For the sake of clarity, a mortgage is a loan from a bank (or a mortgage lender) that helps you in buying a home. Every loan requires collateral, which is why the home you are purchasing will also serve as the collateral for the loan. Although it seems simple and straightforward, the concept of a mortgage in itself is not as simple as it looks. There are a lot of requirements that have to be fully understood by the prospective homeowner. Issues such as the payment plans and the terms and condition of the bank or building society issuing the mortgage must be firmly understood to avoid misunderstanding or default by the mortgagor.
Applying for a mortgage can be appealing; however, understanding the process of repaying it is critical. There are five parts to your monthly mortgage:
Are you ready to buy a home? Securing a loan involves checking all of your financial details like debts, income, and assets. The bank must determine if you’re financially fit and they’ll be taking you under the magnifying glass. Stay ahead of the curve and prepare; here is the process:
Buying a house is a business transaction that involves some form of financial compensation. Your credit score is checked to determine your financial responsibility, and this will be a crucial factor in securing your loan. The higher your credit scores, the brighter your chances of securing the mortgage, and vice versa. For example, the minimum credit score to officially apply for the Federal Housing Administration (FHA) loan is 580. The range of FICO is from 300 to 850; the categorization of Rating Scores is as follows:
579 or lower
580 – 669
670 – 739
740 – 799
800 and above
Applicants with Very Good and an Excellent credit score are perceived as financially stable and stand a far better chance to secure a mortgage than those with Good, Fair, and Very Poor ratings.
Studying your credit report will help you understand and repair some financial slips. Start by requesting a free* Equifax, Experian, and TransUnion credit reports at annualcreditreport.com or by calling 1-877-322-8228.
(You can obtain a free report once every 12 months).
Your credit score may be provided for free on your credit card statement or online account. You check your credit reports as often as you want using creditkarma.com, it won’t affect your scores. Once you know where you stand, there are steps you can take to increase your credit score:
A. Pay down your balances as much as you can, don’t let debt sit month-to-month on your credit cards.
B. Keep a sound ratio of your available credit, ideally 30% or less. If your total credit line is $15,000, don’t exceed $5000.
C. Pay bills on time, it’s one of the main parts of your credit score so don’t be late!
D. Stop applying for other credit cards, loans, or lines of credit; it will cause a drop in your credit score that can last a year.
E. Don’t close older bank accounts as they are a valuable part of your financial history.
All of the above will rejuvenate your credit score and put you in a stronger position to secure mortgage loans in the nearest future.
The money you pay upfront is your equity in the property, and serves as security against loss for the lender. A 20% down payment or more will drastically improve your mortgage approval and help you avoid some additional fees like PMI. The more substantial down payment means smaller monthly payments and more equity sooner.
Although preferred, 20% down payment is not always possible, and not required. You can get away with as little as 3% down, or in some cases no downpayment at all. Low down payment carries several caveats.
Generally, if your down payment is less than the 20%, you will be required to obtain private mortgage insurance (PMI), which serves as an insurance for the private lenders. The premium for this insurance becomes a part of your monthly mortgage bill.
You may find a lender who will not require mortgage insurance, but they will most likely impose other fees upfront. Concluding – lower down payment will cause more in fees and a higher interest rate on your home loan, and you’ll end up paying more over the life of the loan.
The debt-to-income ratio refers to the borrower’s accumulated debt compared to their income each month, a crucial factor for lenders looking into your credit history.
DTI helps determine if you can repay your debts every month and make timely mortgage payments.
The smaller your debt to income ratio is, the better chance you’ll get a loan. An ideal DTI is less than 36%, yet some lenders will accept DTIs as high as 43% percent.
To determine your DTI, add all your monthly payments and divide them by your gross income.
For example, let’s say your anticipated mortgage is $1,500 a month, and you already pay $250 in auto loans and $250 in student loans. Your total monthly debt is $2,000. If your gross income per month is $6,000, your DTI would be 33.3% because $2,000 is 33.3% of $6,000.
Statistically, borrowers with higher DTIs struggle with mortgage payments more often, hence the risk factor of not getting approved for loan increases proportionally to your DTI.
Each lender is different and makes decisions on a case-by-case basis; however, as a general rule, you’ll want a smaller debt-to-income ratio for the better mortgage rate.
