Via LearnVest By Libby Kane ~
A mortgage is just a loan granted to qualified applicants for the purpose of buying a home. Sounds simple, right? Well, it’s a little more complicated than that. Applying for (and getting) a mortgage is a multi-step process, from gathering your income statements to choosing a lender. And there’s no fixed way to do it, since each lender has its own method–and rates can change day to day. This checklist will help you navigate what can sometimes be a challenging process.
Determine how much home you can afford.
As a general rule, try not to shop for a house that’s more than 2.5 times your annual salary. So if you make $100,000 per year, that $275,000 house may not be the right fit for you.
Next look at how much you have saved for a down payment, which is the portion of the cost of the home you aren’t borrowing. Do you have 20% or more socked away for a house of your target price? (While most lenders only require that a borrower put down 3%, they prefer that an applicant borrow no more than 80% of the cost of the house–and that’s a good idea for your finances, too.)
If you can’t pay that much, you may still qualify for a mortgage, but you might be considered a high-risk borrower, which means that you will probably pay a higher interest rate. Keep in mind that if the housing market dips, and your mortgage goes under water, the fact that you have so little equity in the house would give you little to no cushion to absorb any loss that you might incur if you had to move.
Finally, when considering how much house you can afford, don’t forget to factor in homeowner’s association fees, property taxes and homeowner’s insurance–all of which could turn a $2,000 mortgage into a $3,500 monthly expense. Overall, you’ll want your mortgage payment, including taxes and insurance, to be no more than 28% of your income.
Additionally, you can have a realtor give you the expected utilities for a home that you’re interested in (these are sometimes made available by the current owner and posted by their realtor in the MLS system) or check county records online to see what property tax rates are in the area.
Check your credit score and credit report.
When you apply for a mortgage, your lender will need to see evidence that you’re a reliable borrower. If you’re planning to apply for a mortgage in the near future, you probably won’t have time to improve your credit score or credit report, but you’ll want to make sure that there aren’t any errors. A score over 720 is considered strong; under 660 is looked upon as weak, which may mean that you’ll have to pay a higher interest rate. (If you do have time to improve your credit score, use our checklist to help you.) You can review your score once a year from each of the three credit reporting agencies using Credit Karma. To get your credit report, use our checklist.
Assemble your financial documents and your down payment.
Be prepared to “undress” financially. The bank will look at your previous financial records, so you’ll want to get them in order. Lenders almost always require applicants to:
- Verify income, which you can usually do by presenting recent pay stubs–or tax returns, if you’re self-employed.
- Show how much cash money you have available to spend. Post-recession, lenders are extremely cautious about liquidity, so it’s not unusual for a lender to require that you have several months’ worth of mortgage payments in the bank. Your bank statements can serve as proof of your liquid assets.
- Disclose other assets you own (real estate, investment accounts, cars, etc.) and all of your debts, including personal loans, credit cards and student loans.
Consider whether you need a broker.
A mortgage broker’s job is to act as an intermediary for you and a lender–a broker will help you figure out what types of mortgages you qualify for, and who offers them. A broker’s chief advantage is insider knowledge of the industry, plus his relationship to lenders. If a broker brings a lender enough business, that lender might be inclined to help him (and you!) to the best of its abilities.
However, since brokers are usually paid by lenders, the lender might increase your interest rate to accommodate that extra cost. A 2009 study found that buyers who work with a broker pay an average of $300 to $425 more in fees than borrowers who did not work with brokers. If you have the time and the patience to approach lenders yourself, working without a broker is usually the more affordable option.
On the other hand, when you’re looking at a $200,000 or $300,000 purchase, it might be worth it to hire a broker who can hunt down the best loan. For instance, brokers may know of specific loan programs that could help you, such as those targeted specifically to teachers, veterans or physicians.
Look for a lender with a reputation for good customer service and timely mortgage closings.
Closing your mortgage on time is imperative. If you’ve promised the seller that you’ll move in by a certain date, and your mortgage hasn’t closed, you may owe penalties–and you could end up without a place to live if you’ve already moved out of your current residence.
For this reason, when you look for a lender, you’ll want to inquire around. If you’re already working with a realtor, ask for a recommendation. Also speak to friends and family who’ve bought homes recently for suggestions.
The next step is to make calls directly to lenders and to your local bank. For both lenders and banks, make your calls in one fell swoop–rates change daily, so calling different lenders on different days may not give you an accurate idea of comparative rates.
When you contact a lender, don’t offer up your Social Security number–instead, give your credit score and income, and ask for a quote. This quote won’t be exact, since the lender will revise it once they have more information. To make the comparison easier, ask for the rates on one specific type of mortgage, such as the common 30-year fixed. And keep in mind that major banks aren’t the only institutions that can grant mortgages: Credit and labor unions sometimes also offer mortgages, and if you qualify, there are special arrangements for military veterans.
Your local bank may also serve as a good resource for a mortgage loan: If you have excellent credit, the bank may lend you the money and hold the loan “in house,” meaning that they will act as both broker and lender. The bank may also make the loan to you initially, and then sell your loan to a larger bank or mortgage lender. This is common, but remember that the terms of your original loan will still be in place–after all, a loan is a contract, and whoever buys the contract is still bound to honor it.
