New government regulations and consumer protection laws force mortgage lenders to make a good-faith effort to be sure home buyers actually qualify for the home loan they’re seeking.
That means lenders must examine closely things like credit score, debt-to-income ratio and down payment.
Consumers have their own set of responsibilities. They should do research on the type of loan (fixed or variable), repayment time frame (15, 20 or 30-year mortgage?), and institution they intend to get a loan from before signing up.
With so much paperwork and verification involved, this is not going to be a speedy process. So, before you go looking for a cute bungalow, take some time to find out how to get a mortgage that you can afford and be comfortable with.
What Credit Score Do I Need to Get a Mortgage?
Your credit score is the starting point for lenders and if it’s not high enough, it also could serve as the ending point. Most lenders want a credit score of 680 or higher to start talking about a mortgage. It’s possible to get one with a score under that, but it would be a stretch to think you’ll get a conventional loan from a bank or online lender.
A credit score between 680 and 750 will lower the interest rate and anything above 750 will get you the lowest interest rate possible. If you’ve stumbled with your credit history and your score is sub-680, you aren’t eliminated from finding a home loan, but it may cost you more.
Veterans Administration loans, which are reserved for military families, want your credit score to be above 620. The U.S. Department of Agriculture’s home loans for low-and-moderate income housing in rural areas, also seeks credit scores of 620 or higher. The Federal Housing Administration offers loans to consumers with scores as low as 580.
What Income Do I Need to Qualify?
The most surprising aspect of how to get a mortgage is the importance lenders place on debt-to-income ratio. Fair Isaac Corporation (FICO), the industry leader in credit scores, surveyed lenders who said that a poor debt-to-income ratio is the No. 1 reason mortgage applications are denied.
The unsurprising news is that most people don’t know what a debt-to-income ratio is. It is the ratio of our monthly debt payments (credit cards, auto, student and personal loans, store credit accounts and any loans you co-signed) divided by your gross income. Lenders use it to measure your ability to handle mortgage payments.
For example, if your make $4,000 a month and pay $1,500 for credit cards, $300 for a car loan and $200 for student loan, your debt-to-income ratio would be 50% (2000 ÷ 4,000).
A good consumer debt-to-income ratio is 36%, but conventional mortgage lenders (banks, credit unions, online sources) like to see that number under 30%. The national average for conventional home loan applicants in July of 2017 was 25%. Note that the ratio includes your projected monthly mortgage payment.
Things are a little looser with FHA where the debt-to-income ratio limit is 28%, but that is still far less than the suggested figures for mortgage hopefuls. The federal government says the highest ratio you can have for a qualified conventional mortgage is 43%. Most lenders put the suggested debt-to-income ratio at 36% or less.
So, if you have a problematic debt-to-income ratio, it would be wise to find ways to increase your monthly income and pay down debt. Getting a second job, doing freelance work or seeking a raise at your primary job would address the income issue. Cutting back on all spending so you could use more money to pay down credit cards, car loans, student loans and other monthly debts would help debt problems.
Refinancing is another option. It is important that you not add any additional debt during the home-buying process.
The safest bet to make on getting a home loan without a hassle would be to reduce your debt-to-income ratio to somewhere under 28%.
How Much Downpayment Do I Need?
A down payment might be the one thing everyone knows is part of the home-buying process, but there is some discussion on how much of a down payment to make; how to fund it; and who benefits most from a big down payment: the buyer or the lender?
It seems obvious that the bigger the down payment, the better it is for the buyer and for good reason: It’s the first jab at reducing the amount of money you must borrow and thus reduces the amount you must repay.
The goal for most buyers is to put down 20% of the purchase price, which affords them a lot of benefits, such as:
- Tilting the approval process in your favor. A 20% down payment is a sign of commitment to the lender. They may overlook a few of the negatives in your file if they know you’re already one-fifth of the way to paying off the home.
- Not having to pay Private Mortgage Insurance (PMI), which protects the lender if you default. PMI usually is about 1% of the loan amount or about $125 a month on a $150,000 mortgage. It is required on loans, if you don’t have 20% down.
- Receiving the best interest rates and terms for your mortgage. Again, back to the commitment level.
- Paying less interest and points on a loan, which means making a lower monthly payment. You’re borrowing less, so you pay less.
- Lower payments mean faster payoff. Getting rid of a 30-year mortgage in 25 years is realistic if your payments are low enough that you can afford to throw extra money at the principal every month.
You could get a government-backed loan from the FHA and your down payment is only 3.5% of the amount borrowed. VA and USDA Rural Development loans can be had for zero percent down, but there are fees involved that mean you have to come up with some money to close the deal.
How Much Home Can I Afford?
There is a relatively simple formula to find out how much house you can afford. It starts by putting down honest numbers that reflect your income, minimum monthly debt payments, money available for down payment and credit score.
Take your numbers and find an online calculator designed to come up with how much house you can afford. You’ll need to provide your income, monthly debt payments, estimated property taxes, homeowner’s insurance and home association fees. Answer 5-6 questions and the calculator will spit out a number that should be reasonably close to how much house you can afford.
Armed with that number, you can start house hunting.
Where Do I Get a Mortgage?
Finding a good mortgage lender is a lot like finding a good marriage partner with one notable exception: the mortgage vows shouldn’t last more than 30 years.
Otherwise, the process is largely the same. You have your pick from suitors that include local and national banks; local and national credit unions; mortgage brokers and online lenders. Each of them offer inviting promises and each has faults that you must accept for better or worse.
The most important rule in choosing a lender is to look around. Apply in at least three places and compare costs and finance charges. An astonishing 71% of homeowners only apply for a loan in one place. A 2016 study by J.D. Power found 27 percent of first-time homebuyers – more than one out of four! – regret the choice of lender they made for a mortgage.
Most of their dissatisfaction stemmed from lack of communication and unmet promises. That could be because buyers don’t realize all that goes into a mortgage loan.
The list of questions you need answered goes far beyond: What’s my interest rate and is this a 30-year or 15-year mortgage? There is a long list of fees involved and each one has a cost.
Some of the fees you could be charged at closing include:
- Loan origination or application
- Brokerage commission
- Credit report
- Title insurance
Ask the lender to give you a dollar-figure for each of the fees, or at least an educated estimate. You are allowed to bargain between lenders over fees. That’s how you find out who really wants you as a customer.
Learn about the Types of Mortgage Lenders
You can get a loan from a variety of lender types including credit unions, major banks, a mortgage broker or an online lender. Let’s look at each option.
Community Banks and Credit Unions
The community bank is the safe choice. You probably have an account there, or had one in the past. There should be more of a personal touch because the community banker makes his money in your neighborhood and needs you as a customer. He can make some concessions on things like credit score and maybe even size of the down payment. Unfortunately, local banks often operate a little short-handed so it may take time to get an appointment or solve a crisis, if you have one.
The national banks are the big guys for a reason. They built reputations as places with plenty of well-trained, highly-qualified personnel, who provide lots of loan programs at affordable rates. Yet, they still have time and manpower to offer 24-hour customer care. And they’re not going anywhere. They’re too big to fail and that can be a downside. You’re just a number to big banks. They rarely know you by name and if you’re account isn’t a big one, they may take their time dealing with your problem.
Mortgage brokers are like the date your sister set you up with: they sound exciting, but you’re not really sure if this will be a good thing. Mortgage brokers are in contact with a lot of lenders, which means they’ll hear about a lot of deals, one of which may be exactly what you need. However, since they get a fee for setting up a deal, there is a question of whether they’re looking at the deals that benefit you … or the ones that benefit them!
Finally, there are the young, attractive online lenders, who are fast-becoming all the rage. Online lenders have all but eliminated in-person contact. The application and review process is done online and it’s quick. Really quick. In fact, Quicken Loans, which introduced the “Rocket Mortgage,” has the highest customer-satisfaction rating in the industry. That’s probably why they shot up to No. 2 in home lending in 2016 after closing $96 billion in loans.
How Do I Get Pre-Approved?
