Mortgage Requirements

Mortgage Requirements

If you plan to buy or refinance a home, having a basic grasp of minimum mortgage requirements will help you zero in on the best home loan for your needs. Knowing the lending guidelines for income, debt, credit scores and down payments puts you in a better position to shop around for a home loan.

Minimum mortgage requirements to buy a home

When you purchase a home, lenders review your entire financial picture to ensure you’re likely to repay the loan. Lenders consider the following items:

Down payment amount. A down payment — the upfront money required to buy a home — can come from your own savings, a gift or down payment assistance.

Credit score. Lenders pull your credit to review your scores and assess how you’ve managed credit accounts over time. Typically, the higher your credit score, the lower your interest rate and monthly payment will be.

Debt-to-income (DTI) ratio. Lenders divide your total debt, including your mortgage, by your gross monthly income to calculate your DTI ratio. The Consumer Financial Protection Bureau (CFPB) suggests a DTI ratio¹ of no more than 43%.

Occupancy. Minimum mortgage requirements are the most lenient if you’re buying a home as a primary residence.

Here are the key mortgage requirements for the most popular loan programs:

Loan type	Credit score	Down payment	DTI ratio	Occupancy
Conventional	620	3%	45% (or less), but can go up to 50% in some instances	Primary
FHA	500-579 580	10% 3.5%	43%*	Primary
VA	No minimum (620 recommended)	0%	41%*	Primary
USDA	640	0%	41%*	Primary, in designated rural areas

*Borrowers with higher DTI ratios may be approved in some cases

Conventional loans. Fannie Mae and Freddie Mac have stricter conventional loan guidelines than government-backed mortgages. Here are some conventional programs worth considering:

• Conventional 97% financing. With no income limits, qualified buyers can borrow up to the maximum conforming loan limit of $510,400 in 2020 (borrowers in high-cost areas have higher limits). However, you must be a first-time homebuyer to be eligible.
• Fannie Mae HomeReady®. The HomeReady program requires a 3% down payment and isn’t just for first-time homebuyers. Income eligibility varies by location. Borrowers must complete a mandatory homebuyer education course.
• Freddie Mac Home Possible®. A 3%-down program that provides extra flexibility for sweat-equity down payments and co-borrowers. Income limits also apply.
• Conventional loans with private mortgage insurance (PMI). Conventional lenders require mortgage insurance to cover the risk of making loans with less than a 20% down payment. Also called private mortgage insurance (PMI), the premium is added to your monthly payment. The lower your credit score and down payment, the higher the monthly PMI cost.

FHA loans. The Federal Housing Administration (FHA) insures mortgages with lenient qualifying guidelines. First-time homebuyers with rocky credit and little saved for a down payment may get approved for a government home loan if they don’t qualify for a conventional mortgage. Features of FHA loans include:

• Loan limits. FHA loan requirements include limits on how much you can borrow based on where you live ².
• Upfront and annual mortgage insurance. To offset the risk of lending to borrowers with lower credit scores, the FHA charges two types of mortgage insurance premiums: upfront and annual. The first is a lump-sum, upfront mortgage insurance premium (UFMIP) of 1.75%. An annual mortgage insurance premium (MIP) ranging from 0.45% to 1.05% of the loan amount is paid monthly as part of your mortgage payment. FHA mortgage insurance premiums are the same regardless of your credit score.

VA loans. Active-duty military service members, veterans and eligible spouses can benefit from home loans guaranteed by the U.S. Department of Veterans Affairs (VA). Even with no down payment, mortgage insurance is not required for VA loans. Instead, borrowers pay a funding fee to offset the costs of the VA loan program to taxpayers.

USDA loans. Low- to moderate-income families can purchase homes in designated rural areas with a loan guaranteed by the U.S. Department of Agriculture (USDA). You’ll pay upfront and annual guarantee fees, but no down payment is required. Use the USDA property eligibility tool ³ to see if a home near you qualifies.

