What is needed to buy a home?

  1. Money for a down payment.
  2. A good credit score.
  3. A good Debt to Income Ratio (DTI).

Part 1: Money for a down payment.

The down payment on the purchase of a house is the money that you pay upfront in cash. The rest of the amount is paid by a mortgage loan which you get from a bank or lending institution, and have to pay back over a period of time in monthly mortgage payments which includes interest.

Experts (and common sense) will tell you the higher the down payment, the lower the monthly mortgage payment. Experts will also tell you to make a down payment of 20% of the price of the home. If you want to buy a $180,000 home, to pay 20% would be $36,000. Who has $36,000 in their savings account? According to Zillow, in 2019, 27% of home buyers only made a down payment of 5% of the price of the home, or less. Also, there are government programs that help you with the down payment, if you qualify.

HUD administers down payment assistance programs for low-to-moderate income families through state housing agencies and other types of government agencies. Most programs are for first time homebuyers. For most of these programs qualifications as a first time homebuyer means you haven’t had a mortgage on a home or owned a home in three years. Also, some Federal (USDA) and local mortgage programs are zero down payment, so no need to offer down payment assistance.

Fannie Mae provides eligibility requirements for the Community Seconds mortgage program to banks and mortgage companies who wish to offer this mortgage to cover down payment or closing costs.

Funding for Community Seconds mortgages must be provided by a federal agency, a municipality, state, county, state or local housing finance agency, a nonprofit organization, a regional Federal Home Loan Bank under one of its affordable housing programs, a Native American tribe, or an employer.
Freddy Mac provides requirements for a similar program called Affordable Seconds.

Part 2: A good credit score.

Conventional mortgage lenders like credit scores of 650 or higher. For FHA insured mortgages a buyer may have a credit score of 580 or lower. If your credit score comes back low, work on raising it. The higher your credit score, the lower the interest rate on your mortgage.

Here are some tips to increase your credit score.

Part 3: A good Debt to Income Ratio (DTI).

Banks and mortgage companies will check your total monthly debt against your total monthly income and do a calculation to find the monthly amount of mortgage payment, taxes and insurance you can comfortably manage.The Government’s Consumer Finance Protection Bureau defines debt-to-income ratio as “all your monthly debt payments divided by gross monthly income.”

There are two Debt to Income Ratio (DTI) types: Front-end DTI and back-end DTI. Mortgage lenders and banks will look at the front-end DTI, which takes into account the amount of your housing expenses only - mortgage plus taxes and insurance. The back-end DTI is the total of all your debt, including housing costs, any credit card payments, student loan payments and car loan payments that appear on your credit report.

The higher the DTI, the harder it will be for you to obtain a mortgage. For FHA insured loans, strive for a front-end DTI of 31% or less, and a back-end DTI under 43%. 

Of course your success at obtaining a mortgage depends on other factors too, but an unacceptable DTI will hold up your chances.

  • Front-end DTI calculation example (using only the mortgage, taxes and insurance):

    You will owe a total monthly mortgage, taxes and insurance of $850.

    Your monthly gross (before taxes) income is $2720.

    $850/$2720 = 0.31.

    0.31 x 100 = 31%.

    Your front-end DTI is 31%.
  • Back-end DTI calculation example (including all debt, including housing costs, credit card payments and loan payments):

    You owe a total of $1200 a month in debt. This includes a car payment of $200 and credit cards payments of $100 plus your housing costs of $850. 

    Your monthly gross income is $2720.

    $1150 / $2720 = 0.42.

    0.42 x 100 =42%. 

    You have a back-end DTI ratio of 42%.