Buying your first home can seem overwhelming, but take a deep breath; we’re here to help you. Understanding the process and requirements for your first mortgage can help you plan and uncover any surprises upfront, saving you from unneeded headaches down the road. All good things, right? Let’s go over the most common homebuying requirements and possible pitfalls of the home buying process to make your experience as smooth as possible.
What are the qualifications for first-time home buyers?
If you’re a first-time homebuyer, you need to meet various requirements in the following categories, which can vary slightly depending on your loan program. Think of each of these requirements as a pillar that leans on the rest of the requirements for support; If there are issues in just one of the pillars, you won’t receive financing to purchase the home.
- Credit Score Requirements
- Credit Profile Requirements
- Debt-to-Income Ratio Requirements
- Employment Requirement
- Down Payment Requirements
- Property Requirements
Prior to the credit and housing crisis of 2008, qualifying for a mortgage was, quite frankly, easier. If you had a strong credit score and big down payment, other issues would be overlooked (such as difficult-to-prove income). The industry has done a complete 180° since then, and as a general rule of thumb, EVERYTHING IS VERIFIED, and more rules have been put in place.
Our investors publish 1,000+ page categorical guidelines for us to follow. If you think we’re kidding, check out Fannie Mae’s UW Guide (Starts on Page 176). These categories are known as underwriting requirements.
Credit Score Requirements
Credit scores provide a lender with a quick determination of your likelihood of repaying a loan. A credit score can range from 300 to 850, where 300 implies an extremely low probability of repaying a loan, while a score of 850 scores indicates a high probability of repayment. Unless there’s a serious extenuating circumstance, your credit score must fall within a range the lender considers acceptable to be approved.
Minimum Credit Score For a Mortgage
Different loan programs require different minimum credit scores:
- Federal Housing Administration (FHA) minimum: 580
- Conventional loans & other first-time homebuyer programs: 620
- Accunet: 620
During the pre-approval process, Accunet (and 90% of mortgage lenders) will pull your credit scores from three different companies: Equifax, TransUnion, and Experian. Your score is averaged from the three — so, for example, if you receive scores of 600, 720, and 740, your credit score for your application will be 720. When we access your credit, it is required by law that those companies 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 in May with an expected closing date in June. Your credit scores will be good for 120 days and will not need to be 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 Requirements
Having a good credit score is incredibly important — but so is the way you built it. A rough rule of thumb: You will need 3 open tradelines to qualify for a conventional loan.
Types of tradelines that help with getting a mortgage:
- Credit cards
- Installment loans
- Car leases
- Student loans
- Any ongoing payment that gets reported to credit bureaus
In Wisconsin, Wisconsin Electric reports to the credit bureau, and that can be counted as a tradeline when required. However, that means if you have missed an electric bill payment recently, you may have a less-than-stellar credit score, so keeping up-to-date on utility payments is a must.
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 at the underwriter’s discretion and may not be possible.
I have no tradelines; how do I start building my credit profile?
If you have no tradelines, that means you won’t have a credit score.
The minimum requirements for a credit 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
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.
One of the easiest ways to start building your credit is with a credit card. CapitalOne has been known to provide credit cards for people without credit scores. The other option is a secured credit card, which 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 tradelines when applying for a mortgage.
Debt-to-Income (DTI) Requirement
An underwriter uses your credit scores and profiles 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 figure this out by performing a calculation called a debt to income ratio (DTI).
Underwriting has slightly different definitions based on the industry you’re referring to. In the real estate industry, underwriting is part of the mortgage process. In it, an underwriter (usually an objective third party with no ties to the deal) evaluates a loan application to determine how much risk a lender is willing to take.
What do underwriters look at?
The underwriting process is essentially in-depth fact-checking; underwriters take multiple things into account before reaching a conclusion, including:
- The buyer’s credit score
- The buyer’s debt-to-income ratio
- Pay stubs that prove reliable income (this can get tricky for commission-based income)
- Bank statements showing your current assets
- Tax returns and W-2
The underwriting process can take anywhere from two days to two weeks, depending on how quickly you compile your records, how many forms you need to submit, and how busy the underwriter is. Since underwriting normally happens right before closing on a sale, make sure to take the waiting period into account, and talk to your Accunet mortgage professional about how to plan for it.
Can I make purchases during underwriting?
You can make purchases during underwriting, but avoid any purchases that might affect your credit.
Here’s why: At the end of the underwriting process, your lender will “refresh” the balances of your credit tradelines. If numbers change compared to the beginning of the process, your lender will recalculate your debt to income ratio using the new numbers.
