Mortgage rates are sticking near record lows, which means borrowers are able to take advantage of deep, deep discounts on loans.
That has many would-be homebuyers navigating through the intimidating mortgage application maze, feeling lost and confused.
But it doesn’t have to be that way — you just need to break the process down to a shorter list of steps. Whether you’ve only recently considered buying a home, or have been steadily saving for years, at some point you’ll need to understand the process of getting your mortgage.
Here are the nine most important steps, in order, to help you on your journey.
1. Make sure it’s the right time
Are you ready to buy a home? It should take more than rock-bottom interest rates for you to step into the market, though today’s record-low rates certainly help.
A common rule of thumb says to spend no more than 25% of your monthly take-home pay on your mortgage payment. Once you have that 25% number, you can use a mortgage calculator to see how much home you can afford, given a certain down payment and interest rate.
But that’s not the only cost to consider — you’ll also need money for closing costs, taxes, maintenance and your down payment. And, with standard (“conventional”) mortgages, when you put down less than 20% of the purchase price, your lender will require you to buy private mortgage insurance, or PMI.
With all those costs, it’s important not to jump in too quickly. As soon as you get the urge to buy, start saving as much as possible. Try stashing your money in a high-yield savings account, which will help it grow the quickest.
2. Get your credit in shape
Your credit score will play a big part in the interest rate you’re offered on a home loan — and whether you can get a mortgage at all. Credit scores of 550 or less aren’t good enough in the eyes of lenders. They’ll want to see a score of 700 before considering your application.
Everyone makes mistakes, so if your score is crummy now, don’t panic — you just need to give it a boost.
First, get a bit more familiar with your score. You can get free credit scores, and even free credit monitoring, from an online service. You’ll also get personalized suggestions on which accounts to pay down first, and you’ll be walked through a checklist of moves you can make to improve your credit score.
The best way to give your score a jump-start is by dealing with your other debts. If you’re struggling to pay even the monthly minimums on your credit cards, consider consolidating your debts. A debt consolidation loan allows you to take out a new, lower-interest loan and use it to pay off your high-interest debt.
There are free online loan-comparison tools that will help you consolidate your debt and keep your credit score from taking any further hits.
3. Get preapproval
If you’re really serious about buying a home, then getting preapproval is an important step. The lender will essentially give you a ballpark idea of how much you’ll be able to borrow for a home.
Knowing that price range — and whether the lender finds any roadblocks in your application — is important before you fall in love with a home.
Besides, sellers and real estate agents will expect you to come with a preapproval; it’s what motivated buyers do.
To get preapproved, you’ll first need to get some important documents ready, so the lender can check your income, assets, credit history, employment and identity.
4. Pick the mortgage program that works for you
Home loans come in different varieties, which means you’ll need to decide which type makes the most sense for you. Here’s a rundown of a few of your options:
Conventional or FHA?
A conventional mortgage is the most common way to finance your new home. These are any loans that aren’t insured or guaranteed by the federal government.
The requirements for a conventional mortgage can be stricter, and typically are only available to buyers with solid credit scores. Again, if you can’t muster at least 20% of the home’s purchase price for a down payment, private mortgage insurance premiums will be tacked onto your monthly payments.
Conventional mortgages can be either “conforming” or “nonconforming.” Conforming loans follow (conform to) specific dollar-amount limits set by Fannie Mae and Freddie Mac, two government-sponsored companies that buy mortgages from lenders. Nonconforming, or jumbo loans, go beyond those limits.
An FHA loan is guaranteed by the Federal Housing Administration and is aimed at helping first-time homebuyers and those with lower or moderate incomes.
The guidelines for these loans are less strict: The credit score requirements aren’t as high as for conventional mortgages, and an FHA loan allows a borrower to make just a 3.5% down payment.
Fixed or adjustable rate?
A fixed-rate mortgage keeps the same interest rate for the life of the loan.
This gives you some certainty when budgeting for your monthly payments: You know exactly what rate you’ll pay, and it won’t change. Neither will your payment amount.
It’s pretty helpful to know that if interest rates suddenly spike, yours won’t. But if rates suddenly drop to record lows, as they have in 2020, you’ll be stuck at the higher rate.
An adjustable-rate mortgage, or ARM, starts out like a fixed-rate loan, and typically with a lower rate than a fixed-rate mortgage. But after a certain number of years, your interest rate can change, in sync with a financial index.
With a 5/1 ARM, for example, the rate will hold steady for the first five years, while the second number tells you often the mortgage rate will adjust after that. With a 5/1, it’s every (one) year.
Before the lender agrees to give you that hefty mortgage loan, you’ll agree on the terms for your repayment. The most common term for a fixed-rate mortgage is 30 years, but terms of 20, 15 and even 10 years are available.
The major advantage to stretching out the term is lowering your monthly payment. With lower payments, you can also usually get approved for a higher overall mortgage.
