If you're here, you probably know what a mortgage is and how it can help you get a home; if not, don't worry! Our previous post might help you learn what it is and how it works.
We're going to talk about what you need to know before getting a loan.
Before you get too far into the mortgage application process, take a step back and review your credit reports. Your credit score will be a key factor in receiving a decent deal on a house loan, or even getting accepted at all.
Begin by requesting credit reports from the three major credit bureaus: Experian, Equifax, and TransUnion. The simplest way to accomplish this is to go to annualcreditreport.com, which is the only website authorized by federal law to provide free credit reports once a year.
Next, go over your reports to make sure there are no inaccuracies or accounts mentioned that aren't yours that could have harmed your credit. Check the accuracy of your personal information, such as your name, address, and Social Security number, for example. Check that the credit accounts and loans indicated on your reports have been properly recorded, including the balance and status. Check to see if any strange accounts have been opened, which could indicate identity fraud.
If you discover an inaccuracy, you can dispute it by visiting the website of the bureau that is reporting the inaccurate information. When you file a complaint, the agency must investigate and respond within 30 days.
This brings us to the following step. Unless your credit is in pristine condition (in which case, congratulations), you should spend some time cleaning it up.
Your credit scores are not listed on your credit reports. Fortunately, obtaining your credit score for free is pretty simple. Many major credit card companies, for example, offer your FICO score for free. Other websites will show you your VantageScore, but keep in mind that this scoring methodology is utilized far less frequently by lenders than FICO and may differ by several points.
Most conventional loan providers consider a credit score of 620 to 640 to be the minimum required for a mortgage. Some government-backed loans can let you borrow with a credit score as low as 500 if you meet other requirements. The higher your credit score, though, the more economical your loan will most likely be.
Making all of your debt payments on time and in full is one of the best methods to boost your credit score. The most strongly weighted component, payment history, accounts for 35% of your credit score. Another 30% of your score is determined by the amount of debt you owe about the total amount of credit provided to you, so keep your debt as low as possible.
Finally, for several months before applying for a mortgage, avoid making major purchases on credit or opening new lines of credit, as this can reduce the number of hard inquiries and length of your credit history.
Before you start looking for your dream home, make sure you can afford it. The 28/36 rule might help you find out how much house you can afford. This is your debt-to-income ratio; for example, a 50% DTI ratio means you spend half of your monthly pre-tax income on debt payments.
Your "front-end" DTI, which includes solely mortgage-related expenses, should ideally be less than 28%. Your "back-end" ratio, which includes the mortgage and all other debt commitments, should be less than 43%—ideally, less than 36%.
If your DTI is too high, you'll need to concentrate on reducing or eliminating any existing debt before applying for a home loan. Remember that your monthly loan payment is only one piece of the picture; there's also interest, homeowners insurance, property taxes, and (possibly) homeowners association fees to consider. You'll also need to examine how much of a down payment you can make and whether you'll be obliged to pay PMI.
You'll need to weigh your alternatives to determine which form of mortgage loan is best for you. Here are a few things to consider:
Conventional Vs Government-Backed
Mortgage loans are classified into two sorts. The first type of mortgage is a conventional mortgage, which is provided by a private bank, credit union, or Internet lender. These loans typically have stringent qualifying requirements and hefty down payments.
Even if your credit isn't in fantastic shape and/or you haven't saved much for a down payment, you may still be able to purchase a home with a government-backed mortgage such as an FHA, USDA, or VA loan. Individual lenders continue to make these loans, but the funds are insured by the federal government. This reduces the risk of these loans for the institutions that provide them, allowing you to negotiate more flexible terms.
Fixed Vs Variable Interest Rate
Another important issue is whether you want a fixed or variable interest rate for the life of your loan. Fixed-rate loans are often a secure decision because you know precisely how much your mortgage payment will be each month.
Variable rates are typically less expensive in the first few years of the loan. However, the rate will reset one or more times over the loan period depending on market conditions. That means your interest rate could rise in the future, making your mortgage payments unaffordable.
