Qualifying for a Loan

In order to qualify for a mortgage, most lenders require that you have a debt-to-income ratio of 28/36 (this can vary depending on the down payment and the type of loan you're getting, however). This means that no more than 28 percent of your total monthly income (from all sources and before taxes) can go toward housing, and no more than 36 percent of your monthly income can go toward your total monthly debt (this includes your mortgage payment). The debt they look at includes any longer term loans like car loans, student loans, credit cards, or any other loans that will take a while to pay off.

Here's an example of how the debt-to-income ratio works: Suppose you earn $40,000 per year and are looking at a house that would require a mortgage of $800 per month. According to the 28 percent limit for your housing, you could afford a payment of $933 per month, so the $800 per month this house will cost is fine (only 24 percent of your gross income). Suppose, however, you also have a $200 monthly car payment and a $115 monthly student loan payment. You have to add those to the $800 mortgage to find out your total debt. These total $1,115, which is roughly 34 percent of your gross income. That makes your housing-to-debt ratio 24/34. Since lenders typically use the lesser of the two numbers, in this case the 28-percent $966 limit, you may have to come up with more down payment or else negotiate with the lender.

You also have to think about what you can afford. The lender will tell you what you can afford based on the lower number in the debt-to-income ratio, but that's not taking any of your regular expenses (like food) into account. What if you have an expensive hobby or have plans for something that will require a lot of money in five years? Your lender doesn't know about that, so the $1,400 mortgage it says you qualify for today may not fit your actual budget in five years -- particularly if you don't see your income increasing too much over that time span.

Pre-qualification versus pre-approval

What's the difference? Getting pre-qualified just means that you have told a lender your income level and your debt and credit information, and the lender has estimated what you can afford. Pre-approval, however, puts you much closer to the actual loan and means that the lender has done the leg work of pulling your credit report, checking your debt-to-income ratio, and has done a more in-depth analysis of your situation. In most cases, you're much better off getting pre-approved so you don't have any surprises when a lender checks your credit report -- particularly if you haven't checked the report yourself first.

What do lenders look at?

A lender will look at your employment and your credit history as indicators of how likely you are to pay back your loan. Lenders want to see stability, which means they will look closely any late payments during the last two years of your credit history. They will pay particular attention to any rent or mortgage payments that were over 30 days past due. They'll look at late payments for credit cards during the last six months.

Your employment for the last two years is also important. Lenders look for steady employment with a single employer for the past two years (or at least employment in the same field). Other income -- such as income earned from part-time, overtime, bonuses, or self-employment -- is also acceptable if it has a two-year history.

Don't be afraid that just because you don't have two years with the same employer behind you won't be able to get a mortgage; you may just have to talk to more lenders and look at different types of loans.

What documents do you need?

Here is a typical list of the documents you need when applying for a mortgage:

• Money for the closing costs
• Completed sales contract signed by buyers and sellers
• Social Security numbers of all applicants
• Complete address for the past two years (including complete name and address of landlords for past 24 months)
• Name, address, and all income earned from all employers for past 24 months
• Previous two years' W-2 forms
• Most recent pay stub showing year-to-date earnings
• Name, address, account number, monthly payment and current balance for all loans and charge accounts
• Name, address, account number, and balance of all deposit accounts, such as checking accounts, savings accounts, stocks , bonds, etc.
• Three months most recent statements for deposit accounts, stocks, bonds, etc.
• If you choose to include income from child support and/or alimony, bring copies of court records of cancelled checks showing receipt of payment.