Buying a home, especially if it’s your first time, can be confusing and stressful. But giving yourself enough time to prepare can make it a little easier.
Mortgage rates are currently well above the record lows of the past few years, making affordability a major concern for many buyers. But experts say you shouldn’t let the current rate environment deter you from getting into a home.
“It’s painful when rates rise but I tell homebuyers to try and see that interest rate as an investment in your financial future,” says Derrick Nutall, vice president of Citi mortgage’s community lending team. “Yes, a home is a great place to build memories, but it’s also helping to create generational wealth.”
Still, taking on a mortgage is often the biggest financial decision you’ll make in your lifetime. Understanding the process ahead of time, familiarizing yourself with key terms and anticipating costs prior to closing can make all the difference when getting a mortgage.
“The first step, and most important one, is to be prepared,” says Scott Lindner, national sales director for mortgage lending at TD Bank. “Meet with a mortgage professional early on in the process so that you can understand the mortgage process.”
Here’s what you need to know about how to get a mortgage and how to choose the right mortgage and lender for you.
1. Get your finances in order
Before making an important financial decision, like taking out a mortgage, it’s important to do a financial checkup to assess where you’re at.
When it comes to getting a mortgage, you should focus on two things: building your credit and growing your savings. Having more cash on hand and a stronger credit score will make it easier to afford a wider range of homes.
“You’ll want to do an honest assessment of your finances so you can see what is affordable for you.” Nutall says. “This will also help you determine where you are credit-wise and whether you may qualify for down-payment assistance.”
The minimum credit score required to get a mortgage depends on the mortgage type and lender. Conventional mortgages backed by Fannie Mae or Freddie Mac have minimum credit score requirements of 620, although individual lenders may set their own, higher credit score requirements on top of that.
You’ll generally have better approval odds and mortgage options with a higher credit score. While it may be possible to get a mortgage with bad credit, it’ll also cost more. The lower your credit score, the higher your mortgage interest rate (and thus your monthly payments). Strengthening your credit by paying bills on time and paying off debt can make a mortgage more affordable.
2. Save for a down payment and closing costs
How much house you can afford goes beyond just the monthly mortgage payment. You’ll also need a sizable chunk of cash for upfront closing costs -- which can average between 3% and 6% of the purchase price -- and, in some cases, a down payment. Your down payment could end up costing tens of thousands of dollars.
A healthy down payment is 20% of the home’s value, but each type of mortgage has different minimum requirements. It’s possible to buy a home with a smaller down payment -- some conventional loans require as little as 3% for a down payment -- and in some cases you can avoid a down payment altogether. You can also look for down payment assistance programs, which are designed to help first-time homeowners or buyers with low-to-moderate income better afford a home.
Pro tip: Contributing to a savings account regularly, particularly one that earns a high yield, can help you better afford those costs when you’re ready to buy a home. Right now, high-yield savings accounts are offering rates between 4.00% and 5.00% APY, so you can earn additional interest on your down payment fund. If you’re not planning on buying a home for a few years, you can lock in a high-yielding CD rate for over 5.00% at some banks.
3. Figure out how much mortgage you can afford
To get a good idea of what your monthly mortgage payment will look like, you can use CNET’s mortgage calculator to estimate your monthly payments. But keep in mind that how much you feel you can comfortably fit into your budget may be more or less than what a bank is willing to lend to you.
One of the ways your mortgage lender determines how much you can borrow is by looking at your debt-to-income ratio. Your DTI shows lenders what percent of your income goes to debt each month. You can calculate it by dividing your monthly debt payments by your monthly income before taxes. You should include your estimated monthly mortgage payment in this number.
For example, let’s say you make $6,000 a month, pay $500 a month in debt payments and your estimated monthly mortgage payment is $2,000. In this case, your DTI is 42% ($2,500 divided by $6,000).
Lenders may approve you for a mortgage if your DTI is 45% or lower. So while you may be approved for a mortgage in the above scenario, you can increase your chances of approval and lower your DTI by paying down any existing debt before applying for a mortgage.
