A man's hand puts a money bag onto scales to demonstrate the balance between home financing and building a home.

Want to Build? How to Qualify for Home Financing

Home financing is an important milestone in many people’s lives and something they strive to achieve. Building a new home and getting financing is a big decision. And it can seem daunting! However, following a few simple steps, you can qualify for home financing and make your dream of building a home come true. 

In this article, we’ll discuss the criteria you need to meet to become eligible for a home loan and provide you with tips for improving your credit score and other financial information. So you can be one step closer to building your new home in Springfield, Missouri, with the right preparation!

Home Financing Overview

Home financing, also known as home equity financing, is obtaining a loan to purchase, build, or refinance residential real estate. Most home financing transactions involve a mortgage, a type of debt instrument. Home financing has many benefits, including the fact that it allows you to buy a home that you otherwise wouldn’t be able to afford. However, only certain people will qualify for home financing, and many factors go into determining who is eligible.

Credit Score and Credit Report Requirements

The most important factor in home financing is your credit score and report. In most cases, lenders will look at your credit report to determine whether or not they will approve you for a home loan. This is because they want to ensure you are financially responsible and won’t miss payments or default on your loan. 

A credit report will show a lender whether or not you have any past or present loans and how you’ve managed them. So if you have paid off all your debts on time in the past, you will likely have a good credit score. And if not, you will likely have a lower credit score, making it harder for you to qualify for home financing. 

When you apply for a home loan, lenders will pull your credit report from one of the three major credit bureaus: Experian, TransUnion, or Equifax. They will then use the information in your report to determine whether or not you qualify for a loan. Therefore, to improve your chances of qualifying for home financing, you should make an effort to improve your credit score by paying off your debts and creating a plan to pay off any remaining balances on time. Consequently, doing so can help you avoid having a lower credit score and make it easier to qualify for a loan.

Improve Your Credit Score

You can improve your credit score by paying off debts and creating a repayment plan that you stick to. Credit bureaus consider your payment history when calculating your credit score. It can show that you are responsible and can repay debts on time. This will then help you improve your credit score and make it easier for you to qualify for home financing. 

There are some ways to improve your credit score. Some of the easiest ways include: 

  1. Pay off your existing debts. This will allow you to focus on paying off one debt at a time.
  2. Put down a deposit on a rental property. Many lenders will factor in this deposit when deciding whether to approve a home loan.
  3. Remove any adverse information on your credit report. Lenders will overlook any past issues with your report if you can remove them.

Debt-to-Income Ratio

The debt-to-income ratio is a critical debt-to-income ratio is a critical factor in the home financing process. And while not all mortgage lenders require the debt-to-income ratio to be calculated, two types of home financing loans require it. 

First, it’s important to understand that the debt-to-income ratio is not a mortgage approval requirement for everyone; it is most commonly used for FHA loans. Second, potential home buyers need to understand exactly the debt-to-income ratio and how it can affect their ability to qualify for a mortgage. Then one can determine what actions can be taken to improve the chances of approval. 

The debt-to-income ratio measures your monthly debt obligations compared to your monthly income. A lender will take your monthly income and subtract your expenses to find your total monthly surplus. Then, they will compare this surplus to your monthly debt obligations. So the greater your monthly debt obligations are compared to your surplus, the harder it will be to qualify for home financing.

Back jeans pocket filled with credit cards.
Too much credit card debt can prevent people from getting a construction loan.

Employment History and Income Requirements

Another factor determining whether or not you qualify for home financing is your employment history. Usually, lenders want a consistent history of at least two years of steady employment before approving a loan. Additionally, they will want documentation of any bonuses, raises, or promotions you have received. 

Lenders want to see that you are in a position to make your monthly payments. This is why they will often review your credit report and income history. Understandably, all lenders want to see that you have a steady income that meets a certain minimum threshold. Therefore, those who qualify for a conventional mortgage will want to show that their income is at least 22% of the home’s appraised value. For an FHA mortgage, the minimum required income is 26%.

Down Payment

People who qualify for a conventional loan will generally be required to make a down payment of 20% of the home’s value. Those who wish to qualify for an FHA loan will have to make a down payment of at least 3.5%. So if you make a lower down payment or have less than stellar credit, you may be required to pay for mortgage insurance. 

Mortgage insurance protects the lender if you fail to make your mortgage payments. The amount you have to pay for mortgage insurance will depend on your down payment. And while lenders prefer that you make a 20% down payment on your home, they will generally allow you to make a smaller down payment if you have excellent credit. However, this may require you to pay for mortgage insurance.

Mortgage Insurance and Other Fees

So if you make a low down payment or have less than stellar credit, you may have to pay for mortgage insurance. Moreover, this insurance is mandatory for people who want to make a down payment of less than 10% on an FHA loan. The good news is that you can get it removed once you have paid off your loan in full. However, there is a strict timeline for making payments, so keep up with your payments to avoid having the mortgage insurance reapplied. 

Beyond mortgage insurance, other fees are associated with applying for a mortgage. These include application and appraisal fees, title insurance, and other miscellaneous expenses. And while these fees can add up, they are unavoidable when applying for a home loan. You can reduce these fees by ensuring your application is in perfect condition and showing evidence of consistent income.

Home Financing Options

There are several types of home financing options. There are also many different types of home loans, each with its own set of eligibility requirements and repayment terms. The first step in qualifying for a home loan is choosing the type you want to apply for. For instance, those planning to build a house will need a construction loan, which is different from a mortgage (read this).

There are several different loan types, each with different benefits and drawbacks. So be sure to explore your options fully when shopping for a loan.

A lender handshakes with customer after a construction loan contract signature.
A construction loan, sometimes referred to as a "self-build loan," is a type of short-term financing used to fund the construction of a house or other real estate investment.

What are Construction Loans?

Construction loans are a type of short-term loan used to finance the building or remodeling of a home. A construction loan typically has a higher interest rate and a shorter repayment term than a traditional mortgage. 

Typically used to cover the costs of materials and labor during the construction phase of a project, construction loans are paid out in installments as the work progresses. A mortgage on the property typically secures the loan, and the borrower must provide a detailed construction plan and a budget for the project. Then, once the construction is completed, the borrower can refinance the loan into a traditional mortgage or pay it off in full.

The Home Loan Application Process

The application process for a home loan can be long and tedious. It can sometimes take a few months from start to finish, so make sure to begin preparing as soon as possible. 

The first step in the home financing process is to select a lender. You can start searching for a lender as soon as you have found a suitable home to buy or have decided to build a new home. You should explore your options and narrow your choices so that you can start the application process as soon as possible.

After you’ve selected a lender, the next step is to find out their requirements and whether or not you are eligible for a home loan. Most lenders will provide you with an application form and ask you to provide evidence of your employment and income. They will also ask you to provide evidence of your past debt obligations and whether you have a criminal record. This can all be submitted via an online portal or fax.

Conclusion

So when applying for a home loan, keeping these tips in mind can be helpful. And, it’s true, qualifying for home financing can feel overwhelming. Still, by understanding your credit score, income, and debt-to-income ratio, you can put yourself in a solid position to secure a loan. Be sure to shop around and compare rates from different lenders, and don’t be afraid to ask for help if you need it. With the right preparation and approach, you can turn your dream of building a home into a reality. Remember, when it comes to home financing, knowledge is power!

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