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Applying for a mortgage is a big financial move. While the mortgage application process can seem overwhelming, by the end of this article you’ll know exactly what you need to do.
In fact, with this seven-step guide, you’ll be ready to apply for a mortgage in no time.
1. Get a Feel for How Much you Can Afford
Understanding how much of a home you can comfortably afford is arguably the most important step when applying for a home loan. Establishing a range for monthly payments early on can prevent potential heartbreak over an out-of-budget home. One of the best ways to get a better idea of your house-hunting budget is to use an affordability calculator.
2. Gather Financial Documents
The financial documents needed to apply for a home loan are usually straightforward. You need to show that you have a stable income and enough money coming in to comfortably afford the house you plan to buy. Typically, you’ll need to provide the following documentation:
- W-2s for the last two years
- Recent pay stubs
- Bank statements for all accounts
- Signed personal and business tax returns
- Profit/loss statement (if self-employed)
- Signed purchase contract (if applicable)
You don’t need to have a signed purchase contract in hand before applying for a home loan. It is entirely possible to begin applying for mortgages before you even begin the house-hunting process.
If you do have a signed purchase contract, the lender will want a copy.
» MORE: See today’s refinance rates
3. Understand Basic Home Loan Requirements
It helps to know what lenders are looking for when they review your finances and your home loan application. In general, lenders consider the following factors during the mortgage application process:
Your credit score shows how you have handled debt payments in the past. Have you paid bills on time? Do you have any debts in collections? Is there a bankruptcy on your record? Are you using a responsible amount of the credit you qualify for?
The higher your credit score, the more likely you will get approved by a mortgage lender. Higher credit scores also get you a lower interest rate, which saves you money on your mortgage payments. While it’s possible to get a home loan with a score as low as 500, most lenders like to see a score of at least 620.
If you want to raise your credit score, focus on paying bills on time and paying down your debt until it’s lower than 30% of your credit limit.
To make sure you can afford the house you want to buy, lenders need to see how much of your income is being used to pay debts. If you divide your monthly debt payment total by your pre-tax monthly income, you get your debt-to-income (DTI) ratio.
The “qualified mortgage” rule recommends keeping your DTI ratio below 43%. But some lenders may prefer to see a lower DTI. They want to make sure that you make enough money to cover all your bills, including your new home mortgage, plus all your living expenses.
Assets are anything of value that you own. And lenders are interested in your assets, particularly your cash-based assets like savings and liquid investments, because they show that you have enough money on hand to cover your upcoming expenses.
Generally, lenders want to confirm three things from your assets:
- You have enough money for your down payment and closing costs.
- You have enough left over after the down payment and closing costs to cover unexpected expenses like home repairs.
- You got the money legitimately. If you can’t explain where sudden, large deposits came from, this will likely raise a red flag for lenders.
The loan-to-value (LTV) ratio tells you how much of the home’s value is being financed by your mortgage. For example, if you pay a 3% down payment, you’re getting a loan for the remaining 97%, so the LTV would be 97%.
The lower your LTV, the lower the risk is for the lender. This is why lenders will usually offer a better interest rate with a larger down payment. A larger down payment will also result in lower monthly payments.
4. Pick a Mortgage Type
There are lots of mortgage options available to homebuyers. Which mortgage type you choose depends on your unique financial circumstances. Here is a breakdown of a few of the most common:
|Conventional 30-year fixed
|Down payments as low as 3%, lower monthly payment
|Conventional 15-year fixed
|Down payments as low as 3%, pay off your loan faster with a lower interest rate, higher monthly payment
|Lower credit score requirement, 3.5% down payment
|$0 down for eligible active duty, veterans and eligible spouses, no PMI, lower interest rates
|$0 down, must be in a designated USDA rural area, low-to-moderate income earners
Conventional loans are the most suitable option for most buyers. You can choose a 15-, 20- or 30-year loan term with a fixed interest rate. Or you could opt for an adjustable-rate mortgage, where the interest rate fluctuates with the market. As long as you have a credit score of at least 620 and enough money to make a 3% down payment, a conventional loan is probably a good fit for you.
FHA loans can be a good option for buyers with credit scores below 620. If your credit score is at least 580, you could qualify for an FHA loan with a down payment as low as 3.5%. If your credit score is at least 500, you might still qualify for an FHA loan as long as you can put 10% down.
If you’ve served in the military, a VA loan could be a good financing option. VA loans offer 0% down payment options, and are available to qualifying military service members, Veterans and their spouses.
USDA loans are available for homes in rural areas and smaller towns. Low-to-moderate income earners can potentially qualify for a 0% down payment option with USDA loans.
5. Fill Out Mortgage Applications
Armed with your documents and information about the mortgage application process, it’s time to start filling out home loan applications. Many lenders allow you to apply for a mortgage online.
You probably want to fill out online applications with multiple lenders so you’ll be able to compare and see which one offers the best terms.
Does Applying for Multiple Mortgages Hurt Your Credit?
Don’t worry about multiple mortgage applications having a negative impact on your credit score. Yes, your credit score can take a tiny hit when a lender runs a credit inquiry. But when you apply for a home loan with several lenders over a short period of time, the credit bureaus can tell that you’re simply shopping rates, and they won’t penalize you for each credit check. The newest credit scoring model allows a 45-day window for making inquiries with multiple lenders.
6. Review Loan Estimates
Each lender will respond to your home loan application with a denial or an offer of credit. You should compare the offers you get to see which lender offers the most favorable terms. Here are three factors to consider:
Annual Percentage Rate
Your annual percentage rate (APR) includes not only the interest expense on the loan but also all fees and other costs involved in procuring the loan. These can include broker fees, closing costs, rebates, and discount points.
Closing Cost Details
Mortgage closing costs are the fees paid to your lender for processing your home loan. These include origination charges, appraisal fees, credit report costs, title insurance fees, and any other fees required by your lender or paid as part of a real estate mortgage transaction.
Total Costs Over the First Five Years
Most borrowers keep a mortgage for about five years before moving or refinancing. While your situation may be different, determining the total amount you’ll pay in interest and fees over five years is a good way to compare loan offers.
7. Choose the Best Lender for You
At this point, you should have the information you need to confidently choose a lender. Once you have made your decision, simply let your chosen lender know that you’re ready to move forward. They will begin processing your loan, and you will have taken a major step toward homeownership.
If you’re still feeling unsure about applying for your home loan or have specific questions, you can talk with a mortgage loan specialist today