You might be fantasizing about buying a home, shopping for new furniture, hosting dinner parties, and making the backyard perfect for the kids. But do you meet the requirements to buy a house?
We’ve put together 9 requirements you’ll likely need to get squared away before you start booking those showing appointments. That way, once you find the perfect property, you can hopefully breeze through the process knowing you’re financially ready.
Generally lenders will look to see that you’re employed and in a stable position; Ideally, you’ve been working at the same place for at least two years. During the VOE (verification of employment) process, the lender will look to confirm your position title, length of employment at your current job, and might even inquire about the future — confirming there’s a strong likelihood you’ll still have that job in five years.
If you’re self-employed, don’t fret! You can still get a loan. While it may be slightly more difficult as a self-employed borrower, there are still loans out there for you. They may just require additional documentation not usually required of a standard W-2 employee. Lenders will also rely heavily on your tax returns to verify the consistency of your self-employed income. Plan on providing at least two years of detailed returns.
A solid income
In addition to length of employment, lenders will also review your salary to confirm you’ll be able to pay the loan back.
If you make an annual salary, the lender will divide that amount by twelve to check your monthly take-home pay. If you’re paid hourly, most lenders will take your average number of hours worked per month and multiply that by your hourly wage.
If you make overtime or receive end-of-year bonuses, the lender will take two years of overtime or bonuses and then divide that by 24 to get the monthly average. And if more than 25% of your pay is from commission, the lender will take the average of 24 months of income as your take-home pay.
The process is the same if you’re self-employed; If that’s the case, you’ll likely need to supply an IRS Form 4506-T (a Transcript of Tax Return).
When we spoke to Joe Bourland, a Phoenix-based real estate agent with more than 18 years of experience, he noted that buyers who have recently switched careers (for example, if you worked in construction for 15 years but recently became a personal assistant) will also need to show two years of steady income, with no significant dip in salary that came with the job change.
Like income, debt is an important part of the equation and is viewed as a ratio to your income — in other words, what percentage of your income are you spending on debt?
Credit utilization accounts for 30% of your credit score, so to have the best possible credit score (and therefore get the best possible mortgage rate), it’s very important to come into the homebuying process with as little debt as possible.
Experts recommend that you keep your credit utilization below 30% in order to keep your score high; That is, make sure that you’re only borrowing 30% of the available credit offered to you. So to maximize your credit score, if your credit card has a limit of $12,000, you’ll want to keep your balance consistently at $4,000 or less.
Of course, credit utilization is only one part of the bigger picture that is your credit score.
While a great score will boost your buying power (you’ll be able to lock in a lower interest rate on your mortgage loan, possibly allowing you to borrow a higher amount), you might not need as high a credit score as you think to buy a home. Here are some popular programs for buyers with lower credit scores:
- FHA loan: This is a loan from a traditional lender that is backed by the Federal Housing Administration. You’ll typically need a credit score of at least 580 and a 3.5% down payment, though if you have a larger down payment (at least 10%) you could qualify with a score as low as 500. On an FHA loan, you will typically have to pay an upfront mortgage insurance premium that’s 1.75% of the base loan amount, and an annual premium that’s 0.7% for a 15-year loan, or 0.85% for a 30-year loan. These can often be wrapped into the loan.
- VA loan: A VA loan is a loan from the Department of Veteran Affairs, and as the name implies, is only for veterans or surviving spouses. There’s no minimum credit requirement, and 90% of these loans are funded without a down payment.
- USDA loan: A USDA loan is backed by the United States Department of Agriculture and supports loans for homes in approved farmland, suburban, or rural areas. The minimum recommended credit score for USDA loans is 640, and you don’t need a down payment.
These government loans are still funded by banks and private lenders; The government agency simply guarantees all or a portion of the loan with the lender.
As for conventional loans, you’ll probably need a score of at least 620 and a down payment of at least 5% — and the higher your score, the better your buying power. If you need to boost your score to get up to 620 (or higher, ideally), work on bringing your score up by doing the following:
- Make sure you’re current on all payments (set up auto-pay!)
- Pay down as much existing debt as you can before applying for a home loan.
- Don’t apply for any new lines of credit (unless you don’t have any credit at all).
- Dispute any negative records on your credit report.
Bourland noted that if one of the dings on your credit report is from medical collections, it’s possible the lender will be willing to overlook that (on a case-by-case basis, of course). He noted that lenders will usually offer one or two exceptions, but you should talk to your lender to review any red flags.
The key, said Bourland, is to start your process early — pull your credit report a year before you know you’re going to be applying for homes so you can review any negative marks on it and get those handled before you start the home loan process.
In riskier loan environments, lenders will raise the standards required to get a mortgage loan, including the minimum credit score. There was a lot of upheaval in the economy in 2020 that affected minimum credit scores, so make sure you’re talking to an agent or loan officer who can keep you apprised of any changes.
