Your Guide to Mortgage Income Requirements
House hunting is a lot of fun, but before you start shopping, it’s vital to know what you can afford.
Because requirements vary between mortgage products, there isn’t a one-size fits all rule for the amount of income needed to be preapproved for a mortgage.
However, there are fundamentals that your personal lender will follow when determining your loan eligibility. It comes down to:
- Income: How much money you bring in each month. Income can come from a job or multiple jobs, rental property, banking interest, royalties, capital gains, and more.
- Debt: How much money you pay out each month. Debt can include credit card debt, student loans, car loans, current mortgages, business loans, or even payday loans.
- Assets: Total value of what you own. Lenders primarily seek information on assets that can be easily validated and liquidated if needed for the transaction. Examples of this would be savings and checking accounts, investments, retirement funds and gift funds.
- Liabilities: Total value of what you owe others. Often, this is confused with debt because all debts are liabilities. However, liabilities also include child support or alimony and other long-term obligations.
Your lender considers all of these factors to see the complete financial picture. Then, they’ll decide how much to loan an applicant based on those factors.
When financing a new home or property, your income, the down payment amount, and your living expenses determine the loan amount. Your credit history and credit score will be part of the considerations as predictors of the interest rate.
Guide to Mortgage Guidelines
As a general rule of thumb, lenders prefer that your mortgage be less than 28% of your gross income. Your monthly gross income includes your salary, bonuses, and outside income. That means if you (or a combination of you and a co-owner) make $5,000 per month, your personal lender is looking for a loan that puts the monthly mortgage payment near or less than $1,400.
That monthly payment often also includes the cost of Private Mortgage Insurance (PMI), taxes and homeowners insurance. This means that the market in which you’re conducting your home search can also impact your loan amount.
Before developing a preapproval plan, lenders will also look at the monthly debt you incur and your future income.
- Do you anticipate making more money?
- Will you incur more debt?
- Will you put down more than 20% for the mortgage or less?
These factors can affect the 28% rule positively or negatively and are known as the front-end ratio for determining eligibility.
Understanding the Back-end Ratio
Your personal lender will also help you quantify your debt-to-income ratio (DTI). This formula helps a lender understand how much income it takes to cover your debt.
Another rule of thumb: your DTI should not be more than 43% of your income. So, if you’re still making $5,000 per month and you have a $300 car payment, $200 per month in credit card payments, these debts would be added to your potential future housing payment of $1,400 to determine the back-end ratio, which in this case, would be 38%.
A higher DTI typically lowers the total loan amount for which a borrower could qualify. A lower DTI allows a borrower to apply for a higher loan amount.
How Your Credit Score Plays a Part
The better your credit score, the better your options will be for an interest rate. The lower your interest rate, the higher your qualified mortgage could be (because you’ll pay a smaller portion of your monthly payment to interest, you can afford a higher loan).
To qualify for the best interest rate, it’s necessary to have an excellent credit rating. FICO lists any credit score at or above 720 as “excellent.” A “good” credit score falls between 690 and 719.
Credit scores in the high 600s or low 700s can still be improved. With a little work, you can boost your credit score by as much as 100 points in six weeks, which will improve your options for a lower interest rate.
Getting the Loan
Once your personal lender provides you with preapproval options, it’s ultimately up to you, the borrower, to decide your loan comfort level.
The idea of spending nearly a third of your gross income each month on a house payment can be different for different people. Just because you qualify for a $500,000 loan doesn’t mean you need to take it.
Consider the neighborhood and market where you’re looking to move and some of your other needs. Let’s say you live in a city now with a vibrant public transportation system, and you’re packing up to relocate to a farm. If you don’t have a car now, you’ll likely need one in a rural area, so that added expense might make you consider a smaller monthly payment and, therefore, a smaller loan.
However, if the opposite is true and you’re selling a car or reducing your monthly debt in other ways (paying off student loans, for instance), you might feel like you’re in a position to pay for the bigger loan amount.
Knowing your credit score and monthly financial outlook at your first meeting with your personal lender will guide you toward a better understanding of your mortgage.