Home Loan Qualifications 2023: What You Need to Know Before Applying

With median home prices reaching $454,900 in 2022, few Americans can afford to pay cash for their homes. More than three-quarters (79%) of recent buyers took out a mortgage loan to help pay for their home purchase, and in 2021, 87% of homebuyers relied on these loans.

Whether you’re in the market for your first home or want to move up to a larger home, you may wonder what it takes to qualify for a mortgage in 2023.

How Do Mortgages Work?

A mortgage is a special type of loan people take out to buy a home. Many types of financial institutions offer mortgages, including credit unions, online home loan lenders, and national banks. 

Qualifying for a home loan can be a complex process, but tends to follow this general sequence:

1. Contact a lender and complete a mortgage loan application.
2. If all financial requirements are met, receive a pre-approval letter, which is a tentative loan approval.
3. Shop around and find a house you want to buy.
4. Wait for the loan application to be approved by underwriting.
5. Finalize details of the home purchase and sign the necessary paperwork to acquire your home.

What to Know About Mortgages in 2023

The home buying landscape has changed significantly over the course of 2022. Rising interest rates and a cooling housing market have combined to give buyers more negotiating power, though the cost of borrowing money to buy a home has increased.

Rising Interest Rates

After reaching a record low of 2.65% in January 2021, the average interest rate for 30-year fixed-rate mortgages rose steadily throughout 2022, reaching a high of 7.08% in October 2022. This change has significantly increased the cost of borrowing money for prospective homebuyers.

For example, consider a $400,000 home purchased with 20% ($80,000) down. For a 30-year fixed-rate mortgage at 2.65%, the monthly principal and interest work out to around $1,289. But at today’s interest rate of 7.08%, the same loan has a monthly payment of around $2,146 per month.

Cooling Housing Market

In August 2022, sales of previously owned homes were 19.9% lower than the previous August. Homes also spent an average of 5 days longer on the market, and 1 in 5 sellers dropped their asking prices to attract buyers. 

Buyers in some markets may notice home prices declining too. Nationally, median home prices dropped 1.05% in July and another 0.98% in August. These are the largest monthly home price declines seen in the U.S. since January 2009.

Basic Factors for Home Loan Qualification

There are several different types of home loans, and depending on the type, the requirements for borrowers can vary. But no matter what type of mortgage a person applies for, there are some basic qualifications for mortgage loans to keep in mind.

As a general rule, lenders want to see that borrowers are able and willing to repay the home loan. This means they expect borrowers to have a stable, verifiable source of your current income, a manageable level of debt, and a history of repaying loans as agreed.

Some types of mortgages have requirements beyond the basic criteria. For some types of loans, borrowers may be required to have a certain credit score. Other loans may require borrowers to put a certain amount of money down.

Income and Employment

Potential homebuyers are required to have a history of steady employment and sufficient household income to repay the mortgage loan. Specific income qualifications for home loans can vary depending on the lender.

Generally, lenders want to see two years of stable employment history. This could include full-time, part-time, seasonal, or contract employment, so long as it’s reliable. Be prepared to provide documentation to support each current income source.

Regardless of employment type, lenders typically require applicants to spend no more than 25% to 28% of their gross monthly income on housing expenses. With this guideline, a household with $6,000 of gross monthly income could be eligible for a home loan with a payment between $1,500 and $1,680.

Debt-to-Income (DTI) Ratio

The debt-to-income ratio expresses the percentage of a person’s income that goes toward paying debt each month. It’s calculated by dividing the sum of your monthly debts by your monthly gross income. Lenders use the DTI to decide if a borrower could handle a mortgage on top of their existing debts.

DTI qualifications for home loans may vary between lenders. A DTI of 36% is generally considered a manageable level of debt, but it’s possible to qualify for a home loan with a higher DTI. For conventional mortgage loans backed by Fannie Mae, the maximum DTI ratio is generally 45% but could be as high as 50% in certain circumstances.

Credit Score and Credit history

Lenders generally consider credit histories during the mortgage application process. The credit history includes details of how well borrowers have managed past loans, from their credit balances to their record of on-time payments. Derogatory marks on credit history, such as late payments or accounts in collections, could lead to a person not qualifying for a mortgage.

On the other hand, credit scores are a 3-digit number that summarizes the information in a person’s credit history. FICO scores range from a low of 350 to a high of 850. A score below 580 is considered poor and could limit prospective homebuyers’ mortgage options, and more loan options are available to people with scores of 620 or higher in general.

The Amount of the Down Payment

The downpayment is the percentage of the home’s purchase price that a buyer pays upfront. It’s a common misconception that homebuyers need a 20% downpayment to qualify for a home loan because some mortgage loan options may accept a lower downpayment. 

That said, lenders often require a downpayment of at least 5% for a conventional loan. For a home priced at $400,000, a 5% downpayment means homebuyers are required to pay $20,000 upfront. Low or no-down-payment mortgage options are also available to people with less savings. However, a smaller downpayment can mean a larger mortgage and higher loan costs.

