When you are planning to purchase a home for the first time or are in the process of refinancing an already existing one, you need to know the basics of how a home loan works. The first thing that you need to know is the major factors that would determine whether you will be qualified for a home mortgage or not.

There are basically three major factors, commonly referred to as “ICE”,  that will determine if a person will be qualified to apply for a home loan. These factors will also determine the type of mortgage that can be offered to a person planning to get a home mortgage.

INCOME: The “I” in ICE refers to income. A person’s gross monthly income and total housing expenses are used to compute the “Debt to Income” ratio. This value gives the ability of a person to pay his or her debts. The DTI is actually the percentage of a person’s gross monthly income that can be used to pay his/her home mortgage. There are two main types of DTIs used to determine whether a person is qualified for a home loan. The first type is called the “Front-end ratio” which indicates the amount or percentage of the person’s income that will go towards the payment of the housing costs. The second type, called the “back-end ratio”, indicates the percentage of the income that will go to paying all other recurring debts that the person has.

In order for a person to qualify for a home mortgage, he must have a debt-to-income ratio rating of at least 28/36. The 28 indicates the front-end-ratio, while the value 36 is the back-end ratio. This means that at least 28 % of his income will be allocated for paying housing expense while 36% is allocated for paying all housing expenses as well as all other recurring expenses that a person needs to pay monthly. The amount of home loan that will be offered to you will be partially based on your DTI.

You can easily determine the amount of mortgage that you will be qualified to have by comparing your DTI value with the amortization payments computed through the use of a mortgage calculator.

CREDIT:  Credit scores are used to evaluate what type of customer you are. Having a bad credit score means if often missing regular payments. This is considered as a high risk investment. Banks and other lending institutions heavily rely on credit score to know whether a person is a  potent applicant  for a home loan or any type of loan.

There are three major credit reporting agencies namely: Experian, Trans Union, and Equifax, which compute the credit score of a person.  The credit score is based on the person’s financial activities. Banks take the report from these agencies to determine the factors such as credit mix, credit balances and credit limits of a person applying for the loan. Credit scores may range from 300 to 850. A person having a low credit rating may not be able to get a mortgage loan. Even if gets the loan, he must have to pay high interest rates. On the other hand, a person having high credit score may qualify for a home mortgage loan with better interest rates.

EQUITY. Equity refers to the appraised value of your home minus what you still owe on an existing mortgage. For example, if your home has an appraised value of $100,000.00 and you still owe the bank $50,000.00 in a previous mortgage, then your home has an equity value of $50,000.00. This equity or home value is another determining factor that will let the banks or lending institutions know if a person will qualify for a home loan.

The three above factors determine a person’s qualifications for obtaining a home mortgage. Depending on a person’s ICE mix, he or she may be offered good or bad home mortgage options. For example, if a person has a relative low income with a ten percent equity interest in his home however a high credit score has; this person will qualify for multiple home mortgage options at very competitive interest rates.

Article by John Hoots of ChicagoMortgageSpecialist. For more information on Chicago mortgage broker, visit his site today.