Mortgage pre-qualification entails granting your lender access to your critical financial information such as credit score, outstanding debts, net and gross income, etc. Without a doubt, this is a major criterion for a successful loan application process. Your loan application process has not fully commenced until this process is instituted. It is this information that will determine whether you would qualify for the other stages of the loan application or whether your request would be denied. Also, just as the name implies, your pre-qualification outcome will determine the nature of mortgage loan that could be issued to you. There are a host of different mortgage loans available, and they would be discussed in the subsequent parts of this report.
Pre-approval for a mortgage is the next step after pre-qualification, and its goal is to prove your financial health. You will be asked to provide the receipts, income verification, proof of identity, etc. Most likely, in this step, a hard inquiry into your credit will be made.
To get pre-approval, you’ll have to provide a lender with hard financial evidence. Some of the documents you will have to submit:
• Photo ID
• Social Security Number
• Proof of Employment & Income:
– A letter from your employer declaring your salary, hire date, and employment status.
– Copies of your most recent W-2 along with two most recent Payroll Stubs
– 1099 form if you’re self-employed or a freelancer, along with last year-to-date profit and loss statement.
– Real estate income (rental income, lease, market value, and address)
• Proof of Residence
• Bank Account: the last 60 days’ worth of statements are required
• Gift Letters (if someone is helping you with the down payment, a formal gift letter is required to prove that you don’t have to pay it back)
• Monthly Expenses & Debts including credit history, rent, bills, car loans, and other financial obligations
Different loan options are available to you, all of which have their characteristics.
Two Types of Conventional Loans:
A) Conforming Loan that follows the rules and upper limits for loan amounts set by Freddie Mac and Fannie Mae. If your down payment is less than 20%, you will be most likely required to pay PMI (private mortgage insurance).
B) Non-Conforming Loan also called “jumbo loan,” goes beyond loan limits outlined by the government. This type of loan fits wealthier buyers looking to buy a house in an upscale area.
The government does not back conventional Loans.
This type of mortgage secures a stable (fixed) interest rate, and it’s paid off in 10, 15, 20 or 30-year terms (30-year fixed mortgage is most common). The interest rate is set at the time of loan approval and varies depending on the term period, the shorter term, the lower the interest rate.
Security is the main benefit of this type of loan; your interest rates will be locked in despite fluctuations of the market (property taxes and insurance fees might change).
If you plan on moving in 5 to10 years, consider Adjustable-Rate Loan.
Adjustable-Rate Mortgage Loans
An adjustable-rate mortgage, also known as (ARM), usually has a lower initial interest rate, but after a set period, the rate changes at adjustment intervals.
After the initial fixed period, the lender establishes a new interest rate based on the market so that the new rate can affect your monthly payments. Most ARMs have hard limits on the amount the interest rate and monthly mortgage payment can shift.
Important factors when considering an ARM loan are the starting interest rate, how long it will be fixed, and adjustment periods.
Consider this type of a loan if you expect your income to rise or if you plan to sell your home before the fixed interest rate expires. Anticipate higher monthly payments if you stay beyond the fix rate period.
If you can’t afford 20% downpayment, have less than a good credit score or higher than normal DTI ratio, the Federal Housing Administration or other government loan may be your option. Proving creditworthiness with cell phone bills, utility bills, gym membership fees or rent may be considered
Many lenders are trying to get your attention and sell you a loan, and every one of them is unique. Start by checking current mortgage rates and the overall market conditions. Ask friends and family for recommendations; some of them went through the process and had great insights. Shop around and compare offers from at least three lenders – even a small fraction of a percent can save you a lot of money.
Getting pre-approval is perhaps the most complex step of the application process. If you decided to go with the lender that already pre-approved you, turning in your application is just a formality. If you choose a different one, it’s the pre-approval process again.
Your financial history, all documents and statements will be probed once again. House appraisal will determine if the value of the property matches the loan amount, and the lender will decide if you’re going to be approved for the loan. Use this time to do a professional home inspection and check for any defects that can be used as leverage in negotiating repairs or even a lower sale price during the closing process.
During the closing, you will be signing a lot of documents, your agent will guide you through the process, but here are a few things to remember: