Applying for a home loan can be super stressful. In this article I’ll tell you how to qualify for a loan and how to get pre-approved. We’ll cover how to go through the entire process without getting taken advantage of or hurting your credit.
Over the last 5 years, I’ve taken out 10 different loans! The first one that I did was terrifying because I had no idea what went into the process. So in this article, I’m going to teach you what I learned, and we’re going to make sure you know exactly what you need to know to get a house loan. By the time we’re done, you’ll know everything you have to do to get pre-approved for a loan so that you can get into that first home. We will go through every single step, so sit back and enjoy your guide to the home loan application process.
With every bank there are 4 things they will look into:
Your credit score
I know that just hearing the words “credit score” can make some people a little nervous. Your credit score can be a scary thing if you don’t know what you’re doing. The reality is, that it’s not that complicated if you understand how it works. To get approved for a loan, you only need a 580 credit score. It’s not that hard to get to that point. With a credit score of 620, it’s a lot easier to get approved, and there are different benchmarks along the way. The higher your credit score, the more likely you are to get approved for a loan, and the lower your interest rates will be. If you’re just trying to get into a property, you really only need the 580 score.
To calculate your credit score, there are 5 factors the banks look at. Each factor is weighted differently. Let’s break them down and look at the relative importance of each.
Credit Score Factor 1: Payment History
The first is Payment History, which is the biggest factor at 35%. All it comes down to is making sure that you are paying your bills on time. If you don’t have any credit, you won’t be able to prove that you’re paying on time. It’s so essential that you have at least three lines of credit. If you don’t already have it, go and get three credit cards. Or two credit cards and a loan on your car.
I know you might have it ingrained in your mind that credit is bad, don’t get credit because you will get into debt, etc. Credit is what makes the world go ‘round. I’m not telling you to blow all your credit and let it build up to a ton of debt. Don’t do that! Pay off your bills every single month. This is how you prove to the bank that you can have credit and pay it consistently. This is so important because it’s worth 35% of your credit score.
Credit Score Factor 2: Amount of Debt/Credit
Next is the Amount of Credit that you already have. At 30% of your credit score, this is another very important factor. So as we said, you need to get at least three lines of credit so you can start building credit. But with those lines, make sure that you’re always paying them off every month and that you never use more than 10%. So if you’ve got a $3,000 line of credit on your credit card, don’t use more than $300 every month.
There’s another benchmark at 30% where you can still gain points if you keep your credit utilization under 30%, but you’re still going to be able to build your credit a lot faster if you’re staying under 10%. I don’t mean leave 10% unpaid on your card every month. I mean use up to 10% of your credit, and then pay it off completely at the end of the month. If you do this, you’ll be blown away by how fast your credit score goes up.
Don’t get garbage credit! So many people will go and get a Best Buy card, a Macy’s card, or something like that. Don’t apply for those cards! Those are bad cards and they don’t get you nearly the amount of points on your credit score. You need to get Tier 1 cards. These are the cards from Tier 1 banks like Wells Fargo, Bank of America, Chase, any of the bigger banks. These are the cards you want because higher credit is given for those than the garbage department store cards.
Credit Score Factor 3: Length of Credit History
Then Length of Credit History is the next aspect they will look at. This is actually worth 15% of your credit score. The way that you build this up is again by taking out credit and showing that you can consistently make payments. That’s why it’s so important for you to get three credit cards and to get a car loan and make those payments. Every six months you will get additional points to your credit score when you prove that you can make payments over an extended period of time. Don’t go take out a car loan and pay it off a month later, that won’t do you any good. You need to show consistent payment history for those six month, year long, and two to three year periods to build up this aspect of your credit.
Credit Score Factor 4: Amount of New Credit
The next aspect is the Amount of New Credit. This is only worth 10% of your score, but I’ve seen a lot of people mess up their score because they don’t understand this aspect. They hear that they need to get credit to get a home loan, so they go out and get three credit cards, take out a loan on their car, and then apply for a mortgage on their house. They get denied because they’ve jacked up their score by getting a ton of new credit. New credit is bad for your score. It’s a catch-22 because you need to get that credit to build up your length of credit history. So you will have some dips in your credit. But if you’re trying to apply for a mortgage tomorrow, don’t get any new credit.