Other Criteria Based on the Loan Type  

Some types of mortgage loans have non-financial eligibility criteria. These loans include government-backed mortgage loans that are targeted toward certain types of borrowers or non-conforming bank loans for homebuyers with unusual circumstances.

Depending on the type, government-backed mortgage loans may require borrowers to meet certain criteria, such as being an active duty service member or honorably discharged veteran or buying a home in an eligible rural area. Other niche loans may have their own specific requirements too. For example, someone who wants a mortgage for unimproved land may need to provide surveys or zoning information.

Overall Mortgage Requirements

Qualification	Conventional Mortgage	FHA Mortgage Loan	VA Mortgage Loan	USDA Mortgage Loan	Jumbo Mortgage Loan	Fixed-rate Mortgage	ARM
Employment history	2 years of stable employment	2 years of stable employment	2 years of stable employment	12 months of stable employment	2 years of stable employment	Varies based on loan type (conventional, FHA, VA, USDA, etc).	Varies based on loan type (conventional, FHA, VA, etc).
Debt-to-income (DTI) ratio	45% or less in most cases	43% (45% under FHA’s Energy Efficient Homes)	VA recommends less than 41%	Typically 41%	43% or less	Varies	Varies
Minimum credit score	620 or higher	500 or higher	No VA-mandated minimum	640 or higher is recommended	680 or higher	Varies	Varies
Downpayment amount	3% or 5%	3.5% or 10%, depending on credit score	Typically 0%	0%	10% to 30%	Varies	Varies
Other criteria	Lenders may set other requirements	Not delinquent on any federal debt	Must meet active-duty service requirements	Home must be in an eligible rural area	6 to 12 months of cash reserves	Varies	Varies

Conventional Loan Requirements

A conventional mortgage loan (the most common type) is a loan that a government agency does not insure. These are a common option — 59% of first-time homebuyers chose them in January 2021 — and borrower requirements can vary between lenders.

There are two types of conventional loans: conforming and non-conforming. Banks, credit unions, and other financial institutions offer both types.

Conforming Loans Requirements

Conforming loans are those that follow the regulations set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The mortgage loan amount is limited to $647,200 in most counties, but borrowers in high-cost counties could be eligible to borrow as much as $970,800. Some general requirements for conventional conforming loans include:

• Employment: Steady employment supported by two years’ worth of W-2s, personal tax returns, or other documentation
• Income: Lenders may prefer buyers to spend no more than 28% of their monthly gross income on housing costs
• DTI ratio: Generally 45% or less, though lenders may allow up to 50% in some circumstances
• Credit: Conventional loans typically require a score of 620 or higher
• Downpayment: A minimum of 3% or 5% down, depending on the program

Non-conforming Loans, or Jumbo Mortgage Loan Requirements

Non-conforming loans include those for amounts greater than your county’s maximum conforming loan amount. These loans are also known as jumbo loans. Conforming jumbo loans are for amounts higher than $647,200 in most areas and $970,800 in some high-cost areas. Non-conforming jumbo loans are for larger amounts, typically from 1 to 2 million dollars.

Since the loan balance is higher, lenders may have stricter requirements for borrowers. These rules vary by lender, but some general guidelines are outlined below.

• Employment: Lenders typically require two years of steady employment, preferably with the same employer.
• Income: In addition to an adequate income to support the large loan, lenders may require borrowers to have cash on hand to cover 6 to 12 months of mortgage payments. 
• DTI ratio: Lenders may prefer a DTI of 43% or less.
• Credit: A score of 680 or higher may be required.
• Downpayment: Required downpayment could range from 10% to 30%.

Government-backed Mortgage Loan Requirements

Government-backed mortgages are loans offered by banks or other private lenders but insured by government agencies. The three agencies that back mortgages are the Federal Housing Administration (FHA), the U.S. Department of Agriculture (USDA), and the Department of Veterans Affairs (VA).

Since these loans are insured by government agencies and offer less risk to lenders, they tend to have more lenient eligibility requirements than conventional loans. This means it could be easier for borrowers with lower credit scores or a smaller downpayment to qualify for a mortgage.

Government-backed mortgage loans are designed to reduce barriers to homeownership. They’re aimed at certain types of borrowers, such as people with low incomes or those buying homes in eligible rural areas. Depending on a borrower’s situation, they could be eligible for one or more government-backed mortgage options. 

Federal Housing Administration (FHA) Loan Requirements

Federal Housing Administration (FHA) mortgages are home loans that are insured by the FHA, a part of the U.S. Department of Housing and Urban Development (HUD). They’re offered by FHA-approved lenders, from local credit unions to online mortgage lenders to commercial banks.

