When you plan to buy a home, you have to do a lot more than find the right home. In fact, the process starts long before you ever set foot in your first potential home. Unless you have the cash to buy the home outright, you will need financing to buy the home. Today there are several loan programs available, each of which pertains to different types of buyers.
We know that looking for a home loan can be overwhelming, but we are here to help make it easier for you. There are many myths and misconceptions regarding mortgage loans today, especially after the housing crisis. Contrary to popular belief, it’s not hard to get a mortgage today, as long as you can meet the minimum requirements. We suggest that you start early and prepare yourself so that your loan application looks favorable to lenders, giving you many choices of a loan product.
The Home Loan Process
The loan process can be a long, tedious one. You will start the preliminary work long before you even apply for a mortgage so that you can properly prepare yourself for the process ahead.
Prepare Yourself Financially
The first step, and the one that may take you several months or longer to complete is preparing yourself financially. Initially, you’ll want to take a long, hard look at your credit score, savings, outstanding debts, and income. These are the factors any lender will look at right away, making a preliminary decision on your ability to secure a mortgage.
Take the following steps to get yourself in a good financial place:
- Check your credit report – You have free access to your credit report from each of the three bureaus once a year. You can choose to pull at three at once, or space them out so that you check your credit report three times a year. Comb through this report and look for any inaccuracies or negative items. If any information is incorrect, write a dispute letter and send it to the credit bureau and the reporting company. The credit bureau has 30 days to resolve the issue or they must remove the inaccurate information. If you have any negative items, such as late payments or high balances on your credit cards, correct the issue and let your credit score improve in the following months.
- Get a handle on your debt – How much outstanding debt do you have right now? If you can’t answer that question, it’s time to get a handle on it. Using your credit report and your most recent credit card/loan statements, you can total up your debts. Does your revolving debt make up more than 30% of your total credit limits? If it does, you need to get those balances paid down quickly. Next, total up your minimum monthly payments and compare it to your gross monthly income. You’ll need to fit a housing payment in that comparison too. The maximum total debt ratio (consumer debts plus a mortgage) cannot exceed 43% of your gross monthly income for any loan program. Use this time to pay down those debts to achieve this number.
- Evaluate your income – Your income plays a vital role in your loan approval too. Of course, you need to make sure you make enough to cover your mortgage payment, plus your existing bills. You also need to make sure your income is stable and reliable. Lenders like to see income that you have had for at least 2 years. This is the ideal situation. If you’ve started a new job in less than two years, you may be able to use it as long as there is enough of a history for the lender to see that is consistent and reliable. If you work on commission or you are self-employed, you’ll want to have at least a 2-year history to show the lender so that they can see the peaks and valleys your income experiences. This allows the lender to figure out your 2-year average. In the years leading up to your loan application, it’s a good idea to limit the deductions you take in order to maximize your qualifying income.
Once you are close to the point of searching for homes, take the time to find a few lenders and get pre-approved. A pre-approval means that the lender evaluates your income, assets, debts, and credit score to make sure you qualify for the loan.
After evaluating your qualifying factors, the lender will write you a pre-approval letter. This letter should state the amount of the loan that you qualify to receive, the loan program you qualify for, and the date the pre-approval is good through. This letter then gives you a foot in the door as you search for homes. Sellers and real-estate agents like to see the pre-approval letter to know that you are a serious buyer and that you qualify for adequate financing.
Process the Loan
Once you find the home that you want to call your own, you will need to finalize your financing. You’ll need the executed purchase contract, any updated income/asset information that the lender requires, and appraisal/title work on the property.
The lender will handle ordering the appraisal and title work. You just concentrate on providing the lender with the qualifying documents they need from you. They will likely need updated income and asset documents to make sure that nothing has changed since your pre-approval. They may also have other miscellaneous documents they need to finish processing your loan.
Once the lender clears your income/asset documents and receives your appraisal and title work back, you are closer to closing on your loan. The lender must make sure that the home is worth at least as much as the purchase price and that there aren’t any outstanding liens on the property. After the lender clears all conditions on your loan, you are ready to close on your home purchase.
The Loan Closing
Your final step is the loan closing. Make sure you don’t make the mistake of assuming you are ‘in the clear’ once the lender says you can schedule the closing, though. The lender may still run a credit check and/or verify your employment/income to make sure nothing changed during the time they processed your loan. It’s best if you keep everything exactly as it was when you first applied so that you don’t risk your approval.
The Mortgage Loan Types
Before you shop for your loan and get pre-approved by a lender, you should understand the loan types that are available. Below are the most common loans and their general requirements.
- Conventional Loans – These loans require great credit, low debt ratios, and money to put down on a home. If you have at least a 680 credit score and you know your housing ratio won’t exceed 28% of your gross monthly income and your total debt ratio will be 36% or less, this may be a good option. Conventional loans often have the most competitive interest rates, but they require at least 5% down on the home. If you put less than 20% down on the home, you will pay Private Mortgage Insurance as a part of your payment. The PMI only lasts until you owe less than 20% of the home’s value, though. You don’t have to refinance out of the loan; you can request cancellation of the insurance once you pay the loan down enough and/or the home appreciates.
- FHA Loans – If you don’t have ‘perfect credit’ or you have a higher debt ratio, you may want to look at the FHA loan. Contrary to popular belief, this isn’t a program just for first-time homebuyers; any borrower that qualifies can use this financing. You’ll need at least a 580 credit score and your debt ratio must not exceed 31% (housing ratio) and 43% (total debt ratio). FHA loans require just 3.5% down on the home and 100% of that money can be gift funds as long as it’s approved by the lender. FHA loans do require mortgage insurance both upfront and on an annual basis (paid monthly). They charge 1.75% of your loan amount upfront and 0.85you’re your loan amount annually. Unlike conventional loans, you cannot cancel the mortgage insurance; you will pay it for the life of the loan.
- VA Loans – If you are a veteran, you can take advantage of VA financing. You must serve at least 181 days during peacetime or 90 days during wartime and have an honorable discharge to qualify. If you served in the Reserves, you must serve at least six years before you are eligible. VA financing provides veterans with 100% financing up to $453,100. Of course, you must qualify for the loan amount that you receive. In order to qualify, you’ll need at least a 620 credit score and a total debt ratio that doesn’t exceed 43%. In addition, you must meet the VA’s requirements for monthly disposable income based on your family size and location. VA loans don’t require mortgage insurance, but you will pay a funding fee equal to 2.15% of the loan amount at the closing.
- USDA Loans – If you don’t mind rural living, the USDA loan may be a good option. Your total household income must not exceed 115% of the average income in the area in order to qualify. This includes income from anyone that lives with you, even if they aren’t on the loan. You can check if your income qualifies here. In addition to being eligible, you must qualify for the loan with at least a 640 credit score, 29% housing ratio and 41% total debt ratio. The USDA provides 100% financing if you qualify for the loan. They do charge upfront mortgage insurance and annual mortgage insurance, but it’s less than what you’d pay on an FHA loan. The USDA charges 1% of your loan amount upfront and 0.35% of your loan amount annually (paid monthly).
Each of the loan programs discussed above offer competitive interest rates. But, the entity offering the programs, (Fannie Mae, FHA, VA, or USDA) don’t set the interest rates. They also don’t fund the loans. It’s up to you to find a Fannie Mae or government-approved lender to get the loan programs that you need.
We recommend that you obtain quotes from at least three lenders to make sure that you get the lowest interest rate possible for your situation. Some lenders may charge lower rates, but higher closing costs and vice versa. Compare your loan options side-by-side to determine which loan will suit you the best not only now, but well into the future as it pertains to your plans.