When you’re shopping out different lenders, whether it’s credit unions or banks, make sure that you shop them out and don’t let them pull your credit. You need to ask them all the right questions, find the lenders that you think have the greatest likelihood of approving you for a loan. You do this by looking at all of the other aspects that we’re talking about right now. Once you find the lender that knows their stuff and knows you’ll get approved with all the other factors they’ve looked at, as long as your credit score is decent, then you have them pull your credit. Every time you get it pulled, that affects your credit score. Let’s say you’re shopping out ten different lenders, and they all check your credit. The last one might have approved you if they had been the only ones who checked your credit, but since you’ve had it checked so many times already you may have lost 10, 20, or even 50 points because of all the other lenders checking it. Having your credit checked too many times may be the ultimate factor that leads to you not getting approved for a home loan. So only have the lender pull your credit once you’re comfortable with the one you want to work with.
Credit Score Factor 5: Credit Mix
And finally the last aspect of your credit score is your Credit Mix. This is only worth 10% of your credit score. If you’re trying to get a loan on a house, and you don’t have a good mix, go ahead and get the loan on the house. Don’t try and get your mix beforehand. If you’re thinking of applying for a home loan down the road or after you’ve got the home loan and you’re ready to build your credit, then you’ll want to get a mix of credit. That means getting your three credit cards, a car loan, and a mortgage. If you have those five things, you’re going to look awesome to a lender as far as having the right mix to maximize that 10% of your credit score.
Just remember that even if your credit isn’t perfect, you’re still going to be able to apply and get approved for a loan. So take advantage of these tips, but don’t freak out. Talk to a great lender. I promise you they’re going to be able to help you get approved as long as you’re doing everything else that we talked about right.
Outside of your credit score, there are a few other factors that lenders use to determine whether and how much to loan to you.
Your job history/income is the next thing that lenders will be looking at. What does that mean? First off, it means that you have a job, and that you can show you’ve got enough income to pay your mortgage. We’ll talk about that later with the debt to income ratio. The biggest aspect of this is that if you’re W-2, you’re set because you can show you have a consistent wage that isn’t going to be changing.
However, if you’re on a commission based job, or a 1099, then you’ve got to show two full years of getting paid enough income in this commission job. That can be a roadblock if you’ve got a huge income, but say you only have one year under this commission job. Now, if you’re working with a good lender, sometimes they can find a loophole to get you through. But two years is usually what they are looking for.
Debt to Income Ratio
The next aspect that banks are checking will be your debt to income ratio. For some reason when people hear this, we freak out. It sounds like some crazy wild algorithm that they’re looking at, but it’s really not that complicated. I’m going to break it down so you know exactly what to look at to know if you fall into the right debt to income ratio to get approved for a loan. The first thing that you need to know is if you’re doing an FHA loan, you can have a 55% or less debt to income ratio to be able to get approved. When it comes to a conventional loan, you only need 50% or less. A lot of people think that when they look into the debt to income ratio they’re looking at insurance, utilities, groceries, etc. They’re not looking at that stuff. They’re only looking into car payments, student loans, other house payments, or any other debt that’s actually reported.
So to figure out your debt to income ratio, let’s do a quick scenario. Let’s say that you’ve got $3,000 dollars in total income every month. Say that you have a $500 car payment. On your student loans, let’s say that you have $200 to pay down 1% of your student loan every month. On your credit cards, we’ll say you need to make a minimum payment of $300. If you do the math on that, that should put you right at $1000. That means to get to your 50%, you have $500 more to spend. On your monthly mortgage payment, you need to be $500 or less.
If you need to change it around because you want a bigger mortgage, then you need to eliminate some of this other debt. You could also increase your income. Either way, that’s how you need to calculate it to get to that 50%. You don’t want to be at exactly 50% if you can help it, because the likelihood of you getting approved goes way up if your debt to income ratio is lower. For most banks and credit unions, you can get approved if you’re at that 50% mark or less.
The last aspect that they’re looking at is your cash on hand. All they want to see is that you’ve got enough cash to make your down payment, your closing expenses, and still have money in the bank so you don’t send yourself into bankruptcy. So as long as you’ve got that, you’re going to be good. Talk to your mortgage officer to make sure that you’ve got enough on hand. They will tell you what that number is going to be for you. Also remember that the more money you have in the bank, after being able to afford your down payment, the better you look to lenders. Make sure that if you do have the ability to keep more money in the bank, do it. This will help you get approved for that loan.
That’s it! If you’ve got all of those aspects, you’re going to get approved for a loan! One last tip that I wanted to give you, and this is probably the most helpful hint, is to find an incredible loan officer. Find someone who has done tons of loans, and someone who is willing to get creative for you. I’ve seen people that are just barely meeting all these requirements, but they don’t get approved for a home loan because they don’t have a loan officer that’s willing to go to bat and help them manipulate things to make sure that they get approved. Do your research, go meet with multiple loan officers, and find the one that can say “If you do XYZ, I’m going to get you approved.”