But just because a lender approves you for a certain amount, it doesn’t mean you should spend this much on a home. A good rule of thumb is to keep your DTI below 36%. That includes not just your mortgage payment, but all of your other monthly debts. So, if you make $6,000 a month, you’ll want to keep your monthly debts -- including your estimated mortgage payment -- under $2,160.
4. Choose the right type of mortgage
You should also understand the different types of mortgages available. Down payment requirements, repayment terms and mortgage insurance requirements also vary by mortgage type. No two loans are exactly the same, so getting guidance on what makes sense for your situation is key.
Types of mortgages
Conventional loans are a good option for buyers with solid credit and a 10% to 20% down payment saved up, though some conventional loans require as little as 3% down. Conventional loans are widely available with most banks, credit unions and private lenders.
Government-insured loans like an FHA loan, VA loan or USDA loan can offer unique benefits that conventional loans cannot and are worth considering if you qualify for them.
- FHA loans are offered by the Federal Housing Administration and are meant to make homeownership more accessible. They’re easier to qualify for than conventional loans -- often requiring a down payment as low as 3.5% and a minimum credit score of 580 in most cases.
- VA loans are backed by the US Department of Veterans Affairs. To qualify for a VA loan, you must be an active or retired member of the military or a spouse of one. VA loans allow you to buy a house without a down payment -- and don’t charge private mortgage insurance either. But they do come with an origination fee, which you can roll into the loan.
- USDA loans, backed by the US Department of Agriculture, provide home loans to middle- and low-income families purchasing homes in qualifying rural and suburban areas. These loans offer lower interest rates than conventional mortgages as well as more lenient credit requirements and no down payment. They also require an upfront guarantee fee and an annual USDA loan fee.
Jumbo loans are a good option if you need to finance more than $726,200 for your home (loan limits vary across the country). These loans may allow borrowers to take up to $2 million in a mortgage, but require a strong credit score and high down payment to qualify. Each lender may set their own rules for a jumbo loan, so it’s important to ask upfront about eligibility and terms.
Mortgage term
Your mortgage term refers to how long you’ll be paying off your loan. Typical mortgage terms are 10 years, 15 years and 30 years. This has a big impact on your monthly payments and how much interest you pay over the life of the loan. A longer loan will have smaller monthly payments, because the purchase amount is spread out over a longer period of time. A shorter-term loan will have larger payments but, over time, save you money on interest. This is because shorter loans usually have lower interest rates and you’re paying the loan off in a shorter amount of time.
Adjustable vs. fixed-rate
Mortgages can also vary in terms of interest rate structure as well. There are fixed-rate loans, which have the same interest for the duration of the mortgage. And then there are adjustable-rate mortgages, or ARMs, which have a fixed rate for a set period of time, then switch to a variable interest rate that changes annually based on market conditions.
Most homeowners opt for a fixed-rate mortgage for predictability -- you’ll know how much you’ll owe each month since your rate will never change. But if you think you’ll sell the home after a few years or refinance in the near future, you might consider an ARM with a fixed-rate term that matches your timeline. This can save you money, since ARMs typically have lower interest rates during the initial introductory period before the rate adjusts.
5. Shop around for mortgage lenders and compare offers
Once you have an idea of the type of mortgage you’re looking for, you’ll want to compare offers from multiple lenders before signing with any particular one. It’s all about working with a lender you feel comfortable with and you trust to understand your situation.
“With the level of volatility in the mortgage market, you need a lender who has every single tool and knows how to use them to help you get the best deal,” says Jennifer Beeston, senior vice president at Guaranteed Rate, a national mortgage lender.
This will ensure you get the best rate and most amenable loan terms based on your financial situation. Even a small difference in your interest rate could save -- or cost -- you thousands of dollars over the life of your loan.
“Buyers should be asking their lenders, ‘Can you lock my rate while I shop? What should I expect with rates? What have you seen with rates? Should I expect to pay discounts?’” Beeston says.