If you’re at the high end of the accepted DTI ratio, a new debt payment could put your ratio above the maximum DTI limit (43%). If you’re nearing the 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, and we will have to update our DTI calculation accordingly.
In general, the DTI formula is:
To calculate DTI, two numbers are used: Your “back end ratio,” and your “front end ratio.”
Back End Ratio: Total Monthly Debt Payments / Total Monthly Income = DTI
Front End Ratio: (Principal and Interest + Taxes + Homeowners Insurance) / Total Gross Monthly Income.
We know this looks intimidating — you don’t need to worry too much about it unless you want to check your own DTI. The important part is this: Your back-end ratio must be lower than 43% (45% on an exception basis) of your gross income. Your back-end ratio must be below 35% of your gross income. (The FHA has slightly different rules to accommodate extreme circumstances.)
Types of monthly debt can include:
- Credit cards: Minimum required payment for each card, added together
- Car loan/Lease payment: Your monthly payment
- Student loans: 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.
- Child support or alimony payment
Employment is straightforward when you’re a W-2 employee; it gets much more complicated when you’re self-employed or run a business. If you’re a W-2 employee, you’ll need to provide pay stubs showing 30 days of payment. 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 oftentimes we can get an exception.
Self -employment income
Self-employment and owning your own business make it difficult to prove income, increasing the difficulty in qualifying.
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 (1 year), 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 company 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 an explanation, because your income varied over 25% 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, just like self-employment income, can only be counted when you have had it consistently for 2+ years.
Down Payment Requirements
Conventional loans require as little as 3% down, while FHA loans require a minimum down payment of 3.5%. However, if you meet special requirements, we can offer you a 0% down payment option through WHEDA (Wisconsin Housing and Economic Development Authority).
How much money do I really need for a down payment?
When buying their first home, many people think they need to put 20% down to get the deal approved — that is not true. Homebuyers can put anywhere from 3% down —That being said, paying less money up-front isn’t always the best idea.
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 down payment, but that’s not all. We also need to factor in property taxes, recording fees, interim interest, any closing costs associated with obtaining your mortgage, and other factors. So, depending on your other loan costs, you could end up paying way more than you intended to.
Making a down payment has tons of moving parts, so it can get confusing, fast. Here are examples detailing a 3% down transaction, and how they can be different based solely on other costs:
Each of those 3 examples shows a $6,000 down payment, but due to different loan costs, the required amount for closing changes. 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.
Verifying your funds prior to making a down payment
You’ll need to provide bank statements to prove you have the funds for your down payment. Mortgage Underwriters seem nosey, but really they’re just looking for money laundering schemes. The underwriter will look through your bank statements looking for large deposits.
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
When you put less than 20% down, you’ll be required to pay private mortgage insurance. Some first-time homebuyer programs (like WHEDA) 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 large structures on the land beside the house itself.
For example: Can you get a conventional loan on the beautiful ranch with a similar-sized barn in the backyard? No, because a conventional underwriter wants the vast majority of the structural square footage of the property to be the residence itself. Basically, there can be no large structures in the backyard.
Call Accunet’s realty team to get started on your pre-approval process.
Acceptable property types for a mortgage:
- Single Family Home
- Town House
What if there are active remodels being done within the property?
This rule applies to ALL purchase and refinance transactions, but first-time homebuyers are typically the most liable to miss it. If there are any active remodels going on, the appraiser will make their report subject to the completion of the remodeling.
It is HIGHLY likely that an appraisal will be required on the property you are purchasing. Once an offer has been accepted, 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 a 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. The property can be in a less-than-ideal condition, but it cannot be incomplete. All remodeling will most likely be quired to be completed before closing.
Purchasing a condo 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 Homeowner Association’s insurance policy.
Requirements 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 they be hit by a meteor and destroyed.
- 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. The coverage amount should be equal the lesser of $2 million or the insurable value of the buildings housing the boiler or machinery.
- Fidelity Bond/Employee Dishonesty: Fidelity coverage is required on all condo projects with more than 20 units. This protects against theft or embezzlement by HOA board members, management firms, etc.
- Severability or Interest/Separation of Insureds: This provides the condo unit owner the ability to sue or file a claim against the HOA.
- 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.
These are great questions to ask your realtor. Essentially, an underwriter wants to see a completed condo project and a large percentage of units as owner-occupied. Based upon the answers to the questionnaire, a lender will be able to lend you money on the condo (or not).
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