Buying your first home can seem overwhelming at first glance, but take a deep breath, we’re here to help you. Understanding the process of obtaining your first mortgage and what’s required can help you plan and uncover any surprises upfront, plus save yourself from unneeded headaches down the road. All good things right? We will go over the most common home buying requirements and possible pitfalls of the home buying process to make your experience as smooth as possible.
Underwriting Requirements and Qualifications for first time home buyers
First time home buyers need to meet various requirements in following qualification categories, which can vary slightly depending on your loan program:
- Credit Scores
- Credit Profile
- Debt to Income Ratio
- Property Requirements
Think of each of these requirements as a stand alone pillar. If you falter in just one of the pillars, you will not receiving financing to purchase the home. We’ll dive into each on of these underwriting requirements in depth. Prior to the credit and housing crisis of 2008, qualifying for a mortgage was quite frankly, easier. Back then, if you had a strong credit score and a big downpayment, that could make up for difficult to prove income (self employed income is typically more difficult to verify). They called those types of loans stated income. Your loan officer would ask, “How much money did you earn in 2007? You could make up any number and the loan officer wouldn’t verify whether your statement was true or false. However, the industry has done a complete 180 degree turn since then and, as a general rule of thumb, EVERYTHING IS VERIFIED, and more rules have been created. Our investors publish 1,000+ page underwriting and qualification guidelines for us to follow. If you think we’re kidding, check out Fannie Mae’s UW Guide (Starts on Page 176). We’ll walk you through the basic requirements.
Credit Score Requirement
Credit scores provide a lender a quick way to determine the likelihood of repaying a loan. A credit score can range from 300 to 850 and is made up of many factors including payment history, how much $ you currently owe, length of your credit history, amount of newly opened credit and other factors. In the eyes of a lender, a score of 300 means you have an extremely low probability to repay the loan while a score of 850 score indicates a high probability of repayment.
Minimum Credit Score For a Mortgage
Different loan programs require different minimum credit scores. The Federal Housing Administration (FHA) requires a minimum credit score of 580, while conventional loans and other first time home buyer programs typically require a minimum credit score of 620. Accunet’s company policy requires a minimum credit score of 620.
During the pre-approval process, we will gather credit scores from 3 companies: Equifax, TransUnion and Experian. We will then use the middle score from the three scores returned. So if you receive scores of 600, 720, 740, your credit score for your application will be 720. When we access your credit it is required by law that they send you a copy of the credit report. Get started with your pre-approval and get your verbal credit scores today.
Let’s run through a common scenario. You are pre-approved in March. Your pre-approval letter will be good for 90 days. You go home shopping in April and get an accepted offer two months later on a home in May and an expected closing date in June. Your credit scores will be good for 120 days and will not need to re-accessed. However, if the original credit report becomes older than 120 days, we will re-access your credit scores. If you missed a payment and your scores drop below the minimum required score, you will no longer qualify. As always, during the time between getting pre-approved and closing, you’ll want to ensure you’re current on all payments.
Credit Profile Requirement
A rough rule of thumb is you will need 3 open trade lines to qualify for a conventional loan. Sadly, we’re not talking about the Oregon Trail and whether you should try to ford the river or take the long route, we’re talking about credit cards, installment loans, car lease, student loan or any other installment/on-going payment that gets reported to the credit bureaus. In Wisconsin, Wisconsin Electric reports to the credit bureau and that can be counted as a trade line when required. However, that means if you have missed an electric bill payment recently, you may have a less-than-stellar credit score, so please pay your electricity bill on time.
A Federal Housing Administration (FHA) loan may allow you to utilize a non-traditional credit profile using things like rent payments, un-reported utility payments or phone bills. This type of exception is always underwriter discretion and may not be possible, but why not try if it is the only option.
I have 0 trade lines, how do I start building my credit profile?
The hardest thing is starting, and the best thing you can do is start today. If you have 0 trade lines it means you won’t even have a credit score. So when a company goes to access your credit, the 3 credit bureaus will not even return a score. The minimum requirements for a score are:
- One account opened for at least 6 months
- Account history within the last 6 months
- Cannot be marked deceased on your credit report
One of the easiest ways to start building your credit is with a credit card. When you do not have a credit score, banks are less likely to approve you for a credit card, or they may give you a low credit limit. CapitolOne has been known to provide credit cards for people without credit scores. The other option is a secured credit card. A secured credit card works like a debit card. You pre-pay the card with anywhere from $200-500. As you spend, it deducts from your initial balance. The difference is, it is reported to the credit bureau. Once you have a credit score, you shouldn’t have a problem getting a normal credit card. Again, you’ll want to have 3 open and active trade lines when applying for a mortgage.
Debt to Income Requirement
An underwriter uses your credit scores and credit profile to see a proven track-record of making payments, but they also need to be certain that you’ll have enough monthly income to pay your debts going forward. The underwriters figures this out by performing a calculation called a debt to income ratio (DTI).
