Mortgage approval comes down to three questions a lender asks about you, and one about the house. Have you repaid debts reliably in the past, do you earn enough to carry this one, and how much of your income is already committed? Knowing where you stand before you apply is far more comfortable than finding out from a rejection.
Check Your Credit First, Not Last
The most avoidable mortgage problem is discovering an error on your credit report while under contract on a house. Errors are common, and correcting one takes weeks you will not have. Check months ahead of applying.
You are entitled to free copies of your reports from all three nationwide bureaus — Equifax, Experian and TransUnion — through AnnualCreditReport.com, the federally authorized source. Do not pay a site that offers to sell you the same thing. Get all three, because lenders pull all three and the files often differ.
Your report is the history; your score is a summary of it. Mortgage lenders typically use FICO scores, which run from 300 to 850, and commonly take the middle of your three scores. A higher score does not just decide approval — it sets your rate, and on a loan this size a rate difference compounds into real money. See what is a FICO score and what is a credit score.
Debt-to-Income: The Ratio That Usually Decides It
Your debt-to-income ratio is your recurring monthly debt payments divided by your gross monthly income. Lenders look at two versions of it.
The front-end ratio counts only the proposed housing payment — principal, interest, taxes and insurance. The back-end ratio adds everything else you owe monthly: car loans, student loans, credit card minimums, child support and alimony. A long-standing guideline is 28/36: housing at or under 28 percent of gross income, total debt at or under 36 percent.
Take a household with $5,000 in gross monthly income, a proposed housing payment of $1,200, and $800 a month in other debt payments.
- Front-end — $1,200 of $5,000 is 24 percent, comfortably inside the 28 percent guideline, which allows up to $1,400.
- Back-end — $2,000 of $5,000 is 40 percent, above the 36 percent guideline, which allows up to $1,800.
Read those two lines together, because they say something the house payment alone does not. This borrower’s housing cost is not the problem — it is $200 below the front-end limit. The existing $800 of other debt is what pushes them $200 past the back-end guideline. Paying off a car loan can do more for their buying power than finding a cheaper house.
Treat 28/36 as a guideline rather than a wall. Many loan programs approve higher ratios, particularly with strong compensating factors such as a large down payment, substantial reserves or an excellent credit score, and the limits differ by program. What does not vary is the underlying logic: the less of your income already committed, the more a lender will lend.
What Counts as Income
Lenders count income they believe will continue, and they want it documented. Salary and hourly wages are straightforward. Bonus, commission, overtime and self-employment income usually need a two-year history, and are often averaged over that period. Alimony, child support, and reliable investment or retirement income can count if you can evidence them and show they will continue.
If you are self-employed, lenders generally work from your net income after business deductions rather than gross receipts — which can come as a surprise to anyone who has been deducting aggressively.
Cash Beyond the Down Payment
You need the down payment, the closing costs, and usually some reserves left afterward. Lenders also want to see that the money has been in your accounts, or to document where a large recent deposit came from. A cash gift from family is fine on most programs, but it needs a gift letter confirming it is not a loan. Plan for that paperwork rather than being surprised by it.
Get Pre-Approved, Not Just Pre-Qualified
Pre-qualification is an estimate based on figures you supply. Pre-approval involves documentation and a credit check, and carries far more weight with a seller. In a competitive market an offer without one is often not taken seriously.
One warning that costs people houses every year: between pre-approval and closing, do not open new credit accounts, finance a car, or change jobs if you can avoid it. Lenders re-check before closing, and a new monthly payment can push your ratios out of range at the worst possible moment.
If your credit is the obstacle rather than your income, see buying a house with bad credit.