Most of us can’t afford to buy a house with cash. Instead, we rely heavily on financing from banks and mortgage companies. This puts homeownership within reach, allowing us to stretch monthly payments over a 15, 20 or 30-year period.
Even if you anticipate needing a mortgage for a home purchase, choosing the right type of mortgage is challenging. There are several available programs, each with its own set of requirements. For example, qualifying for a USDA home loan requires purchasing a home in an eligible rural area. And if you’re interested in a VA home loan, you have to be a veteran, active duty military, National Guards member, reservist or an eligible spouse of a service member. If you don’t qualify for these programs, a conventional or FHA home loan are two options available to first-time buyers and repeat buyers.
Regardless of the chosen program, a lender will review every aspect of your finances including your employment history, income and assets. Typically, you must be employed for at least 24 consecutive months to qualify for a home loan, and you must have adequate income and assets to afford a mortgage payment and mortgage-related expenses. But along with these general requirements, conventional and FHA home loans have program-specific requirements.
Here is what you need to know when determining the right program for your situation.
A common misconception is that qualifying for a home loan requires perfect credit. It’s true that a higher credit score helps you qualify for a cheaper, favorable mortgage rate, which can lower the monthly payment and reduce interest charges over the life of the loan. But you don’t need a 700 or 800 credit score to buy a house. You may be eligible for a mortgage with a score in the 600s or high 500s.
Credit score requirements vary by lender and program, however many lenders allow a minimum credit score of 620 for conventional financing. If your credit score is lower than 620, you may qualify for FHA financing, which is often more flexible with credit scores below 620. Keep in mind that while a mortgage approval with a low score is doable, approval is based on your most recent credit activity. There are no guidelines regarding how many late payments or negative remarks are too many within a given timeframe. Lenders make this determination after a careful review of your credit report. Even so, the more negative items added to your credit report within the past one or two years, the harder it becomes to get a mortgage.
Lack of a down payment is one of the biggest hurdles to homeownership. Fortunately, most lenders no longer require the traditional 20% down for a conventional and FHA home loan.
Review your assets to see how much cash you have for mortgage-related expenses such as the down payment and closing costs. The amount you have in reserves can dictate the most appropriate mortgage program. Qualifying for a conventional home loan requires a minimum 5% down, with the option of the seller contributing up to 3% of your closing costs (higher contributions are allowed with a higher down payment). For an FHA home loan, you can qualify with a down payment as low as 3.5%, and the seller can contribute up to 6% of your closing costs.
Mortgage programs also limit the amount of income a borrower can spend on their mortgage payment every month. Lender determines max affordability by comparing the future mortgage payment with your gross monthly income, and by comparing total monthly debt payments (including the mortgage payment) with your gross monthly income.