Minimum mortgage requirements for a refinance mortgage

Lenders use a different set of criteria to approve refinance mortgages versus a purchase loan. Factors considered for a refinance include:

Reason for a refinance. Getting a mortgage to reduce your current monthly payment usually comes with the easiest qualifying guidelines. Some government-backed refinance programs don’t require income paperwork or an appraisal. Tapping equity with a cash-out refinance (which replaces your current loan with a larger loan and lets you withdraw the difference in cash) comes with extra restrictions.

Loan-to-value ratio (LTV). Lenders consider how much money you’re borrowing compared to the home’s value. Refinance mortgage guidelines for LTV ratios are more flexible for rate-reduction refinances than other types of refinance transactions.

Here are the key mortgage requirements for the most popular refinance loan programs:

Loan type	Maximum LTV ratio	Purpose of refinancing	Credit score	DTI
Conventional rate-and-term refinance	97%	Reduce rate and payment	620	45%*
Conventional cash-out refinance	80%	Withdraw cash from home equity	620	45%*
FHA streamline refinance	N/A	Reduce rate and payment	N/A History of on-time payments	N/A
FHA cash-out refinance	80%	Withdraw cash from home equity	500	41%*
VA interest rate reduction refinance loan (IRRRL)	N/A	Reduce rate and payment	N/A Prove on-time payments	N/A
VA cash-out refinance	90%	Withdraw cash from home equity	No minimum (620 recommended)	41%*
USDA refinance	N/A	Reduce rate and payment	N/A History of on-time payments	N/A

*Borrowers with higher DTI ratios may be approved in some cases

Home loan requirements vary when it comes to the paperwork you’ll need and how closing costs can be financed. Refinance mortgage closing costs typically run 2% to 6%, depending on your loan amount.

Conventional rate-and-term refinance. This conventional refinance program allows you to reduce your rate and roll in closing costs for up to 80% of your home’s value. Plan on providing income documents again but, in some cases, an appraisal isn’t required.

Conventional cash-out refinance. Replacing your current loan with a larger one and pocketing the difference in cash entails the same process as when you bought your home. You may pay a higher rate if you have poor credit scores. A conventional cash-out refinance doesn’t require any mortgage insurance and is an ideal cash-out choice for borrowers with a credit score of 620 or higher.

FHA streamline refinance. As long as you’ve made at least seven payments on your current mortgage on time, you’re eligible for an FHA streamline refinance, which is quite different from the refinance of a mortgage for a conventional loan for which you require a certain credit score. No income verification or appraisal is required. One catch, though: You’ll pay a higher interest rate if you don’t want to pay closing costs out of pocket; they can’t be rolled into your loan amount without an appraisal.

FHA cash-out refinance. Although you can tap equity up to the same LTV as a conventional loan, FHA requires you to pay both MIP and UFMIP again. The FHA program is one of the more common cash-out refinance loans for bad credit.

VA IRRRL. A VA interest rate reduction refinance loan allows eligible borrowers with a current VA loan to refinance without proving income or getting an appraisal. An added bonus: you can roll closing costs into your loan amount.

VA cash-out refinance. Current VA borrowers can tap more equity than conventional or FHA loan programs allow. Full income and credit documentation, along with a VA appraisal, are reviewed for approval.

USDA streamlined-assist refinance. Homeowners with a current USDA loan paid on time in the past 12 months are eligible. No appraisal or income verification are required. Closing costs (including the guarantee fee) can be rolled into the loan amount.

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Credit score

Remember: A mortgage is a type of loan. When you’re applying for any type of financing, your credit score is perhaps the most important piece of the puzzle. This three-digit number essentially provides lenders with a general idea of your creditworthiness.

If you have accounts in collections or a history of making late payments, for example, you’ll have a lower-than-average score, which directly affects your loan options. That means you could get hit with higher interest rates or bigger mortgage insurance premiums, or both.

“Your credit score is really important on conventional loans,” John Moran, founder of TheHomeMortgagePro.com, tells MagnifyMoney. “Some other loan programs are less credit-sensitive.”