A down payment
A big myth is that you need a down payment of 20% (or more) to buy a home. That’s not true at all, and in fact, for first-time buyers, the average down payment in 2019 was just 6.7%. For repeat buyers, it was 16%.
That said, a larger down payment might help lenders and sellers see you as a favorable buyer, given the financial security you’re showing. That means that lenders might be willing to lend you more money, increasing the number and range of homes you can consider.
If you definitely don’t have 20% down, these government-backed programs could be a good option for you:
- FHA loan: The down payment you’ll need for this loan varies based on your credit score; if your score is 580 or higher, you can put down as little at 3.5%. If your score is between 500-580, you’ll likely need a higher down payment of at least 10%.
- VA loan: There’s no down payment requirement for a VA loan.
- USDA loan: There’s no down payment requirement for a USDA loan.
If you want to pursue a conventional loan, but have little money for a down payment, you might still qualify, with a few caveats:
- The interest rate on your loan will likely be higher, as lenders will see you as a higher-risk borrower.
- Lenders will likely require you to pay PMI — private mortgage insurance. PMI is meant to protect your lender in the instance that you can’t make your mortgage. payments; If you end up in foreclosure, and your home sells at auction for less than your mortgage balance, your PMI will cover the remainder to pay your lender back.
- You’ll start off your homeownership with very little equity in your home, i.e., you won’t own any of it outright (which, had you made a down payment, you would). This is particularly risky if you don’t plan on staying in the home for a long period of time. Depending on market fluctuations, you could end up owing more on your home than it is worth if you had to sell.
It’s unlikely that you’ll be able to secure a conventional loan with 0% down, but some lenders will go as low as 3%. Lenders can set their own income and credit score requirements for these loans, as long as the minimums set by Fannie Mae or Freddie Mac — a credit score of at least 620 — are met or exceeded. Also, 3% loans are typically reserved for first-time buyers.
Like with credit scores, lenders might ask for a bigger down payment in riskier loan environments. We saw mortgage overlays imposed in 2020 that required buyers to put a full 20% down on home purchases. Depending on your timeline to buy, you’ll want to stay in the loop by talking with your agent or loan officer (or both).
Unfortunately, the down payment is only a portion (albeit the biggest portion!) of the funds you’ll need to close on a home. You’ll want to be sure you have a little extra in your savings account, as there are a few other costs involved, including:
- Lender and broker fees: These cannot exceed 3% of the total purchase price of the home.
- Appraisal and home inspection: Expect to pay $300 to $1,000, depending on where you live.
- Attorney fees: Some states require that a lawyer be present during closing negotiations; This fee will vary widely based on the specific attorney’s rates as well as location.
- Taxes: It’s not unusual for a state to require the homebuyer to fork over two months’ worth of city and county taxes as closing.
- Homeowners insurance: Most lenders will require you to buy homeowners insurance, and some will want you to pay for a year in advance.
- Title and escrow fees: A title or escrow company will provide title insurance and conduct other aspects of the closing, so expect to see fees for these services as well.
Ballpark idea of how much you can spend
You can’t get into the homebuying game without knowing how much you’re willing to spend. It’s important to set your budget before you get preapproved, so you aren’t potentially taking on more of a financial commitment than you can handle. HomeLight has a comprehensive home affordability calculator where you can input your income, current debts, and other bills in order to get a sense of how much home you can afford.
Getting preapproved is a very important step: It allows the lender to consider your credit and income, so they’ll be able to confirm you’re cleared for a particular loan amount, and this matters a lot to the seller. Sellers don’t want to make it ten steps away from the finish line, only for the deal to fall through; Preapproval lets them know you’re serious and you’ve got the financials to back up your interest and intent.
But it is important to note that all preapprovals are not created equal. Some lenders issue a preapproval based only on information you estimate, while others may require significantly more information and do a full verification or underwrite of your credit and financial records. The more information they verify, the stronger your preapproval will be.
HomeLight Home Loans can help you get preapproved in as little as five (!) minutes, and with a little more information, their fully-underwritten preapproval can tell you exactly what you can afford.
A real estate agent
While HomeLight articles offer a great resource to guide you through the homebuying process, nothing will be as helpful as having a top real estate agent by your side. An experienced agent will be an expert in the area you’re looking to buy in, and will be able to flag new listings for you.
Bourland explains how important it is to not only have a knowledgeable, experienced real estate agent by your side, but also one that you can trust: ”Find an agent who’s looking out for your best interest. If you suspect they aren’t, find someone else!”
In addition, an experienced real estate agent has likely seen all kinds of unusual home-buying scenarios, so if you’ve got a unique situation — a little less money down or less-than-perfect credit — they’ll know the best way for you to proceed. Find a great real estate agent on HomeLight today to begin your homebuying journey!
Header Image Source: (Étienne Beauregard-Riverin / Unsplash)