But if you can manage higher payments, 15-year mortgages have some benefits: Interest rates are lower on shorter-term loans, and your lifetime interest costs will be much smaller versus a longer-term mortgage.
The annual percentage rate, or APR, gives you a more precise idea about total borrowing costs, compared to a simple interest rate.
So how exactly does an APR differ from an interest rate? APR represents your interest plus a few other expenses.
At a quick glance, you can see the annual costs of your interest, mortgage broker fees and other lender charges that are part of the loan process. That means the APR will normally be higher than the interest rate.
5. Shop lenders
Saving money is crucial when you’re sinking so much into something as costly as a home.
But shopping around to find the best mortgage rate can save you a lot more than pennies. According to a Freddie Mac study, borrowers who comparison shop to five lenders can save about $3,000 over time, compared to someone who seeks out only one loan offer.
Rates can vary from one lender to the next, so start by comparing a minimum of five rate quotes. Pay close attention to interest rates, APRs, closing costs and discount points, which are upfront fees that lower your interest rate.
If you’re a good candidate, lenders will want your business. That means they may even be willing to knock the costs down a bit — if you ask.
6. Submit your application
Once you find the best rates, you’re ready to submit your mortgage application. If you’re using the same lender that preapproved you, you’ll only need to update your most recent financial information.
If you’ve targeted a new lender, here’s what you’ll need to submit as part of your application:
Proof of income. Buyers generally need to provide W-2 wage statements from the past two years, along with pay stubs from the past 30 days, as proof of employment and steady income. You may also need proof of any income outside your regular employment, such as rent from an investment property or cash from a side hustle. And if you’re self-employed, you’ll need to prove to the lender that your business makes enough money, too.
Proof of assets. The lender will want to ensure you have the cash for a down payment and closing costs. You’ll need to provide bank statements or a proof-of-funds letter to show you’ve got the money. If you’re getting some help from family, you may also need a gift letter to prove that their financial assistance isn’t a loan.
Proof of identity. In addition to your Social Security number, the lender will need a signed authorization to pull your credit report.
7. Go through the underwriting process
Feel like a lot of steps? It is, but you’re almost there. Now you’re waiting on your application to get approved, and this is when the lender will take a look at you as a borrower and decide if you’re eligible (and worth the risk) for the loan.
So, what will the lender be looking at?
Credit and job history. The lender wants to feel certain you’ll be able to keep up with your monthly payments. Even if you are working, a lender might get nervous if you’ve switched jobs a few times lately.
Your other debts. If you have other debts — like student loans or a sizable balance on your credit cards — it might signal to lenders that you’re not ready to add more. Lenders will look at your “debt-to-income ratio,” which is calculated by adding up all your monthly debt payments and dividing them by your gross (pretax) monthly income. You want that number firmly under 43% to avoid scaring away lenders.
This is also when the lender would want the home appraised. An appraiser will research the house to tell the underwriter how much it’s truly worth. Underwriters want to know that you’re not spending (and borrowing) more than the property is worth.
8. Get ready to close
Once you’re approved for your loan, take a moment to celebrate.
Once you’ve done a dance around your living room or have exchanged high fives with your significant other, it’s time to get back to work — because the process isn’t over yet. Closing costs are an important (read: costly) part of your homebuying journey.
Here are a few of the closing items to consider:
Discount points. Want to bump your mortgage rate lower? You can pay discount points, those fees we mentioned earlier that can “buy down” your rate. This option makes the most sense if you plan on being in your home for a while.
Homeowners insurance. Find the best rate on insurance before closing — otherwise your lender may choose a policy for you. With a bit of comparison shopping, you may be able to save $1,000 per year on your home insurance.
Title insurance. Once you have the title, you legally own the property. The fee covers the search for essential documents as well as title insurance, which provides some protection if someone comes along and claims an interest in the home.
The final walk-through. If you’ve agreed on repairs after the home inspection, this is the time to make sure they’ve been completed. You also should make sure there’s been no new damage since the inspection.
A cashier’s check. Homebuyers will usually pay 2% to 5% of the purchase price of their home in closing fees — and writing a personal check won’t cut it. You’ll need to secure a cashier’s check, which is guaranteed by the bank. Give yourself a few days before the closing to get this done, just in case you run into any issues.
The hard work is over — now it’s time to seal the deal.
At your mortgage closing, you’ll meet with a group of people to sign your mortgage and (many, many) other documents.
Depending on state laws, the other people at the table may include your lender, your attorney, the seller and that person’s agent and attorney, a closing agent, and a title company representative.
Make sure you review and sign all your loan documents, even though there’ll be a lot of them. If something looks different than you expected, don’t sign until you clear it up.
You’ll hand over that cashier’s check to cover the closing costs and other items, like prepaid interest, taxes and insurance.
Finally comes the best part: You grab the keys to your new home.