Your personal finances are the biggest component of home affordability.
The personal factors that help determine your affordability are also the easiest to control. Understanding them early on will help you, as they say, “make good choices.”
The biggest factor in getting a home loan is your income. This is because both lenders and regulators are concerned with your ability to repay the loan. A steady stream of income is the biggest factor to consider when it comes to repayment, and often, income for the previous 12 to 24 months will be considered.
Lenders also want to make sure that you’re not spending too much of your income on housing. They use a debt-to-income (DTI) calculation to make sure that once you start paying your mortgage, you’ll have enough money left over to pay for essentials.
So what happens if you don’t have a typical salaried job? Say you’re retired, you make money day-trading the stock market, or you drive Uber full-time? A lender will ask for information to try to understand how much you make and how consistent it is. Inconsistent income or lumpy cash flow doesn’t make getting a mortgage impossible, it just means more paperwork.
Lenders will also consider your assets when qualifying you for a mortgage. Understanding what is considered an asset can be tricky, so we’ve put together a list for you.
Some common assets are:
Cash – This includes money in your checking and savings accounts. It also can include any trust funds you may have access to. In certain cases, it could also include gift funds.
Retirement accounts – If you have a 401k, an IRA, or a similar retirement account, this is an asset.
Investments – If you have investments outside of your retirement accounts, like stocks, bonds, or mutual funds, these are considered assets.
There are also a few common items that are assets, but are not used as consideration when qualifying for a home loan:
- Personal property – The value of any vehicle you own, like a car / motorhome / Vespa, will not be included as an asset. Same goes for other personal items like jewelry.
- Real estate property – Unless you are selling the property, the value associated with a real estate asset is not eligible.
- Privately held stock / unvested options – If you own stock in a privately held corporation, that asset is ineligible when qualifying for the loan. Same goes for any unvested stock options or restricted stock you may have in public companies.
- Cash – Cash is a funny thing. When it’s in a bank account and it can be verified, mortgage lenders can use it to qualify you for a loan. However, if it is “cash on hand,” then it is ineligible. If you have been stuffing money in your mattress to save for your down payment, you should work to get that deposited with a bank or credit union.
After income, your debt payments are the next largest factor when calculating your affordability amount. If you make $10,000 a month, but $8,000 of that goes to paying a pile of credit card debt, your affordability amount is going to be pretty low.
Lenders are concerned with the cash you have left over after making your current debt payments — will it be enough to cover your new home loan payments?
Lenders aren’t so concerned with the total amount of debt you have (or even your net worth). They care about the minimum amount you have to pay monthly to meet your debt obligations. If you have $23,000 in student loans that cost you $250 a month, that is going to do way less damage to your affordability than $10,000 in credit card debt with a $450 monthly payment.
Not all recurring monthly payments are considered debts. When calculating affordability, lenders include:
- Existing property payments – Lenders will consider expenses associated with any owned properties.
- Credit card debt – This may include other “open 30 day accounts” like an American Express card.
- Student loans.
- Auto loans or leases.
- Personal loans, installment loans, or revolving loans.
- Alimony or child support.
- Any court-assigned debt.
Some common monthly payments that are not included:
- Cell phone payments.
- Voluntary memberships, like gym dues.
- Business debts – Unless your business debts appear on your credit report, or your business account is delinquent, the debt generally does not factor into your eligibility.
4. Cash to Close: Down Payment & Closing Costs
While your down payment is a big part of determining your affordability, it’s not the only component. Between closing costs, fees, and taxes, you can expect to pay an additional 2-5% of your home price at the closing table. For a more accurate estimate of your closing costs, you can visit our quote tool. It provides a breakdown of some common fees and the costs associated with them.
This can be anywhere from 0% in certain scenarios all the way up to 25%+. There are many loan products that are designed for borrowers with limited cash for a down payment, lenders are often far more accommodating than most people think. However, because the borrower is putting down less cash, the loan is considered riskier, so you end up paying more in the form of a higher interest rate and mortgage insurance.
Closing Costs & Fees
There is a long list of potential fees that you may have to pay to get your mortgage, which we will get into later. The important thing to remember is that you can expect to pay 2-5% of the home value in closing costs. That’s in addition to your down payment.
Cash-strapped buyers have another option when it comes to lender fees and closing costs: the “no-cost” loan. This name can be misleading, because there is definitely a cost to it. In exchange for paying no lender fees, the borrower agrees to a higher interest rate.
5. Credit Score
There is a lot of focus and attention put on your credit score, for good reason. But we’ll let you in on a secret: if your score is above a certain level, it has a limited impact on your mortgage. The trick is getting it to that level (which is a different topic all together). For some people, credit scores can make all the difference and here’s why:
Your credit score has to be high enough to justify getting a loan
Many lenders have a minimum credit score requirement. While some lenders may dip into the 500s, a score above 620 is usually enough to qualify for some sort of loan. Some specialty loan products have a higher minimum score, but for the most part, pass that minimum score test and you have cleared the first hurdle.
Your credit score impacts is your interest rate
The lower your credit score, the riskier your loan seems. This added risk directly translates to an increased interest rate for your loan. The important thing to note is that your credit score does not directly affect your affordability; it affects the interest rate you qualify for, and your interest rate impacts both your affordability and your lifetime loan cost.
Credit scores are usually grouped into tiers during pricing. Tiers can vary widely, but for every 20-50 points difference in your score (depending on the lender), you move up or down a tier.
Each tier usually equates to an interest rate adjustment of .125 – .25%. Generally, lenders have a top tier where, above a certain credit score, it’s all the same. In many cases, that top-tier score is between a 740 and 780 FICO score.
Not sure what your credit score is? You should check it. We actually recommend checking this often, even if you have a great credit score. It’s always good to make sure there’s no suspicious activity.
To learn more about what affects your home affordability, see “Condo vs. House: How Property Types Affect Your Home Loan“. To calculate your home affordability now, check out our home affordability calculator.