There is a lot of talk going on right now about the first time home buyer tax credit, what will happen when it expires, and whether Congress will approve an extension of the home buyer tax credit program. But no matter what happens with the tax credit for home purchase — and whether or not you end up taking advantage of it — you need to understand what is required if you want to qualify for a home mortgage loan. Here are the basics of what many mortgage lenders are looking for right now:
- Credit Score: In the heyday of mortgage lending, you could qualify for a home loan with just about any credit score. As you might imagine, mortgage lenders are not so rash anymore. In order to even be considered, you will likely need a credit score of 660-680. If you want the best interest rate, though, you will need somewhere around a 720-740. Those low mortgage interest rates are nice, but not everyone will qualify for them.
- Debt-to-Income Ratio: The amount of debt you have in relation to your income is a major consideration for mortgage lenders. They want to make sure that your debt won’t overcome your ability to pay. For most lenders, the debt-to-income ratio tops out at around 40% of your monthly income being used for debt payments. However, if you want the best mortgage rate, you will need to adhere to the 28/36 qualifying ratio. This states that your housing costs cannot exceed 28% of your monthly income, and your total debt payments each month should not exceed 36%.
- Down Payment: The days of 0% down payment mortgages are pretty much over (at least until the next housing bubble), so you will need to put some money down. Many lenders want a 10% to 15% down payment, although some will accept 5% down. For the best rates, some lenders are now requiring 20% to 30% down payments. As a result of these new down payment requirements, many people are turning to FHA loans, which only require a 3.5% down payment.
- Income Documentation: Gone are the days of low-doc and no-doc loans. Now, you need documentation of your income — and plenty of it. Some mortgage lenders require six months of pay stubs and two months’ worth of bank statements on top of your last two years’ tax returns. Making sure that you can handle the payments is paramount to mortgage lenders right now. If you are self-employed, this process can be even more onerous: When I applied for my home mortgage loan, I had to go through an income audit with an accountant (price: $600) in order to acceptably document my income.
In addition to these basic requirements, some banks may require a certain degree of liquidity. They may require that you have at three months’ worth of payments available in a savings account, emergency fund or some other place where it is readily available. Some banks want as much as 12 months or more available for payments. They want to know that if you lose your job or run into some other problem, they will still be paid — for at least a little while.
First Time Home Buyer Tax Credit for Home Mortgage Loans
These rules still apply even if you are trying to get a first time home buyer tax credit, although you can use the $8,000 tax credit toward your down payment. If you want to take advantage of the first time home buyer tax credit, though, you might be running out of time. If Congress doesn’t extend the deadline (currently November 30, 2009), then you need to hurry. Home loans need to close by November 30 in order to qualify. With most mortgages taking around 45 days to close, it means that if you don’t get the paperwork started by October 16, you could be in trouble. If you run into issues, it can take up to 60 days to close on a mortgage — and you could miss the deadline.
Responsibly getting a home mortgage has always required good financial management, planning and preparation. Now, though, with tightened lending standards, it is even more important that you prepare ahead of time to buy a home.
Miranda is freelance journalist. She specializes in topics related to money, especially personal finance, small business, and investing. You can read more of my writing at Planting Money Seeds.