage.

Credit score

The minimum credit score for a conventional mortgage is 620. The higher your score is, the lower an interest rate you will pay and the more types of mortgages you will qualify for.

Here’s a table of some of the variation you might see based on credit score:

You can see that the lower credit scores have much higher rates and consequently higher payments.

Certain loans are available with lower credit scores, like FHA loans. If you have a score below 680, you may find your loan options more limited.

Income

Income determines how large a mortgage you will qualify for. The way that the amount you can borrow is calculated is based on a formula that considers your debt as well. It is called the “debt-to-income ratio,” or DTI.

Here’s how it works: your total debt payments is divided by your gross income, which equals your DTI.

Here’s how to calculate your DTI

1. Add up your monthly debt payments, like car payments and credit card payments, student loans and estimated mortgage payment you’d make when buying a home.
2. Add up your gross income, which is your pay before taxes and before other deductions are taken out.
3. The debt to income ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments.

To qualify for a mortgage, typically the highest DTI that will be accepted is 43%, but lenders prefer ratios of no higher than 36%. The lower your DTI is the more mortgages you will qualify for.

There’s a “front end” and “back end” DTI. The front end DTI considers only housing related costs: insurance, property taxes and mortgage. The back end DTI also considers total debt payments from credit cards, auto loans, student loans, etc.

For FHA loans, the front end DTI is 31% and back end DTI is 43%. Higher DTIs might be considered if the borrower has a particularly strong credit score.

Down payment

For many loans, you will need a 20% down payment. But there are loans that you can qualify for where you can put less money down, even as low as 3%, such as an FHA loan.

The amount of your down payment and the size of the mortgage that you qualify for determine how expensive a home you can purchase. So it’s a bit of a balancing act.

(A term you may come across is “LTV”. That stands for Loan to Value, and refers to the percentage of the home price covered by the mortgage. A 20% down payment would result in an 80% loan to value as the remaining 80% not covered by a down payment would be covered by a mortgage. If you only put 5% down, that would be an LTV of 95%, for example.

What you want to do first is to figure out what the maximum down payment that you can put on a home.

If you do put down less than 20% as a down payment, you’ll need to pay mortgage insurance. Mortgage insurance can run between 0.15% to 1.95% of your loan amount each year but can be more if you have a low credit score and small down payment. The insurance payment is rolled into your monthly payment but you can also have an upfront payment with some loans that is typically rolled into the loan amount. It adds extra cost to your mortgage, as banks consider less than 20% down more of a risk.

How credit score, income and down payment work together to determine your ability to qualify

Your credit score, debt-to-income ratio and amount of down payment all determine your risk. You may find that if you are able to make a large down payment that a lender will accept a slightly higher DTI or lower credit score, for example. Or, if you have a very high credit score, you may find that you have more loans available to you than someone with the same DTI and down payment but lower credit score. Lenders consider your overall risk profile when making you an offer for a mortgage.

The best strategy is to increase your odds as best you can before you start shopping around for a mortgage. To do this, you’ll want to boost your credit score as much as possible, consider ways to increase your down payment, and reduce your debt load so that you can have more options.