Before you start looking at houses, work with your loan officer to get pre-qualified, which will let you know how much home you can afford. This can help you narrow your home search to houses within your budget, give you an idea of how much you’ll need for a down payment, and help you identify budgeting goals to work toward.
To determine the loan amount you can qualify for, your lender will look at your income, debts, savings, and assets. As a general rule of thumb, your monthly housing expense should not exceed 28% of your gross monthly income. While getting pre-qualified can be a big advantage during your home search, it’s not a guarantee for a loan. Getting approved for a mortgage happens later in the process. Learn more about the mortgage application and approval process.
Qualifying for a Loan: What Lenders Look At
To determine the loan amount you can qualify for, we will look at your credit, income, assets, and debts.
The 4 Cs of Credit
Character represents your credit history or financial integrity. Your credit score, how much credit you’ve used in the past, and whether you make your payments on time are examples of your financial integrity.
Capacity represents your ability to repay a loan. The amount of your income and assets are compared against your monthly debts to make sure you can afford a loan.
Collateral is the asset securing the loan — in other words, the value of the home itself. If you default on your payments, the home can be repossessed by the lender.
Capital is how much money you’re able to invest in the collateral, represented by your down payment. The amount of capital you contribute shows that you have “skin in the game” and reduces the risk to the lender.
Understanding Loan-to-Value (LTV)
LTV expresses how much you’re borrowing compared to the value of the home. A lower LTV is more favorable because it represents less risk to the lender. This ratio is calculated as:
For example, let’s say you need to borrow $90,000 to purchase a $100,000 home. Your LTV ratio would be 90%.
The higher your down payment, the lower your LTV. This is important because an LTV higher than 80% (in other words, a down payment less than 20%) typically means you’ll have to pay mortgage insurance. Learn more about how mortgage insurance works.
Understanding Debt-to-Income (DTI)
DTI shows how much debt you have compared to your monthly income. The lower your DTI, the better your chances are for qualifying for a loan. The ratio is calculated as:
For example, let’s say your total monthly debts add up to $2,000, and your gross monthly income is $6,000. Your DTI ratio would be 33%.
Remember, your monthly housing expense (not including other debts) should not exceed 28% of your gross monthly income.