And make sure to exhaust your options before choosing a lender. While it’s favorable to find a lender that can offer a low interest rate, it’s crucial to find a trustworthy lender with a good reputation: If you stumble across a lender with unbelievably good interest rates, they probably are just that–unbelievable.
Choose the mortgage that’s right for you.
Mortgages aren’t one-size-fits-all. The payment plans vary by interest rate and by duration–the most popular plans offer a fixed rate (the interest rate will always be the same) for 15, 20 or 30 years. The other option is an adjustable rate, which means that the interest rate will change each year. Loans can be fixed, adjustable or a combination of the two. (Read more about types of mortgages in our 101 story.)
An adjustable rate mortgage, in which the interest rate changes at preset intervals to reflect the current market, may be ideal if:
- You are primarily looking for low interest rates in the short term
- You don’t intend to stay in the home long enough for rates to rise (say, if you’re planning to renovate and flip a house)
A fixed rate mortgage, in which you pay a fixed interest rate for the duration of the mortgage, may be ideal if:
- Interest rates are rising
- You’re counting on a steady, predictable payment
- You plan to stay in the home for a long time
A combined mortgage, in which the rate is fixed for three, five or seven years before becoming adjustable, may be ideal if:
- You expect to sell the home before the rate becomes adjustable
- You plan to refinance or have your loan re-evaluated for a potentially better rate before the rate becomes adjustable
In preapproval, a reputable mortgage lender will agree to give you a mortgage loan for a specified amount, but you won’t make a commitment to buy a specific property. Whether or not the preapproval will also “lock in” your rate–give you the same interest rate in your actual mortgage as in your preapproval letter–depends on the lender and whether rates are rising.
If rates are rising, you may want to lock in your rate. If rates are going down or have been low and don’t show much sign of movement, it may not matter. Many borrowers decide not to lock in their rate since they don’t know how long it will take to find a home, and then have their offer accepted. If you want to lock in your rate for a longer than normal period (i.e. 60 days instead of 30 days), it may cost you more in points or in a slightly higher interest rate.
You’ll fill out a full mortgage application, which will ask you about your comprehensive financial history. You’ll also usually pay an application fee, so don’t take this step unless you’re truly ready to start shopping for a home. In some cases, you won’t even need to meet with your lender to submit the application–they’ll let you send it via email.
Preapproval used to be less common, but it’s now expected that you’ll get preapproved before you even start house-hunting. Not only does it improve your chances of getting the seller to take your offer seriously, but it will make the final mortgage process move more quickly once you’ve agreed to a price.
There are two caveats: First, just because you are pre-approved for a certain amount of debt doesn’t mean that you should necessarily borrow that much. It’s a good rule of thumb to knock 20% off whatever the approved amount is, and use that as the ceiling for your potential loan.
Second, pre-approval letters typically only last for 90 days, so it’s not something that you want to do too early in the process. You can get the letter re-validated if your hunt takes longer than you anticipated, but remember that you’re working against the clock. If you get your actual mortgage after the initial 90 days, your lender may require you to re-verify the information that you provided to confirm that your financial situation hasn’t changed.
Ask for an estimate of closing costs.
Once you have signed a contract for the purchase of your home, ask the lender for a “good faith estimate” (you can review this here). Your lender will estimate how much money you’ll need for closing costs, which are the extra charges and fees you’ll be asked to pay when you finally become the owner of the house.
Closing costs can include pointsPrepaid interest in the form of an upfront fee imposed by a lender (they work out to about 1% of the loan amount), taxes, title insuranceAn insurance policy that protects your ownership rights to the property should someone else try to claim ownership and try to buy, sell or otherwise profit from it., financing costsFees paid to the lender for the use of their money. and more (a commonly missed charge, for example, is “fuel adjustment” or the price for the heating fuel that’s already in the house when you buy).
When the final form is presented to you, your lender or broker is required to show you which numbers cannot change and which are subject to a 10% variation. You’ll be required to pay all of the charges whether or not they vary, so start saving up as soon as possible. In some instances, a motivated seller will offer to pay your closing costs just to get the deal done. Although this may seem like a good thing, it may mean that they are less willing to budge on the sale price and you’re really just amortizing the cost into your 30-year note.
Consider what you’ll do if you get rejected.
So let’s say that you’ve done your research, figured out how much you can afford, decided whether you need a broker, found a trustworthy lender, chosen the mortgage structure that’s best for you and submitted your paperwork … but the lender says, “not so fast!”
Even if you’ve done everything right, it doesn’t necessarily mean that you’ll get the mortgage you want. It’s not very common to get rejected outright–if you do, it’s most likely because of a problem with your credit report, and you’ll be entitled to review it.
More commonly, you’ll be approved for a smaller mortgage than the one you applied for, which means that you’ll need to either rethink the house you had intended to buy and bid on something smaller or delay buying a house until you have more money–and need only a smaller mortgage to make up the difference.
LearnVest is the leading lifestyle and personal finance website for women.