The DTI calculation takes your monthly debt payments and divides them by your total monthly income (Monthly Debts / Monthly Gross Income).
Monthly Debts Include
- Mortgage’s Principal and Interest Payment
- Taxes and Insurance (including Monthly Mortgage Insurance)
- Car Loan/Lease Payment
- Student Loan Balance * 1% = Monthly Student Loan Payment for Qualifying
- Total of your minimum required credit card payment
- Child support or alimony payment
In general the formula is:
Total Monthly Debt Payments / Monthly Gross Income = DTI
(Principal and Interest + Taxes + Home owners Insurance) / Total Gross Monthly Income.
More in Depth: Calculating your Total Debt Payment
If you’re applying with someone else or a spouse, both person’s income and debts will be factored into the DTI calculation.
Credit Cards: Take your minimum required payment for each card and add it together
Installment Loan (think car loan): Add your monthly payment
Student Loans (these are the trickiest): Payment for qualification purposes is the lower of your student loan amount * 1%. So a $100,000 loan will have a $100 payment. OR the actual payment that will fully amortize the loan. That’s a calculation one of our loan consultants can run you through.
Ultimately it comes down, to what is reported on your credit report. If you have a minimum credit card payment of $200 reported, but you paid off the card last week, a lender will have to use the $200 as a payment because it was reported on the credit bureau.
Major Purchases during Underwriting are NOT Recommended
New house means new furniture, right? Yes, of course, however, waiting until after closing to open up that new credit card with the new bedroom set is recommended. Here’s why: At the end of the underwriting process,your lender will “refresh” the balances of your credit trade lines. Not a new report but just to make sure things look the same as when you started the process. If numbers change, your lender will recalculate your debt to income ratio using the new numbers.
When you’re at high end of the DTI ratio at the beginning of the process, a new debt payment during the process could put your ratio above the maximum DTI limit. If you’re nearing the maximum 43% DTI limit, DEFINITELY wait to put large purchases on credit until after closing. The soft credit check performed at the end of the process doesn’t return your scores, but it does return your debts and their updated payments. We will have to update our DTI calculation accordingly.
Employment is straight forward when you’re a W2 employee, it gets much more complicated when you’re self employed or run a business. When you’re a W2 employee, you’ll need to provide pay stubs showing 30 days of pay. Even if you’ve recently switched jobs, 30 days of employment will suffice when your new job is within the same industry. If you’ve switched industries, you may need to be at your employer for at least 6 months, but often times we can get an exception to this rule.
Self Employment Income
Self employment and owning your own business increases the difficultly of qualifying because it is more difficult to prove income.
Let’s look at an example. You started your consulting business 1 year ago and you’re doing great. You earned $50,000 last year and you’re projecting to earn $75,000 next year. Unfortunately, due to the length of self employment, underwriters will not count this income. Self employed borrowers need to show 2 years of income. Assuming you have no other income source, an underwriter of a conventional mortgage will not be able to count your business income as a source of income until you show 2 full years.
Let’s look at another example. In year 1 of your business, you earned a profit of $25,000. In year 2, you earned a profit of $50,000. First, you’ll also have to provide explanations because your income varied over 25% from year to year, despite the increase being positive. Lenders like stability and predictability. For your debt to income ratio calculation, underwriters will use the average of the two years, not the latest year. That means your gross yearly income for DTI calculation is $37,500.
Part Time Income
Part time income, just like self employment income, can only be counted when you have had it consistently for 2+ years.
Conventional loans require as little as 3% down while FHA Loans require a minimum downpayment of 3.5%. However, if you meet special requirements we offer you a 0% down payment option through Wheda (Wisconsin Housing and Economic Development Authority.
How much money do I really need?
Let’s do an example. You write an offer for $200,000 on a house and plan to put 3% down. You’ll need to come up with $6,000 for your downpayment, but that’s not all. We also need to factor in Property Taxes, Recording Fees, Interim Interest, Funding your Escrow Account with home owners insurance and lastly, any closing costs associated with obtaining your mortgage. It gets confusing quickly because there are so many moving parts. Below shows 3 examples detailing a 3% down transaction.
Each of those 3 examples shows a $6,000 downpayment, but due to different loan costs, the required amount for closing goes up or down. In column 1, the total funds to buy the house is $10,180, and the required cash needed at closing is $9,330.In column 2, the total funds to buy the house is $9,012, and the required cash needed at closing is $8,162. Both those options require quite a bit more than $6,000. Assuming you only have $6,000 for your downpayment and you really want the house, you have two options: A Gift, or a Seller Credit.
Obtaining a Gift
Here is an article on can I receive a gift as a downpayment.
The seller credit can go towards everything except for the down payment (that’s really good news!). Here’s more details on that.
