You’ve been saving for a down payment for years and road-tested your budget to make sure you can handle a mortgage payment plus the added costs of being a homeowner, like keeping money in an emergency-repair fund. Now you’re ready to get the keys to your first home.
But unless you’re planning to put down all cash on that Cape Cod in your favorite up-and-coming neighborhood, first things first: You'll need a home loan. And the process isn’t as simple as comparison-shopping for the mortgage with the best rate. You’ve got some homework to do and paperwork to gather before you even get on a lender’s radar. Here are the steps.
1. KNOW YOUR LENDING VOCAB
From ARMs to PMI, there are a lot of terms to know before you gather any applications, so get familiar with the jargon first. “If you’re denied [for a loan], a loan officer is only going to take so much time to give you info,” says Simone Griffin, vice president of affiliate relations at HomeFree-USA, a nonprofit that provides financial and homeownership coaching. The reason: Loan officers and realtors work on commission, so they likely won’t want to spend too much time explaining things to you. These terms can help.
Fixed-rate mortgage. This is a type of mortgage in which you’ll pay the same interest rate over the life of the mortgage, usually 15 or 30 years. Regardless of how interest rates are moving up or down in the lending market, your rate is locked in.
Adjustable-rate mortgage (ARM). With this type of mortgage, you’ll pay one rate over a certain period of time, after which the rate will become variable, depending on what’s going on with interest rates in the markets. So for instance, a 5-year ARM means that you’ll pay the same rate for five years, but after that the rate will readjust. It could be higher or lower than the original rate you started with.
Private mortgage insurance (PMI). Ideally you’ll be able to make a down payment of at least 20 percent on your home. If you put down less than that, you’ll likely be charged PMI by your lender because you’ll be viewed as a higher lending risk. Once you’ve surpassed 20 percent equity in your home, you can look into removing PMI with your lender.
Debt-to-income ratio (DTI). Debt-to-income ratio is a number that lenders use to determine how much mortgage you can afford. You calculate it by taking your monthly income and dividing it into the sum of your monthly debt payments (such as what you pay for auto or student loans, and the minimum payments due on your credit card balances). A higher DTI can limit the amount you’re approved for, or affect whether you’re approved at all. Lenders usually prefer that your total DTI doesn’t exceed 36 percent of your gross monthly income.
PITI. A mortgage payment doesn’t just include the amount you’re borrowing. It’s the monthly sum of what you owe in principal, interest, taxes and insurance, also known as PITI. Lenders usually prefer that your PITI not exceed 28 percent of your gross monthly income.
Pro tip: For more resources that first-time homebuyers can tap to get educated, Griffin points to this handy tool for finding Department of Housing and Urban Development–approved counseling agencies, as well as helpful beginner homebuyer’s guides at Freddie Mac and Fannie Mae.
2. CHECK YOUR CREDIT
The better your credit report is, the better your credit score will be — which, in turn, can help you increase the chances of getting approved for a mortgage with a lower interest rate.
A “good” credit score is around 740, but what most lenders want to know is the likelihood that you’ll be delinquent on a mortgage payment, says Fred Kreger, vice president of enterprise production for American Pacific Mortgage and former president of the National Association of Mortgage Brokers. This is the type of insight you can get from your payment history details in a credit report. He suggests requesting your credit report through AnnualCreditReport.com to see whether you have any dings that are counting against you. You’re entitled to a free credit report every year from each of the three credit bureaus (Experian, Equifax and TransUnion).
Being current on your payments is one of the best ways to improve your score and show your creditworthiness, so if you’re behind on any bills, get caught up as soon as possible. It may even be worth waiting a few months before you start applying for mortgages so you have time to raise your score. While you don’t need a stratospheric score just to obtain a mortgage, the higher your score, the better the lending terms you’ll get.
3. GET PRE-APPROVED
Getting pre-approved doesn’t mean you actually have a loan in hand. It means that a lender has looked at your credit report and other financials and decided how much they’re willing to let you borrow. Getting pre-approved helps make the homebuying process easier because it 1) gives you an idea of the price range you can aim for; and 2) it informs sellers that you can make a solid, lender-approved offer. Just keep in mind that what you’re pre-approved for doesn’t mean you should borrow that much; you should assess what you can comfortably afford.
Also, it’s not mandatory to go with the lender who pre-approves you, but doing so would help speed up the homebuying process because that lender will already have many of the financial documents you need to submit in order to get a mortgage. These could include:
- Your identification and Social Security number
- Pay stubs for the last 30 days
- Two years’ worth of W-2s
- Two years’ worth of tax returns
- Recent bank statements
- Details on any other loans you have
A pre-approval, by the way, doesn’t last forever. It’s typically valid anywhere from 60 to 90 days, depending on the mortgage lender, so ideally you’d do this when you’re serious about buying a home.
4. KEEP SHOPPING AROUND
You’ve put down an offer — and it’s been accepted! Before you commit to going with the lender who provided your pre-approval, it’s worth weighing your options to make sure you’re getting the most competitive rates and terms. There are different types of lenders, from credit unions to banks to mortgage bankers. Ask your real estate agent for suggestions or get referrals from people you trust, and look at mortgage-comparison sites. You might also want to consider hiring a broker to help find lenders for you, although you’ll pay a broker’s fee. Potential lenders you contact will pull your credit report to determine what they can offer you.
If your credit score or down payment size don’t qualify you for a conventional loan (generally, you need to put down at least 5 percent and have a credit score in the mid-600s) you might qualify for a government-backed loan. The most common are those backed by the Federal Housing Authority, which may lend to you for as low as 3.5 percent down if your score is at least 580.
In addition to your interest rate, see what kind of lender fees — origination fees, underwriting fees and closing costs, for example — the mortgage provider may tack on. “Certain products come with things beneath the surface that the average consumer may not know about,” Griffin says. “There are tons of products out there. Don’t settle for something that might not be good for you.”
5. SUBMIT YOUR MORTGAGE APPLICATION
Now you’re ready to submit your application. The lender will help you fill out the form, which will ask for information like the type and length of the mortgage, interest rate, details of the property you’re buying and other loan terms. You’ll also need to submit your financials for a new lender. If you’re going with the lender who pre-approved you, they may ask for updated versions of certain documents.
Within three business days, you’ll receive the more complete details of your mortgage, called a loan estimate. Receiving this doesn’t obligate you to go with the lender — in fact, you can submit multiple mortgage applications so you can compare multiple loan estimates. You can use this opportunity to bargain for better loan terms as well, such as reduced fees or closing costs.
Once you’re satisfied with the mortgage terms, you’ll want to verify with your lender that you want to move forward within 10 business days to keep the agreed-upon interest rate, and they may ask for additional financial information to fully complete the approval — and get you one step closer to owning your new home.