For most Americans, taking out a mortgage is essential for buying a home. But how do you secure a mortgage? This guide breaks down the mortgage process, so you’ll know what to expect when you apply for a home loan.
How to get a mortgage
Step 1: Strengthen your credit
The best loan offers go to borrowers with credit scores in the 700s because a strong score demonstrates responsible debt management.
“Having a strong credit history and credit score is important because it means you can qualify for favorable rates and terms when applying for a loan,” says Rod Griffin, senior director of Public Education and Advocacy for Experian, one of the three major credit reporting agencies.
If your credit score is lower, you can still get a loan, but you’ll likely pay a higher interest rate.
To improve your credit before applying for a mortgage, Griffin recommends these tips:
- Make all payments on time and reduce your credit card balances: Your payment history on your report goes back two years or longer, so start now if you can.
- Bring any past-due accounts current: Past-due accounts will sink your score. Bringing all of these accounts current and continuing to pay them on time can limit some of the damage.
- Review your credit reports: You can check your credit reports weekly for free at AnnualCreditReport.com. Check for errors on your credit reports, and contact the reporting bureau immediately if you spot any. For example, an error might be a paid-off loan that hasn’t been recorded as such, or an incorrect address.
- Check your credit score: Check your reports and score well before applying for a mortgage. When you review your score, you’ll see a list of the top factors impacting it, which can tell you what changes to make to get your credit in shape, if needed.
Step 2: Know what you can afford
To determine how much house you can afford, start by calculating your debt-to-income (DTI) ratio. This is done by adding up all your monthly debt payments and dividing that total by your gross monthly income.
A lower DTI ratio gives you more flexibility in your budget for non-housing expenses. Andrea Woroch, a personal finance expert from Bakersfield, California, emphasizes the importance of considering all your monthly expenses and savings for future goals.
“The last thing you want is to be tied to a mortgage that restricts your lifestyle and prevents you from achieving your aspirations,” Woroch warns, highlighting the risk of becoming “house poor.”
Step 3: Build your savings
Your initial savings goal should focus on accumulating enough for a substantial down payment.
However, it’s important to know that you can still purchase a home without a full 20 percent down payment. For instance, conventional loans often require as little as 3 percent down, FHA loans require 3.5 percent, and VA and USDA loans may not require any down payment at all.
Additionally, building your cash reserves is crucial. A good guideline is to have about six months’ worth of mortgage payments saved, even after making your down payment. This financial cushion can provide security in case of job loss or other unexpected events.
Don’t overlook closing costs, which are the fees associated with finalizing your mortgage and typically range from 2 to 5 percent of the loan amount. These costs are separate from escrow payments. Furthermore, you should budget for annual maintenance and repair expenses, which can be around 1 to 4 percent of the home’s purchase price.
Step 4: Compare mortgage rates and loan types
Once your credit score and savings are in good shape, it’s time to explore the best mortgage options for your needs. Here are the main types of mortgages:
Conventional Loans: These are not backed or insured by the government. To qualify, you typically need a credit score of at least 620 and a down payment of 3 to 5 percent.
FHA Loans: Insured by the Federal Housing Administration, FHA loans offer more flexible financial requirements. They require a minimum down payment of 3.5 percent, a credit score of at least 580, and a debt-to-income (DTI) ratio not exceeding 43 percent.
VA Loans: Available for eligible military members and guaranteed by the U.S. Department of Veterans Affairs, VA loans have no down payment requirement, although credit score criteria may vary by lender.
USDA Loans: These loans are backed by the U.S. Department of Agriculture and are available for properties in designated rural areas. They also require no down payment, with credit score requirements differing by lender.
Jumbo Loans: Jumbo loans exceed the federal limits for conforming loans (generally $766,550, or $1,149,825 in high-cost areas). They usually have stricter credit score and down payment requirements.
When comparing loans, pay attention to interest rates and fees, as these will impact the annual percentage rate (APR). Even small differences in rates can lead to significant savings over time. Also, consider whether you’ll need to pay for mortgage insurance and for how long.
Mortgages can also vary by their rates and terms:
- Term Length: Most mortgages come with terms of 15 or 30 years, but there are options for 10, 20, 25, and even 40-year terms.
- Fixed-Rate Mortgage: This type has a consistent interest rate throughout the loan term, making monthly payments predictable. The 30-year fixed-rate mortgage is particularly popular in the U.S.
- Adjustable-Rate Mortgage (ARM): ARMs start with a lower introductory interest rate, which adjusts after a set period based on a specified market index. They are often labeled with terms like 5/6 ARMs, 7/6 ARMs, or 10/1 ARMs, indicating the duration of the fixed rate before adjustments begin.
Step 5: Find a mortgage lender
Once you’ve chosen the type of mortgage, the next step is to find a mortgage lender.
“Ask friends, family, and your agent for referrals,” advises Guy Silas, branch manager at Embrace Home Loans in Rockville, Maryland. “Additionally, check rating websites, conduct online research, and take the time to read consumer reviews about different lenders.”
Silas emphasizes that your choice should consider more than just price and interest rates. “You’ll rely on your lender for accurate preapproval, help with contract negotiations, and trustworthy advice.”
Reviewing lender feedback can provide insights into the strengths and weaknesses of various lenders, as well as overall customer satisfaction, helping you make an informed decision.