You’ll need to provide bank statements to prove you have the funds for your downpayment. The underwriter will look through your bank statements looking for Large Deposits. Mortgage Underwriters seem nosey, but really they’re looking for money laundering schemes. What’s a large deposit in the eyes of an underwriter? A large deposit is anything over 50% of your monthly pretax income. Let’s say you earn $4,000 a month, anything over $2,000 would need a letter explaining where the deposit came from. The underwriter may also request a statement from the source of your large deposit.
Private Mortgage Insurance
Lastly, as a FYI: When you put less than 20% down, you’ll be required to pay private mortgage insurance. Some first time home buyer programs do NOT require private mortgage insurance (WHEDA). Another option to avoid monthly private mortgage insurance is pre-paying your mortgage insurance with a seller credit. Rest assured, all of our loan consultants will be able to perform a cost analysis detailing which option suits you the best.
Purchasing a single family home typically has no additional underwriting requirements. However, beware of other large structures on the land of the single family home. Can you get a conventional loan on the beautiful ranch with a similar sized barn in the back yard? No, because a conventional underwriter wants the vast majority of the structural square footage of the property to be the residence. Basically, no large structures in the back yard. The acceptable property types for a mortgage are:
- Single Family Home
- Town House
- 2 Unit
- 3 Unit
- 4 Unit
Some of these properties come with their own requirements which we will now go over.
Are there active remodels being done within the property?
This requirement isn’t limited to first time home buyers, but all purchase and refinance transactions. However it is something worth knowing because first time home buyers can miss it.
It is HIGHLY likely that an appraisal will be required on the property you are purchasing. Once you have an accepted offer on a property, Accunet mortgage will take an appraisal deposit and order the appraisal. An appraiser will go out to your future home, take a bunch of pictures, find comparable properties and provide us an appraisal report with an appraised value (we will also send you the appraisal report). The value is important, of course, but the kicker is the condition of the property. If there are any active remodels going on, the appraiser will make their report subject to the completion of the remodeling. The property can be in a less-than-ideal condition, but it cannot be incomplete. If the bathroom is all torn up, it’s likely that the repairs will be required to be finished prior to closing. Just be sure, your property is finished and no active remodeling is going on because all remodeling will be required to be completed before closing.
Purchasing a condos requires special treatment because the condo association must meet Fannie Mae’s guidelines. Lenders require a condo questionnaire to be filled out which asks questions about the Condominium project and the HOA’s insurance policy. Let’s go over some of the required aspects of the HOA insurance policy.
Replacement Cost Coverage
Every condo project must be insured to cover 100% of the cost to replace the project improvements, including the individual units should it be hit by a meteor and destroyed. In order to meet that, the Fannie Mae requirement states the policy must indicate that they have guaranteed replacement cost, extended replacement cost or have inflation guard endorsement. If the policy does not have this specific language or endorsement then lenders need to get verification from the insurance agent that the coverage amount is reviewed annually with the HOA and the amount is adjusted accordingly to insure it remains equal to 100% replacement.
Building Ordinance or Law Endorsement
This endorsement insures against the increased cost of repairs or improvements that could be enforced by new codes or land use laws after a covered loss event occurs.
Boiler and Machinery/Equipment Breakdown Endorsement
This endorsement is required to protect against loss of a projects central heating or cooling blowing up. The coverage amount should be equal the lesser of $2 million or the insurable value of the buildings housing the boiler or machinery.
Fidelity coverage is required on all condo projects with more than 20 total units. Also called employee dishonesty. Protects against theft or embezzlement by HOA board members, management firms, etc…basically for those who might have access to the association funds. The HOA coverage must be at least equal to the greater of 3 months HOA dues or total of funds held in reserve and operating fund accounts (defined as reserve fund plus operating fund divided by 4 or just operating fund if reserve fund does not exist).
Severability or Interest/Separation of Insureds
This is required to be a part of the liability policy. It essentially provides the condo unit owner the ability to sue or file a claim against the HOA, even though they are a member of the HOA. This means you will technically be suing themselves to some degree, but we’ve all seen weirder things.
Other Questions To Ask your Agent about the status of the Condo Project
- Is the condo project complete?
- If not, how complete is it?
- Is the condo project done with all phases?
- What percentage of the units are owner occupied?
- And other questions…
When you’re out with your realtor, you can ask these basic questions. Essentially an underwriter wants to see a completed condo project and see a large percentage of units as owner occupied. Based upon the answers on the questionnaire, a lender will be able to lend you money on the condo or not.
MultiFamily (2-4 Unit) Requirements
MultiFamily Units require a larger down payment.
Wrapping it all Up
The mortgage approval process is continually changing with new and different rules being implemented each year. In general, the easiest way to get an answer to your question is to give us a call at 262-781-1100. We are happy to help in any way we can.