For conventional home loans, Moran says your credit score has to be at least 620, but for FHA or VA loans, you may be able to get away with a score in the 500s. But it’s not just about getting approved. The lower your score, the higher your mortgage rate will likely be — and that can add tens of thousands of dollars to the cost of your loan over time.

FICO, America’s leading credit reporting agency, looks at several important factors when determining your score. Your payment history, amounts owed, and length of credit history are chief among them. If you’re aiming for a home in the next year or two, you’ve got time to improve your credit if you start now.

Trust us — it’ll be worth the effort. You can see below what estimated mortgage rate folks would get based on their credit score and how much it could cost them over time. For our purposes, we’ll assume they’re all getting a $250,000 30-year fixed rate loan.

Score Range	APR	Monthly Payment	Total interest paid
760-850	3.914%	$1,181	$175,224
700-759	4.136%	$1,213	$186,760
680-699	4.313%	$1,239	$196,072
660-679	4.527%	$1,271	$207,462
640-659	4.957%	$1,335	$230,777
620-639	5.503%	$1,420	$261,180
Source: Calculated using the MyFico Loan Savings Calculator Rates current as of Feb. 2, 2022.

You can find a detailed breakdown of your credit score by pulling up your credit report for free. Your report unpacks your credit history for lenders, so it’s vital to know what’s on it. This is crucial because you could end up spotting an error that’s weighing your score down.

If your credit score could use some work, don’t fret—there are plenty of ways to give it a good boost before buying a home. Establishing credit history, keeping your credit utilization ratio below 30%, and making consistent on-time payments are all on the list.

Debt vs. income

Your credit score goes hand in hand with your current debt load. Lenders specifically zero in on how your debt relates to your income. Together, this determines what’s known as your debt-to-income ratio (DTI)..

To calculate out your DTI, it’s fairly simple: Add up all your monthly debt obligations (not including your current housing payment unless you own the home and plan on keeping it), then divide that number by your gross monthly income. So if you pay, for example, $2,000 a month toward debt and you’re grossing $4,500, your DTI comes in at about 44%.

What’s a good DTI? Strive for 36% or less.

Fannie Mae, which sets the lending standards for the vast majority of mortgage loans, generally requires a maximum total DTI of no more than 36%. However, if the borrower meets certain credit and reserve requirements, they can generally get away with 45%.

Why? A high DTI is a red flag to lenders that you may not be able to afford a new monthly loan payment. In a lot of ways, it’s more telling than your credit score.

“The only thing that really matters to lenders is how this new monthly payment and your other debts relate to your income,” said Moran. “One of the quickest ways people can turn things around is by paying down revolving debts like credit cards and lines of credit, which increases your available credit and decreases your credit utilization ratio.”

He adds that making a smaller down payment in order to pay down revolving debt might improve your chances of qualifying since doing so will boost your credit score relatively quickly. Knocking those balances down also lowers your monthly minimum payment, so you may be able to qualify for a larger loan. In other words, your DTI isn’t the end-all-be-all when applying for a mortgage loan, but it’s pretty important.

Down payment

Lenders also look at how much of a down payment you can make, which ties directly back into your debt-to-income ratio. According to Bob McLaughlin, director of residential mortgage at financial services company Bryn Mawr Trust, putting down a higher down payment makes you more likely to get approved since it essentially decreases the risk for the lender. As a result, better loan terms and interest rates will likely be on the table.

“If you have the ability to put 20% down, you also avoid having to pay private mortgage insurance, which makes it easier to qualify,” he said.

Another perk is that you’ll have more equity in your home as well as a lower monthly mortgage payment. But for many, saving for a 20% down payment is a serious barrier to homeownership. Not surprisingly, a 2016 report put out by the National Association of Realtors found that the average down payment for first-time homebuyers has fallen in the 6% range for the last few years. The good news is that according to Moran, you can still get approved with a lower down payment.

“You can put 0% down for VA loans, 3.5% for FHA loans and even as little as 3% for conventional loans,” he said.

