Mortgage 101: How to Prepare for Buying a Home
If you’re in the market for a new home—and in the majority of people without enough cash to buy a house in full—then you’ll need a home loan, also known as a mortgage.
The better prepared you are for the mortgage process, the better your chances of closing on the right home at the right time. But what exactly is a mortgage and how do you get one?
Mortgages help homeowners finance a home over the long-term rather than pay the entire value of a property up front. Lenders use the property as collateral in case a borrower fails to pay back the loan.
Mortgages include the principal (the total amount borrowed), interest (the fee to borrow the money), property taxes, and insurance, which protects the lender from defaulted payments.
Before you start the mortgage process, let the real estate agents at Team Rita walk you through the steps from the paperwork to the pre-approval to your big day: the closing.
First things first: Your financials.
It’s always a good idea to gather your financial information before meeting with a mortgage lender.
Here are some helpful tips:
- Income. Hold on to your pay stubs and any tax documents from your employer, accountant, and the IRS so that underwriters can quickly and easily verify your income.
- Financial records. Keep your financial records organized, up to date, and ready to share with your lender.
- Assets. Save all the numbered pages of your incoming account statements. (For example: page 6 of 6).
- Gifts. Keep a signed gift letter and account statement for all monetary gifts from family members and friends. All gifts must be “seasoned” — or active in your bank account for at least 60 days.
- Bank deposits. Keep your deposits separate, small, and documented. Make copies of checks and deposit slips, and avoid depositing cash.
- Rent. Pay your rent on time and save proof of payment. If you own a home you’re selling, keep your Closing Disclosure handy.
- Job. Avoid changing jobs in the midst of the mortgage application process. There are strict rules about job probations, career changes, and even changes in status such as switching from a salaried to commissioned position or taking a leave of absence.
Check your credit report and score.
Mortgage lenders want to see two things: an accurate credit report (contact the credit bureau to correct any problems or mistakes) and a good-standing credit score.
Scores range between 300 and 850 — the higher the score the better. Most lenders accept 620 or higher for a conventional loan and 580 or higher for an FHA loan.
Any negative changes to your credit score can impact your mortgage approval. Changes in credit can delay financing, alter loan terms, and prevent closings.
Here’s how to maintain a healthy score:
- Try to use 30 percent or less of your available credit
- Pay your bills on time
- Keep your older accounts open (even the inactive ones)
- Don’t apply for new credit
If you must open a new account, double check with your real estate agent or mortgage lender first.
Find your debt-to-income ratio.
Mortgage lenders want to know the ratio between your debt and income. (Just divide your debt by your income to get your percentage.) Most lenders prefer 36 percent or less. However, some allow 43 percent or higher – and even up to 50 percent.
Of course, you can always boost your debt-to-income ratio by paying off your debt or bringing in more income.
Figure out your down payment.
The most common down payment is 20 percent for one simple reason: you won’t have to pay private mortgage insurance (PMI) — usually between 0.5 to 1 percent of the loan. (Bonus points for making you a more attractive borrower to lenders.)
However, don’t panic if you can’t swing the 20 percent. Some conventional lenders accept down payments as low as 3 to 5 percent. Certain VA lenders loan with no down payment at all. Work with your lender or real estate agent to find your down payment sweet spot.
Select your mortgage type.
Different mortgage loans have different interest rates, down payments, and qualifications.
Here are some questions to consider:
- Do you want a fixed-rate mortgage (the same interest rate for the life of the loan) or an adjustable-rate mortgage (an interest rate that changes over time)?
- Do you need a conventional (regular) loan or a government-insured (FHA, VA or USDA) loan?
- Are you borrowing enough to qualify for a jumbo loan?
Your lender or real estate agent can help you answer these questions and select the right type of mortgage for you.
This next step of the process is an informal Q&A between you and a mortgage lender. Based on your answers to questions ranging from how much you make to what you owe, a lender can figure out if you qualify for a mortgage and for what amount.
A pre-qualified mortgage doesn’t necessarily guarantee an approved mortgage. However, it does give you and the lender a good idea of your target price range.
Nothing is set in stone. Plus, you don’t have to get a mortgage from the same lender who pre-qualifies you.
More involved than pre-qualification, pre-approval is for prospects who are serious about buying a home. Agents, lenders, and sellers alike consider this stage the real start to the home buying process.
Pre-approval is a written commitment to your maximum qualified mortgage amount based on a lender’s careful review of your credit report, income, and assets.
Here’s how pre-approval puts you ahead of the game:
- Frees you from a lender’s mercy when you want to make an offer without time to shop around.
- Makes you a serious buyer in the eyes of sellers.
- Saves you the potential time and energy wasted browsing homes beyond your budget.
- Gives you an edge over other potential buyers making offers on the same home.
- Accelerates the time to close escrow.
Pre-approval means you are likely to get the loan. However, it doesn’t mean you have the loan yet. You still need to apply for the loan, go through underwriting, and get final approval.
After pre-approval, avoid taking out any loans or applying for new credit. However, feel free to shop around for a better rate from another lender.
Apply for a mortgage loan.
With an approved offer on a home, make it official by applying for a mortgage loan. You have many options — including banks, credit unions, mortgage lenders, mortgage brokers, and online mortgage companies — each one with its own pros and cons.
Banks, credit unions, and mortgage lenders offer personal service but not the best interest rates. Mortgage brokers can find the best mortgage for your needs but not without charging you an extra fee. Online mortgage companies deliver fast service on a wide variety of loans but not the personal touch of professional lender.
Your real estate agent can help you narrow down the choices to find the mortgage type that works for you.
Close on your home.
Your mortgage becomes official on the day you close on your home. Gather your closing funds and get ready to sign lots of paperwork. With your closing in writing, grab your new set of keys and schedule a date to make your first month’s mortgage payment. Pat yourself on the back for buying a new home!