Buying your first home is an exciting time. However, the process of buying your first a home can add unneeded stress at an already stressful time. We will uncover common home buying requirements and possible pitfalls of the home buying process to make your experience as smooth as possible.
We will briefly go over the home buying process and then take a deep dive into first time home buyer requirements from the perspective of obtaining a home loan (mortgage). We’ll get into questions like Do I qualify to buy a home? and What are the requirements to buying my first home?
If you’re paying cash for your home and you do not need a mortgage, this article will likely be unhelpful to you. However, if you’re like the vast majority of first time home buyers and need a mortgage, this article will hopefully be extremely helpful.
Home buying process overview
In a nutshell, it is…
- Get pre-approved from a lender
- Find a Realtor
- Find a House
- Write an Offer on the House / Counter Offer
- Receive an Accepted Offer
- Call your mortgage company IMMEDIATELY to get the process started
- Mortgage Underwriting
- Get Home Inspection / Complete Paperwork for Application
- Lender will schedule Appraisal
- Receive Financing Contingency
- Mortgage Approval
We’re going to mostly focus on #1 Get pre-approved and #7 Mortgage Underwriting because that’s where we have the most experience and where things can go awry. Let’s dive in.
What is a pre-approval letter and what is its purpose in the home buying process?
A pre-approval letter is a piece of paper that you get from a bank, credit union or mortgage banker. A pre-approval letter tells the seller, “Hey, the person who wrote this offer to purchase your house. I’m here to tell you, this person will be able to obtain financing to buy your house. Rest assured, if you accept their offer, everything will work out great!”.
That’s great in a perfect world, but here’s the problem, not all pre-approval letters are created equal. Most lenders will issue what is known as a Credit Verified Pre-approval. The lender goes through the motions of obtaining your social security numbers, dates of birth and other basic information needed to access your credit reports. They first look at your credit scores and ensure they meet the minimum credit scores to qualify (more on that later). Then they likely look at your open credit cards, installment loans and other debts to ensure you don’t have any late payments, bankruptcies or collections. They ask you basic information about the purchase price and downpayment. If that all looks good, they tell you the rate and issue you a credit verified pre-approval which will be good for 90 days which becomes your home shopping window.
Unfortunately, a typical credit verified pre-approval is NOT good enough in today’s world where strict lending guidelines dominate everything. A credit verified pre-approval can lead to unexpected surprises during underwriting possibly preventing you from obtaining financing on your home. During mortgage underwriting you’ll face substantial amounts more scrutiny with regards to verification of downpayment, income and debts.
Going through verifying your downpayment, income and debts eliminates surprises down the road and that’s why we encourage all of our first time home buyers to get a Rock Solid Pre-approval. A rock solid pre-approval is different because Accunet will run you through a complete application process UPFRONT in hopes of discovering any underwriting pitfalls before ever writing an offer. Plus, you’ll have the piece of mind of having the next best thing to a cash offer. For now, let’s dive into some of those underwriting requirements.
Underwriting Requirements and Qualifications for first time home buyers
Qualifying for a mortgage has the following qualification categories each with its own unique requirements.
- 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 qualify. We’ll dive into each on of these underwriting requirements in depth. But, let’s do a little history lesson first. 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 little to no income. 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 your income. However, since the crash, the industry has done a complete 180 degree turn since then and, as a general rule of thumb, EVERYTHING IS VERIFIED. On top of that, more rules have been created. Our investors publish 1,000+ page underwriting and qualification guidelines for us to follow. If you think I’m kidding, check out Fannie Mae’s UW Guide (Starts on Page 176).
Credit Score Requirement
Credit score provides 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 a 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 company policy requires a minimum credit score of 620.
During the pre-approval process, a lender will access your credit scores from 3 companies: Equifax, TransUnion and Experian. The lender 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 a lender accesses your credit it is required by law that they send you a copy of the credit report.
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 a borrower 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, etc. A trade line can be any of the following: credit card, car loan, 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. However, please be sure to 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.
(PERFECT TIME FOR THIS [can rocket clicks create?]) — Check out our post on Build your Credit Profile when you have no credit.
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
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, once again, 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 what’d reported from 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 close to the 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.
Employment is straight forward when you’re a W2 employee, it gets much more complex 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. If you’ve recently switched jobs, 30 days of employment will suffice if your new job is within the same industry. They call that continuity of employment. If you’ve switched industries, you’ll need to be at your employer for at least 6 months.
Self Employment Income
Self employment and owning your own business increase the difficultly of qualifying.
Let’s look at an example. You started your consulting business 1 year ago and you’re crushing it. You earned $100,000 last year and you’re projecting to earn $200,000 in the next. 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.
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. 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. 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.