With less strict eligibility requirements than conventional mortgage loans, FHA loans are designed to help low to moderate-income Americans become homeowners. The requirements can vary between lenders, but some general lending criteria set by the FHA include:

• Employment: Lenders verify two years of employment history. FHA guidelines require borrowers to explain employment gaps of one month or longer.
• Income: Borrowers’ housing payments are generally limited to 31% of their monthly gross income.
• DTI ratio: The maximum DTI for FHA loans is generally 43%.
• Credit: FHA loans require a score of 500 or higher.
• Downpayment: Borrowers with credit scores of 580 or higher can put 3.5% down, but for those with scores between 500 and 579, the minimum downpayment is 10%.
• Other criteria: FHA borrowers must not be currently delinquent on any federal debt.

Veterans Affairs (VA) Loan Requirements

Veterans Affairs (VA) home loans are mortgages issued or backed by the U.S. Department of Veterans Affairs. They’re available to eligible service members, National Guard/Reserve members, and veterans. 

VA home loans are designed to help military members and veterans become homeowners. Private lenders, such as banks and mortgage companies provide VA loans. Some of the basic requirements include:

• Employment: Applicants must meet the minimum active-duty service requirement, which varies depending on when they served, and show two years of stable employment. 
• Income: Borrowers are required to have sufficient residual income after paying their monthly housing expenses. Residual income limits vary by location and family size.
• DTI ratio: The VA doesn’t set a maximum DTI but recommends a ratio of less than 41%.
• Credit: The VA doesn’t set a minimum credit score requirement, but borrowers are required to be able and willing to repay the loan, as shown on their credit history.
• Downpayment: VA loans are typically no-down-payment loans.
• Other criteria: Veterans must have a discharge under honorable conditions.

U.S. Department of Agriculture (USDA) Loan Requirements

U.S. Department of Agriculture (USDA) mortgages are home loans issued or backed by the USDA. It issues mortgages to low or very-low-income people through the Section 502 Direct Loan Program and backs loans issued by financial institutions through the Single Family Housing Guaranteed Loan Program. Both programs are limited to eligible rural areas.

The eligibility requirements for the two programs are slightly different, but in general, homebuyers interested in a USDA loan could qualify if they meet the requirements below. 

• Employment: USDA requires a 12-month history for most income types.
• Income: Housing expenses are limited to 29% of gross monthly income for very-low-income applicants and 33% for low-income applicants.
• DTI ratio: No more than 41%, with some exceptions.
• Credit: A score of 640 or higher is considered acceptable, but applicants may qualify with lower scores.
• Downpayment: Neither program requires a downpayment.
• Other criteria: The home must be in an eligible rural area, as defined by the USDA.

Fixed-rate Mortgage Loan Requirements

A fixed-rate mortgage is a home loan option that offers the same interest rate for the length of the loan. It’s an alternative to an adjustable rate mortgage, an option that offers an interest rate that could go up or down over time. 

Borrowers could choose a fixed-rate option with any of the mortgage types outlined above. For example, there are fixed-rate conventional loans, fixed-rate VA loans, and fixed-rate USDA loans. The requirements for these loans can vary depending on the mortgage type as well as the lender. 

Homebuyers may prefer a fixed-rate loan if they want a predictable mortgage payment each month. Since the interest rate stays the same for the length of the loan, the monthly principal and interest payments also stay the same. However, the interest rate could be higher than for an adjustable-rate mortgage option.

Adjustable Rate Mortgage (ARM) Loan Requirements

An adjustable-rate mortgage (ARM) is a home loan option that features a fluctuating interest rate. The rate tends to be fixed for a given period of time at the beginning of the loan term, and then it may increase or decrease later, depending on market conditions. 

Many of the mortgage types described above, including conventional loans, VA loans, and FHA loans, offer an adjustable-rate option for homebuyers who qualify for a mortgage. However, it’s important to note that no adjustable-rate mortgages are available through the USDA home loan programs.

ARMs tend to have lower interest rates at the beginning than fixed-rate loans, so in the short term, the mortgage payment may be lower and, therefore, easier to qualify for. Over time, the payment may become higher. This option might appeal to homebuyers who can tolerate some uncertainty in their budgets.

How to Get the Best Mortgage Rates

A lower mortgage interest rate can lower your monthly mortgage payment and reduce the overall cost of the home loan. To increase your chances of qualifying for a mortgage with a lower interest rate, try these actionable steps:

• Improve your credit score. Lenders may offer lower rates to borrowers with higher credit scores. To raise your score, make payments on time, work to pay down outstanding debt, and dispute errors you find on your credit report.
• Save a larger down payment. Homebuyers who put down 20% or more tend to be offered lower interest rates since lenders see them as lower-risk borrowers. 
• Get a co-signer. Borrowers with poor credit may consider asking a family member with good credit to cosign the mortgage. This could help you secure a lower interest rate, but note the co-signer is agreeing to be responsible for the loan if you fall behind on the payments.
• Shop around. Interest rates can vary between lenders. Consider getting quotes from multiple mortgage lenders or working with a mortgage broker to compare loan options.