You may know the house you want, but unless you have experience buying one, you may not know whether you can afford it. That is where the mortgage pre-approval process comes in.
You visit a bank or mortgage lender, give them information about your income and expenses, they do the math and tell you how big a mortgage you are pre-approved for.
Your pre-approval is not binding. You don’t have to take a loan from that lender and the lender doesn’t have to give you a loan. It just means that you qualify to borrow the amount they arrived at to start the process.
That amount is crucial to a seller, who knows whether you’re really qualified to make an offer on their home. It also tells you what neighborhood to look for your dream house.
Which Mortgage is Right for Me?
There are almost as many ways to pay for a house as there are houses to pay for, but the gold-standard has been – and apparently always will be – the 30-year fixed mortgage.
Lenders have dressed up rates, terms and conditions on 15-year, 20-year, fixed and variable rate offers, but more than 85% of mortgages in 2016 were 30-year fixed rate.
30-Year vs 15-Year
The reason is fairly obvious: 30-year fixed rates mean lower payments that never change.
The 15-year mortgage rates have been sensational for the last decade, but the difference in monthly payment has been several hundred dollars. So, even though you pay off your home 15 years faster, buyers prefer the comfort and routine of a lower payment.
Here are today’s mortgage interest rates:
Fixed vs Variable Rate
Variable-rate mortgages also have benefitted from low rates, but make up only 3% of the market because of the fear that the rates could soar anytime.
Conventional, FHA or VA Loan?
The only real debate is whether to get a conventional, FHA or VA loan on the house, but once again, there is a runaway leader.
Conventional loans are any mortgage that is not part of a government program. They account for 64% of the market. They are offered by banks, credit unions, mortgage brokers and online lenders. They’re popular because they usually offer the best mortgage interest rates and terms.
FHA loans, offered by the Federal Housing Administration, account for 22%. VA loans, offered by the Veterans Administration, account for 10%.
FHA loans are popular because it’s easy to qualify, you can make a down payment as low as 3.5% and your credit score can be under 580.
VA loans are for active or retired service members and their families. You don’t need a down payment and there is no minimum credit score.
How Do I Start My Mortgage Application?
The application for a mortgage is similar to what happens in the pre-qualifying process and virtually identical to what is needed in the pre-approval process.
The basics for the mortgage application process are the same as its two siblings – name, current address, household income and expenses – the lenders just dig a little deeper knowing you are now ready to sign a contract.
You will need paperwork to back up things like:
- Employment history. Have recent paycheck stubs (one month or more), W-2s and federal tax returns for the last two years. If you own a business, have your 1099s or profit and loss statement.
- You’ll need bank statements and paper statements for IRAs, stocks, bonds, CDs or any other securities.
- Real estate holdings. If you own a home, and a second home or rental property, have documents that verify addresses and current market value If you have mortgages out on the property, provide paperwork that includes the lender’s name and address; the loan number, how much you still owe and what your monthly payment would be.
- This obviously is an important area, particularly in verifying. List credit cards, mortgages, auto, student or personal loans with the names and address of the creditors, the account numbers, balance on the account and minimum monthly payment. If you make alimony or child support payments, list those.
This information is passed along to the lender’s underwriters, who determine the risk associated with offering you a mortgage. The underwriters verify the information you have submitted and determine whether you actually qualify for the size mortgage you are seeking.
They will talk to your employers to check on your status and pay. They also pull credit reports, look at credit scores, money available for down payment and how much you have in reserve for this major undertaking.
Understand that this process is time-consuming. Underwriters must talk to a lot of people and review a lot of documents before committing their institution to lending hundreds of thousands or maybe even millions of dollars for you to buy a home.
Ultimately, underwriters come up with the debt-to-income ratio that is the No. 1 reason loans are approved, or denied. So, be accurate and complete with the information you provide.
Then sit and wait for the answer. If you’ve been through the pre-approval process and submit “clean” paperwork, meaning everything checks out, you could be approved in a few weeks. If not, it can take months before you find out you were approved or denied.
About The Author
Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].
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