6. Get preapproved for a mortgage
Once you’ve narrowed down lenders, you’ll want to get preapproved for a mortgage. Mortgage preapproval gives you a good idea of how much you’re likely to be approved to borrow and shows sellers you’re a qualified buyer. To get preapproved, a lender will check your credit score and proof of income, assets and employment.
If approved, the lender will send you a preapproval letter. Even though a preapproval letter doesn’t guarantee you’ll qualify for financing, it shows the seller you have the finances in a place to pass an initial examination from a lender.
Most preapproval letters are valid for 60 to 90 days, and when it comes time to apply for a mortgage all of your information will need to be reverified. Also, don’t confuse preapproval with prequalification. A prequalification is a quick estimate of what you can borrow based on the numbers you share and doesn’t require any documentation. It’s less rigorous than a preapproval and carries less weight.
7. Find out if you need private mortgage insurance
During your research of different lenders, pay attention to whether you’re going to need private mortgage insurance, which can add hundreds of dollars to your monthly mortgage payments. PMI protects a lender in case the borrower defaults on their loan, so it’s your lender’s call whether it will require you to have PMI on your loan. Generally, lenders will require PMI on loans with a down payment of less than 20%.
You won’t need PMI on VA loans, even if you don’t put any money down. USDA-guaranteed loans don’t require PMI, but borrowers are instead charged an upfront and annual guarantee fee that serves the same purpose. FHA loans require a one-time Up Front Mortgage Insurance Premium and annual mortgage insurance premium, or MIP, instead of PMI.
If you have a conventional loan, you can file a request with your lender to cancel your PMI once you have at least 20% equity in your property. If you don’t request a cancellation, your lender must automatically cancel PMI on the date your loan-to-value ratio, or LTV, reaches 78% based on the original payment schedule, per the Homeowner’s Protection Act.
8. Submit your application
Once you’ve found a house and your bid has been accepted, you can begin the formal application process.
You can complete your mortgage application online, over the phone with the lending institution’s loan officer or in person if your lender has a physical branch. The lender will ask for your full name, income information and Social Security Number for a credit check. There will also be some questions about the home you’re looking to purchase. The lender will then provide a loan estimate form within three days of the initial application.
If you decide to proceed with the application, the lender will need to verify every part of your finances. Depending on your situation, the list of what you need to submit along with your application can get long. Compiling the necessary paperwork ahead of time could save you some stress and time.
Examples of forms you may need to submit include:
- Tax returns
- Pay stubs, 1099 forms, W-2 forms
- Bank or investment account statements
- Government ID
- Authorization to pull credit reports
- Documentation of all your debts
- Employment history
- Housing history
If you’re self-employed or a freelancer, expect to provide extra documentation such as:
- Two years of tax returns and business tax returns
- Business bank account statements
- Copies of your business licenses
9. Navigate the underwriting process
Next, the lender will verify that you’re a qualified borrower during a process called underwriting.
Your financial health will be closely scrutinized during this step, using the documentation you supplied in the previous step. Your lender may ask for further information or for letters explaining any employment gaps or money received from friends or relatives to help with down payment or closing costs.
The underwriting process is meant to answer one question: Are you likely to repay this loan? So during this time, lenders are sensitive to any change in your credit profile. Avoid any big purchases, closing or opening any new accounts and making unusually large withdrawals or deposits.
During this step the lender will also authorize a home appraisal to verify the home’s value. You should also schedule a home inspection, which will provide a deeper look at the home’s condition, so you’ll know if there are any damages or issues to raise with the seller before closing.
At the close of the underwriting process, you’ll find out if you’re approved for a home loan.
10. Close on your home
Before you get the keys to your new home, you need to finish the closing process, which technically starts when your offer is accepted.
As a part of closing, the lender requires a home appraisal to verify its value. You’ll also need to have a title search done on the property and secure lender’s title insurance, as well as homeowner’s insurance. Your lender will also verify that you’re still employed during the closing process, and may even require employment verification up to the day of closing.
It can take anywhere from a few weeks to a few months (in a worst-case scenario) before you wrap up with a final walkthrough of the property. After that, all you need to do is sign the dotted line at the closing appointment and your funds will be transferred from escrow.
