It can be both tough and stressful work trying to get mortgage financing approval. Fortunately, this process can be made a lot easier if you know what will happen in advance so you can be prepared. Instead of being blindsided and made more stressed out by each request from your lender, you can breeze through the application process.
Buying a house doesn't work like other purchases, even when you buy an expensive car. This is a major purchase that will likely drag out over the course of two months. I've been through this stressful time before myself and know what it was like to deal with it. I'll be sharing my knowledge with you here to help you get approved for financing to buy your own home and get through the closing.
Home Buying Basics
Buying a house can be a process that is stressful to navigate, even for someone that has done it many times. For a first-time home buyer, this process can be downright confusing and even a bit misleading. I'm going to teach you all of the important aspects to know about getting financing approval to buy a house.
Unless you're making an all-cash offer to buy, this won't be a quick process. Except to wait at least a month to go through the entire financing process, although it is more likely to be 45-60 days. This is the time it takes from the day you get an offer accepted until you close on the house. Down payment and closing cost funds are not actually due to be paid until closing, but you will need to show that you have those funds shortly before you close. This may give you a bit of leeway room to come up with a bit of additional money while you're in the middle of the process.
While you wait to close on your house, think of your mortgage broker like the babysitter of your 1-year-old baby. You'll get numerous calls and/or emails from them during this time. Do not ignore them or put them off until later. Answer all calls or return them right away if you do miss them. When they ask you for additional documentation, ad nauseum, jump through hoops to get them what they need as fast as you can. Every day you make your broker wait on documentation is a possible day that your closing gets delayed. The faster you hustle through the rough parts, the sooner it will be when you're walking in the door of your new home.
Before I get into some of the finer details about getting approved for a mortgage, I want to talk about pre-approvals too. I found this process / requirement to be a bit odd and somewhat pointless. Most home sellers won't even accept an offer from you without a pre-approval letter. However, you can also run out to a number of different websites to get one for yourself with ease. Those sites will let you input any income number you want and don't consider your debts, so you'll get told you can purchase a really expensive house.
The problem with this scenario is that most "pre-approvals" are worthless and don't guarantee that you'll be approved for financing. I'd call it more like a pre-approval to apply for financing. Some banks will actually run your information to give you a "real" pre-approval letter that is much more accurate. The bad news is that even those don't come with a guarantee for financing approval.
People that want to buy a house, especially first-time home buyers, may get a false sense of hope from these pre-approvals. Even worse, home sellers can have sales drag on for months only to fall through at the last minute. This forces sellers to go through the entire process all over again until they actually find somebody that gets final approval and cleared to close. Needless to say, this is a bit of a pointless process that can be frustrating for everyone involved.
For the strongest pre-approval letter that can also give you the best hope of actually getting approved, call your bank or visit them in person. Ask them to actually run all of your information including credit checks to get a more accurate pre-approval. This can help your offer get accepted, and it can give you a more realistic expectation of a maximum buying price too.
There are a couple of major factors that lenders will look at to determine if they can approval you for a mortgage or not. One of them is income. You have to show that you have a way that you can pay the monthly payments on the loan. On top of that, lenders want to see that this income is steady and reliable.
The money you make working a job is viewed as the most reliable since you'll usually get a steady rate of pay and paycheck. You just need to show a few pay stubs and your hiring date to prove your job income. When you're self-employed, proof of income gets tougher. A lender will want to see two years of your personal and/or business tax returns. You may even need to show a profit-and-loss statement for the current year too. Any big declines in your income over the time period can count against you. All of the self-employment profits (net income on taxes only) will be averaged to calculate your monthly income.
Your job income and/or averaged self-employment net income are then used to figure out how much you can afford to pay each month on the mortgage. Take your monthly income and divide it by 3.5 to get your max monthly mortgage payment amount. See the section on debt for more information about how this figure may get adjusted lower in some cases. The actual purchase price that you can afford could vary depending on how much money you have available as a down payment.
Credit Score Requirements
A lender is also going to look heavily at your credit score and even your entire credit report. They need to judge how like you are to repay your mortgage loan before they can approve you. This information gives them a lot of insight into your past credit habits.
The minimum credit score that you need to get financing approval depends on the type of loan you're trying to get. Conventional loans require a minimum score of 620. FHA loans at 3.5% down and VA loans at 0% down require 580 (officially VA loans don't have a minimum score but this is the realistic lower limit). FHA loans at 10% down require 500. Even though these are the official minimum scores, you'll often find that individual lenders want slightly higher numbers. I've found it realistic for some lenders to require 640-680 for conventional and 600-620 for 3.5% FHA.
If your credit score isn't as high as it needs to be to get approved, start repairing your credit as early as possible. I can take an entire year of flawless credit practices just to raise a score by 50-100 points. The lower end of that scale is more realistic too, unfortunately. Also keep in mind that a lender will pull reports from all three major credit bureaus. They'll use all three reports, but the score used for approval is the middle score of the three. The numbers you see for your credit reports can be a bit different from what the lender calculates too. For this reason, make sure you have a good 5-20 points extra to avoid surprises.
See a related mortgage article for more information: Minimum Credit Score Requirements for Home Loans.
Tidy Your Debt
Debt is also heavily scrutinized by lenders. Anything that you self-report and items that show up on any of your three credit reports will be factored. Even monthly debt payments that you don't actually make will be counted - this often happens with collection account balances.