“There are people all the time buying homes with these minimum down payments, but it really all boils down to what you’re comfortable with and the kind of monthly payment you can handle.”

FHA and VA loans are usually the first low down-payment loans that come to mind, but options like personal loans and USDA loans may also be worth considering. Just keep in mind that taking this shortcut could potentially translate to a financial burden — low down payments typically necessitate higher insurance rates and extra fees to protect the lender.

That said, lenders are really looking at your big financial picture, not just your down payment size. If you’re putting down less, but have a good score and a steady source of income, you’re much more likely to get approved for a mortgage loan than someone with a lower score and/or spotty employment status.

Employment history

Our insiders say that your income and employment history are just as important as your credit score, DTI and down payment size. Again, it all comes down to lenders feeling confident that you can indeed repay your loan.

“You have to fit the underwriting guidelines per your profession, and there is little flexibility there,” said McLaughlin.

Piggybacking on this insight, Moran says that the ideal situation is if you’ve worked for the same employer for two years and you’re salaried. The second ideal way to get the green light is if you’re an hourly worker who’s been with the same company for at least two years.

But all this begs one obvious question: What about self-employed folks? The freelance economy is growing rapidly. According to the latest Freelancing in America survey conducted by Upwork and the Freelancers Union, these folks are predicted to make up the majority of the U.S. workforce within the next decade. Moran says that for these workers to qualify for a mortgage, they’ll need to have a two-year work history.

Check out our guide on getting approved for a mortgage when you’re self-employed.

“It’s a little bit of a kiss of death to start self-employment right before applying for a home loan,” he said.

“Most lenders won’t approve you because they want to be sure you’ll be able to afford your new loan payment. The only way to really prove you have a steady income is with two years’ worth of tax returns.”

In rare cases, Moran adds, you may be able to get away with one year, but it’s not the norm. Things are different of course, for self-employed newbies who are applying with a spouse who works a steady 9-to-5, which could tip the scales in their favor. Again, it’s all about the big picture. That said, a new salaried position will typically erase doubts stemming from a spotty employment history, as long as you have about two months’ worth of pay stubs, according to McLaughlin.

Loan size

All the factors we’re highlighting here are interwoven. The size of the loan you’re applying for fits right in. The higher your loan amount, the higher your monthly payment, which impacts that all-important DTI.

This is why you may be more likely to get approved if you’re seeking a lower amount. But whether you’re looking for $100,000 or $400,000, it really boils down to how big of a monthly payment your budget can absorb.

The general rule of thumb here is to keep your mortgage loan (including principal, interest, taxes, and insurance) at or below 28% of your total income. Moran has worked with ultra-conservative folks who like to keep that number at 25%, but he says it really varies from person to person.

“Some people like to travel and don’t want to be house poor; others are homebodies and just really want a nice house because that’s where they’re going to spend their time,” he said.

“It’s all a trade-off, but either way, lenders will only pre-qualify you for what they think you can actually afford.”

How to get preapproved for a mortgage

Pre-approval is a term you’re likely to hear in the home-buying process. This is when the lender takes into account everything from your credit score and debts to employment history and down payment size to offer you a maximum loan amount.

When you come to the table with a pre-approved offer of lending from a bank, you’re already way ahead of the competition. And this can really give you an edge. When you’re living in a metro where most people are coming with double-digit down payments and pre-approvals to boot, you’re competing with very attractive borrowers.

Pre-approvals will ding your credit score, but the hit won’t be too bad if you complete several mortgage applications over a short time period, like 30 to 45 days. Multiple inquiries should only count as one hard inquiry on your credit report.

A good rule of thumb is to get mortgage quotes before you apply for pre-approval. You can get quotes quickly from different lenders at LendingTree by filling out a short online form.

Included in a pre-approval letter will be the estimated loan amount you might qualify for and your estimated mortgage rate.

The pre-approval process is also meant to prevent you from making offers on homes you can’t afford. But this doesn’t mean you have to actually take out a loan for the full amount. Many choose to get preapproved for their top number, then dial back during negotiations.