Shorter Vs Longer Term
Finally, examine how the length of your loan will affect the cost. On the one hand, a shorter loan term of 15 or 20 years allows you to pay off your loan sooner and save money on interest rates. However, this implies that your monthly payments will be substantially greater, restricting part of your cash flow. In this case, you may need to borrow less.
Another alternative would be to prolong the loan term to 30 years or more. This would reduce your monthly payments and even allow you to borrow more. However, extending the number of years spent repaying the loan increases the total amount of interest paid over time.
You have a decent financial situation and know how much you can borrow. Now comes the hard part.
Loan providers require a significant amount of documentation as part of the mortgage approval process, so gather everything before you apply. You might need the following:
Income Verification
First, you must demonstrate that you have sufficient income to sustain your mortgage payment. Lenders will most likely request tax returns for the previous two years, as well as current W-2 forms or pay stubs. If you are self-employed, you must instead provide 1099s or profit and loss statements from the last two years to establish your income.
If you get alimony or child support, you must additionally present court decrees, bank statements, and legal documentation proving that you will continue to receive that money.
List Of Liabilities
Lenders may also request paperwork regarding outstanding debts, such as credit card balances, student loans, or any current home loans.
Proof Of Income
Additional assets, in addition to income, can help you acquire a mortgage. Expect to supply bank statements from the last 60 days for checking and savings accounts, retirement funds, and other brokerage accounts.
Other Paperwork
You may be required to provide extra documentation depending on the lender. For example, if you currently rent, the lender may require canceled rent checks or a letter from your landlord as confirmation that you pay on time.
Also, bear in mind that if you intend to use gifted monies for your down payment, you will need to produce a gift letter as well as a clear paper trail of where that money originated from. Furthermore, if you sold an asset for cash, you may be required to show evidence proving that sale (for example, a copy of the title transfer if you sold a car).
With everything out of the way, it's time to apply for a loan. But don't let your excitement lead you to sign a contract too quickly. Choosing the finest mortgage lender and loan offer takes time and research to guarantee you're getting the greatest price.
The mortgage interest rate you choose will have a significant impact on the entire cost of your loan. Even a fraction of a percentage point can build up to a large amount of change over time. Assume you borrow $200,000 at 4.25% for 30 years. Over the life of the loan, you'd pay a total of $154,197 in interest. If your interest rate was 3.50%, you'd save $30,885 over the same 30 years by paying $123,312 in interest instead.
In addition to the interest rate, consider closing charges, origination fees, mortgage insurance, discount points, and other fees that can add thousands of dollars to your loan. These costs are frequently folded into your loan total, which means you pay interest on them in addition to the principal.
Examining the annual percentage rate (APR) is one simple approach to comparing the exact cost of a mortgage. This is the total yearly cost of your loan after all fees are deducted, given as a percentage of the quantity borrowed. However, keep in mind that the APR assumes you will keep the loan for its entire term; if you plan to relocate or refinance within a few years, the APR may be misleading.
While it is thrilling, purchasing a home can also be extremely stressful. Getting pre-approved for a mortgage is one way to alleviate some of the stress of the home-buying process.
When you get preapproved, a lender will look at personal factors like your credit score, income, and assets to estimate how much you can borrow. This gives you an advantage because home sellers know there's a good chance you'll be able to acquire financing quickly. Furthermore, rather than choosing a home and then gnawing your nails as your mortgage application is reviewed, you can begin house-looking with a more definite number in mind.
It is important to note that getting preapproved does not imply that you will have the funds in hand when the time comes to buy. You will still need to file an official mortgage application and go through the entire underwriting procedure before receiving formal approval.
Final Note
Securing a mortgage is one of several phases in the overall home-buying process, but it is critical. Take your time weighing your alternatives. After all, 30 years is a long time to be stuck on an expensive loan.
You're almost there. All that remains is to prepare for closing day. This includes performing a final walkthrough of your home, obtaining homeowners and title insurance, obtaining a cashier's check for your down payment, and warming up your contract-signing arm.
Caroline Soriano