Ultimately, any debt that you carry will be totaled to calculate a debt-to-income ratio (DTI) for you. Ideally, your debt payments and your future mortgage payment should total up to be less than 36% of your income. Some lenders and some types of loans will let you go as high as 45% or even 50% DTI, but you really don't want approach 50% whenever possible.
Using a max DTI of 45%, you may be planning on a 28% mortgage payment. However, if your debt payments total up to more than 17% of your income in this scenario, you may have to buy a cheaper house or else your application will get denied. For this reason, it can be a good idea to tidy up your debt well in advance of applying for a mortgage. The less debt you carry, the more expensive of a house you'll be able to buy or even the more likely you'll get approved.
Minimum Down Payments
Lenders will also require you to have money in the bank ready to pay for your down payment, closing costs and other expenses. The down payment and closing costs don't actually get paid until the closing date, so lenders usually check on the availability of these funds fairly late in the approval process. Sellers will often ask for earnest money to hold in escrow after they accept your offer. This has to be paid right away, but it also counts towards your down payment so you don't have to come up with extra money for the earnest payment.
The minimum down payment for your house loan will be a percentage of the purchase price. The exact percentage varies for different types of loans and can possibly vary depending on your credit score too. VA loans can be obtained for 0% down, but there is still a loan fee and closing costs. Conventional loans go as low as 3% but may be 5% for lower credit. FHA loans are 10% for credit scores of 500-580 and 3.5% above that level.
Even reaching those minimum down payment amounts can be a struggle for many people. However, if you do happen to have more cash available then you may want to consider a larger down payment. Anyone getting a conventional loan should shoot for 20% down whenever possible to drastically reduce your overall purchase cost. Without a 20% or higher down payment, you'll have to pay for private mortgage insurance (PMI). PMI simply gives you another monthly payment that makes your mortgage more expensive. All FHA loans, even with 20% down, have to pay PMI for 12 years.
Lower down payments result in a higher principal balance that gets financed. This gives you larger monthly payments. PMI then gets added on top of that to increase the payment even more. As a result, 3% down compared with 20% down can often result in payments being $300 up to thousands per month higher.
You quite frankly need a lot of cash in the bank to buy a house. This will make your transition into being a homeowner much easier and smoother. In addition, this is also another factor that lenders will look in when they decide whether to approve or deny your loan.
Down payments might range between 0% and 20%. Closing costs are another 3% to 6%. Paying 20% down and 6% closing costs on a $300,000 house would require $78,000 at closing. If you were only focused on the $60,000 down payment, you could find yourself unable to complete the purchase.
In addition to those major expenses, you'll also need extra cash for inspections and moving expenses. Some people may even want some minor work done to the house before they move in. Lenders also want to see that you have 3-6 months' worth of mortgage payments in the bank in addition to your other funds. This is so you're not broke on closing day and can still afford your monthly payments.
Each lender and/or type of home loan can have different requirements to get approved. Credit score, DTI, income and money in the bank for a down payment and additional costs are the biggest factors that they will look at. They'll also look at the house itself and insist on an inspection being performed to ensure there aren't major problems. While the big factors are mostly the same, others will change from one situation to the next.
Job length has been one thing in particular that has been changing a lot lately and may still change in the future. When the COVID pandemic happened, mortgage lenders started to require six months of job history to get approved. Self-employed people have always needed 2+ years in business with a good income.
FHA loans have their own list of requirements that you won't find on other types of loans. Some of them will actually be requirements for the seller's home and have nothing to do with you. For example, the roof and air conditioning system can't be more than a certain number of years old on houses financed with FHA loans. Once you know the type of loan and lender you're using, make sure you find out the little details that can make or break your final approval.
Last Minute Check-Ups
The home buying and financing approval process has a lot of back and forth between the lender, broker and buyer. You'll have to prove your income and submit past tax returns. One random day you'll be presented with a literal laundry list of documents that are needed from you. I believe my list asked for 12 things, and they want most of this stuff quick.
After some time passes and you provide a ton of requested information, don't be surprised if you're asked to provide an item a second time. You may even get some bad info from the broker along the way and have to repeat some steps.
Just when it seems like you're finally close to the end, you'll probably get yet another document request. They'll want more clarification on some items, verification of down payment and closing funds, and even yet another proof that my income has continued. Being self-employed, I ended up providing two years of tax returns two separate times. I had to show a year-to-date profit and loss statement and show that I was still in business. Then right before closing they wanted more proof that I was still in business including payment records from sales from the last 7 days.
Clear to Close
Unfortunately, until you get a clear to close letter and/or a verbal confirmation that you are clear to close on your home loan, nothing is guaranteed. Something may get discovered at the last minute that can stop or delay a sale. The only issues I experienced with my house purchase was a delay of 4 days beyond the originally intended closing date. It was those 4 days when they were bugging me about proving my last 7 days of business income, so they can seriously string you along until the last second and then some.
I have heard of bad situations happening right before closing and sales completely falling apart. This actually happened two different times on the house I bought with two buyers before me. Through no fault of the seller, their financing fell through and got denied no more than 3 days away from their closing date.
Once you have a clear to close confirmation, you'll get instructions to wire your down payment and closing costs and a final closing date! Until you get that confirmation though, try to remain hopeful but also don't be too shocked if something unexpected happens. Don't move out of an existing house, sell furniture or do anything else drastic until you're 100% sure that you're going to get a final approval for your mortgage financing application.