The First-time Home Buyer’s Playbook

    By Brent Duhaime

    Being a first-time home buyer can feel like solving a math equation where you don’t have all the variables. 


    Never fear, though. Once you understand how lenders evaluate you for eligibility, the rest is a breeze. Let’s get into it.


    Mortgage lenders determine home affordability using several non-negotiable key factors, all of which assess whether a borrower can afford their monthly mortgage payments and associated costs. The main considerations include:


    1. Income and Employment Stability

    • Lenders look at a borrower’s gross monthly income to calculate how much they can afford to spend on housing. They typically prefer that no more than 28%–30% of gross income goes toward monthly housing payments.
    • They also check employment stability for consistent income, pay stubs, tax returns, and employment history.


    2. Debt-to-Income (DTI) Ratio

    • The DTI ratio compares a borrower's monthly debt payments (credit cards, loans, etc.) to their gross monthly income. Mortgage lenders aim for a DTI ratio of 36% or lower, with a cap of 43% in a lot of cases.
    • There are two types of DTI:


    • Front-end DTI: This means housing costs (mortgage, taxes, insurance) as a percentage of income.
    • Back-end DTI: This includes all monthly debts (housing, credit cards, loans) as a percentage of income.


    3. Credit Score

    • Lenders look into credit scores to determine a borrower’s creditworthiness. Higher scores often lead to better loan terms and lower interest rates. A score of 620 or higher is needed to qualify for most loans, but higher scores mean better rates (that’s 700+).


    4. Down Payment

    • The size of the down payment impacts how much money needs to be borrowed, directly affecting monthly payments and overall affordability. A larger down payment lowers the loan-to-value (LTV) ratio, improving your chances of approval and lowering mortgage insurance costs in some cases.


    5. Interest Rates

    • Lenders also decide what interest rate the borrower qualifies for based on their creditworthiness and the current market rates. Lower interest rates mean lower monthly payments, improving affordability.


    6. Loan Term

    • The loan term (15, 20, or 30 years) also factors into affordability. Shorter terms have higher monthly payments but save on interest over the life of the loan, while longer terms lower monthly payments but increase total interest paid.


    7. Other Housing Expenses

    • Lenders consider other homeownership costs, including:
    • Property taxes
    • Homeowners insurance
    • Private mortgage insurance (PMI) if the down payment is under 20%.
    • HOA fees (if applicable).


    8. Reserve Funds (Cash Reserves)

    • Some lenders may require borrowers to have cash reserves, typically equal to a few months of mortgage payments, to ensure they can cover the payments in case of emergencies.


    These factors help lenders assess whether the borrower has the financial ability to afford a home without overstretching their budget.