If you’re unsure about what to look for, consider working with a mortgage broker. They can guide you through the various loan options and may help you secure better terms than you could obtain on your own. Keep in mind that interest rates, fees, and terms can differ significantly among lenders.
Step 6: Get preapproved for a loan
Once you’ve chosen a lender, the next step is to get preapproved for a mortgage. During preapproval, the lender will assess your finances to determine your eligibility for funding and the loan amount they’re willing to offer.
“Many sellers won’t consider offers from buyers who haven’t obtained preapproval,” notes Griffin. “Getting preapproved is crucial because it lets you know exactly how much you’re eligible to borrow.”
It’s important to understand that mortgage preapproval is different from prequalification. Preapproval requires more extensive documentation and involves a hard credit check, while prequalification is less formal and simply indicates that you might be a good candidate for a loan.
However, keep in mind that preapproval does not guarantee you will secure the mortgage. That confirmation comes after you make an offer on a home and successfully complete the mortgage underwriting process.
Step 7: Begin house-hunting
With a preapproval in hand, you can start actively searching for a property that suits your needs. When you discover a home that offers the ideal mix of affordability and livability, be prepared to act swiftly.
“It’s crucial to know what you’re looking for and what’s realistic within your budget,” advises Katsiaryna Bardos, finance department chair at Fairfield University in Connecticut. “Take time to review the housing market, and be ready to move quickly when you find a home that fits your criteria.”
Step 8: Submit your loan application
If you’ve found a home you want to buy, it’s time to complete your mortgage application. Many lenders now allow you to fill out applications online, but applying in person or over the phone with a loan officer can sometimes be more efficient. During the application process, your lender will conduct a credit check and request various documents, including:
- Proof of Identification: This can include your driver’s license, Social Security card, and/or other government-issued ID.
- Proof of Income: You may need to provide pay stubs, W-2s, 1099s, and receipts for alimony, child support, or rental income.
- Proof of Assets: Bank statements, investment and retirement account statements, as well as documents for bonds and stocks.
- Gift Letters: If you receive funds from friends or family for your down payment, a gift letter will be required.
Step 9: Wait out the underwriting process
Even if you’ve been preapproved for a loan, final financing is not guaranteed. The ultimate decision rests with the lender’s underwriting department, which assesses the risk of each borrower and the specifics of the property, determining the loan amount, interest rate, and other terms.
Here’s an overview of the underwriting process:
- A loan officer will verify the information you provided in your application.
- Once you make an accepted offer on a home, the lender will arrange for an appraisal to assess whether your offer amount is justified. The appraised value considers factors like the home’s condition and comparable properties in the area.
- A title company will perform a title search to confirm that the property can be legally transferred, and a title insurer will issue a policy ensuring the accuracy of this search.
“After all your financial documents are collected, they are submitted to an underwriter—either an individual or a committee responsible for making credit decisions,” explains Bruce Ailion, an Atlanta-based real estate attorney and Realtor. “The outcome will be a yes, no, or a request for additional information from you.”
Step 10: Close on your new home
Once you’ve received official approval for your mortgage, you’re close to finalizing the process. The last step is completing the closing.
“The closing process can vary by state,” says Ailion. “Primarily, it involves confirming that the seller has ownership and is authorized to transfer the title, checking for any other claims against the property that need to be settled, collecting funds from the buyer, and distributing those funds to the seller after deducting various charges and fees.”
Closing comes with several expenses, which typically include:
- Appraisal Fee: This is paid to a professional appraiser to assess the value of the property you’re buying.
- Credit Check Fee: A fee for obtaining your credit report, usually under $30.
- Origination or Underwriting Fee: This covers the costs of creating and processing your loan, typically ranging from 0.5 percent to 1 percent of the loan amount.
- Title Insurance Fees: These fees cover title and settlement services, including the lender’s insurance policy, which is generally 0.5 percent to 1 percent of the purchase price.
- Prepaids: Upfront expenses such as property taxes and homeowners insurance premiums.
- Attorney Fee: Often a flat fee; however, hiring an attorney is not mandatory in all states, as only 22 require one to be present at closing.
- Recording Fees: A flat fee for recording the transaction with the appropriate local authority.
In addition to paying these closing costs, you’ll review and sign numerous documents, detailing how funds will be disbursed. The closing or settlement agent will also enter the transaction into the public record.
What are mortgage lenders looking for?
Mortgage lenders seek creditworthy applicants who demonstrate sufficient income, a consistent repayment history, and manageable debt levels. Ultimately, they need assurance that you will repay the money you borrow.
The key factors influencing a lender’s decision on your mortgage application include:
- Credit Score: Credit scores are determined by your credit history, repayment patterns, credit utilization, and the mix of credit types. While you may qualify for a mortgage with a lower score, a higher credit score generally secures you a better interest rate.
- Income and Employment: You must provide evidence of a stable employment history and an income level sufficient to cover monthly mortgage payments.
- Low DTI Ratio: The debt-to-income (DTI) ratio measures your monthly debt payments against your income. A lower DTI ratio is preferable; typically, a DTI of 36 percent or less is ideal, though some lenders may approve applications with ratios up to 50 percent.
- Assets: Lenders will review your bank accounts and the value of other assets you hold. In some cases, they may require you to have up to six months’ worth of mortgage payments in cash reserves, depending on the type of loan and your financial situation.
