How to Qualify for a Home Loan

6 Min Read | Last updated: August 9, 2024

An officer handing over home keys to a happy couple.

This article contains general information and is not intended to provide information that is specific to American Express products and services. Similar products and services offered by different companies will have different features and you should always read about product details before acquiring any financial product.

Before approving you for a home loan, lenders may look at your income, assets, and credit score. These tips could boost your chances of getting a mortgage.

At-A-Glance

  • The better positioned you are financially, the easier it may be to qualify for a home loan with lower interest rates.
  • A 20% down payment is not mandatory to qualify for a mortgage.
  • Getting preapproval from a lender can help speed up the buying process.

It’s that time in your life – the part when you commit to going from renter to homeowner. The process can be arduous, but it can also be fun and freeing, as you dream of the endless possibilities: Where will the man cave go? What color will we paint the nursery? Can my car really fit inside that one-car garage?

 

Dream those dreams, but also take time to learn how best to prepare for the sizable financial leap. Unless you have the savings to pay in cash, you’ll probably want to get a mortgage. Let’s take a look at the factors to consider if you want to qualify for a home loan – especially one with the lowest possible interest rate.

What Lenders Look for in Mortgage Applications

Lenders want to get paid back on the money they give to borrowers. Their job is to assess the risk of potential borrowers, and they may do so by exploring the following financial indicators: income, debt-to-income ratio (DTI), credit history, total assets, and type of property.

 

Income: When determining mortgage-loan worthiness, lenders may want to see proof of income.1 They might ask for W-2 statements and tax returns, recent pay stubs, and year-to-date money earned, for example. You may also be asked to show proof of any additional income, such as alimony, company bonuses, investment funds, or side gigs.

 

Debt-to-income ratio: Lenders may also look at your DTI. This percentage shows how much money you owe compared to how much money you make.1 It’s a good idea to calculate your DTI before shopping for mortgages. A simple way to calculate your DTI for mortgage purposes is to add up all your fixed payments each month – including your future monthly mortgage payment – and divide it by your pre-tax monthly income.2

 

Let’s say you and your home-buying partner total $10,000 a month in gross income. Here’s an example calculation:

DTI Calculation

Gross monthly income $10,000
Future monthly mortgage payment $2,000
Other monthly debt payments $1,000
Total monthly debt payments $3,000
Debt-to-income ratio $3,000 / $10,000 = 0.3 or 30%

Borrowers with low DTI ratios will look more attractive to lenders.1 The Consumer Financial Protection Bureau (CFPB) recommends maintaining a DTI ratio of 36% or less, though it’s possible that larger lenders may still approve a mortgage if your DTI is higher than 36%.2

 

Credit history, credit report, and credit score: Obtain a copy of your credit report, review it, and aim to fix any errors you find. The cleaner your credit report and the higher your credit score, the better your chances of qualifying for a lower interest rate.1 Experts recommend having a credit score of 620 or higher when applying for a conventional loan.3 Online tools let you look at interest rates based on both different credit scores and the state where you are buying a home.4

Total assets: Lenders generally review a borrower’s assets to prove they can cover the down payment and closing costs.1 Assets may include:5

  • Cash and cash equivalents, such as cash on hand, money in checking or savings accounts, and certificates of deposit (CDs).
  • Physical assets, such as homes, cars, boats, jewelry, artwork, or land.
  • Nonphysical assets, such as stocks and bonds, pensions, IRAs, and 401(k) accounts.

Property type: The intended use for the home can make a difference in the loan qualification process. Lenders consider a primary residence as a safer investment than a second home or investment property, since a homeowner may be more inclined to take care of the financial needs of their everyday home than an additional one.6

How Future Homeowners Can Improve Approval Chances

While only you can determine which home is “right” for you, there are some ways to improve your chances of qualifying for a home loan with a favorable interest rate. Among them:7

 

Reduce debt: Be as aggressive as possible in reducing your debt. As long as you’re not taking on any additional debt, this effort will lower your DTI and could improve your credit utilization rate, or the percentage of your total credit limit in use.

 

Cut spending: Consider areas of your monthly expenses where you can cut back for a while. Maybe that means one or two fewer streaming services, dining out less frequently every month, or keeping that old winter coat for one more year. Trimming here and there can add up over time.

 

Start saving: It’s never too early to start saving for your first home. Consider setting up an automatic direct deposit from your checking account to a high-yield savings account to help build a nest egg. Every dollar counts when you’re saving for a down payment and closing costs.

 

Get preapproved: Once you’re ready to go house-hunting, you can give yourself a little momentum by showing that lenders already consider you fit to buy. You can do this through either a mortgage prequalification or preapproval. They sound similar, and according to the CFPB, there isn’t much difference, in practice. Both refer to a letter that says a lender is willing to offer you a loan up to a certain amount – but neither is a guarantee that you’ll get the loan. For either of these letters, the lender will likely take a careful look at your finances, from credit history to proof of income.8

 

For more tips on how to get ready to buy a home, read “First Time Home Buyer Checklist.”

Different Types of Mortgages Have Different Qualifications

In addition to a conventional home loan, there are other types of mortgages that may suit your needs. For example, U.S. Federal Housing Administration (FHA) loans, Department of Veterans Affairs (VA) loans, and U.S. Department of Agriculture (USDA) loans are three common government-backed home loan alternatives. Each aims to make getting a mortgage easier for certain individuals, and all of them, therefore, tend to have different requirements than conventional loans.

  • FHA loans allow borrowers to purchase a home with a smaller down payment than that required for conventional mortgages, making it a popular choice for first-time homebuyers. For example, homebuyers with a credit score of 580 or above can make a down payment as low as 3.5% of the agreed-upon sale price of the home. But FHA loan borrowers will have to pay mortgage insurance premiums to protect the lender if the borrower were to stop making payments.9
  • VA loans help eligible veterans, service members, and their spouses by providing a home loan guarantee to the bank or lender. That guarantee helps the borrower qualify for competitive interest rates, and often eliminates the need for a down payment and private mortgage insurance.10
  • USDA loans aim to help low- to moderate-income people purchase a home in a qualifying rural area. Qualified homebuyers do not need to make a down payment.11

The Takeaway

For most people, buying a home requires investing in two key resources: time and money. But with the right approach, you may be able to apply both of these to your advantage. Shoring up your financial picture by paying down debt, for example, could boost your credit score and lower your debt-to-income ratio, thus making you a more attractive borrower in the eyes of a lender. And that could, in turn, yield a lower interest rate on your mortgage, saving you some money – and potentially shortening the length of your loan.

Headshot of Michael Grace

Michael Grace is a personal finance and technology freelance writer based in New York.
 
All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.

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