Owning a home is a childhood dream for most. Taking it from a dream to reality can be tricky. And sometimes tedious if you’re not on solid financial footing.
Approach securing a mortgage in stages.
- Pre-Mortgage prep: The tasks you should complete before shopping around for the best mortgage.
- Shopping for a mortgage: What you should do when seeking the best rates.
Tackling this process in these two stages will ensure you hit all the most important milestones and boost your approval chances. Since the entire process is a marathon, more than a shotgun sprint, having a checklist of tasks will help limit the overwhelm.
Let’s explore the two stages of the mortgage process.
I | Stage 1: Pre-Mortgage Prep
~ Note: In this first stage, you’ll be getting your financial cards in order and setting your monetary targets and goals. Start this stage at least a year before you want to buy a home so you can start your financial planning.
1. Check your credit report.
Your credit score is the foundation of your financial life. Making sure it’s all in order before you consider savings or researching mortgage options will save you time and heartache later.
When you apply for a mortgage loan, lenders will check your credit. It’s how they’ll decide if you’re a safe investment. Your credit history shows your track record of repaying debt from other loans and your credit card. They’ll compare your debt-to-income ratio using this information.
The final evaluation of your creditworthiness determines if you qualify for the loan and the mortgage rate.
Apply for free copies of your credit reports from the three credit bureaus (Experian, Equifax, and TransUnion) and review the information.
Check the credit reports and fix any mistakes.
Monitoring your credit is a good habit whether or not you’re applying for a loan. There may be discrepancies:
- Debts you’ve already paid for that still show as outstanding
- Outdated information, like a former spouse’s name on your records
- Details that aren’t yours that may have come from someone else with a similar name
- Incorrect classifications of closed accounts by creditors when you’re the one who closed it
- There might be information about accounts you didn’t open, which is an indicator of identity theft
There is a variety of misleading information that can plummet your score. Check your report, highlight the mistakes, and get them fixed immediately.
2. Strengthen your credit score.
If there are no inaccuracies in your report, focus your efforts on getting your credit in shape if it needs improving.
300 – 629 = Bad
630 – 689 = Fair
690 – 719 = Good
720 – 850 = Excellent
If your score is ‘Good’ or ‘Excellent,’ you have little to worry about. A ‘Fair’ credit score isn’t bad, but it can do with some improvements to help you secure a lower rate. A ‘bad’ score requires a lot of work.
620 is the minimum credit score you need to qualify for conventional loans not backed by a government agency.
Your score equals the credit risk you pose to a lender. The lower the score, the higher the risk, and the less likely an approval for a loan. Increase your score as far as possible to qualify for favorable terms.
- If you have any outstanding loan payments, pay them off. Back payments drop your scores and can also indicate that creditors can’t expect timely monthly payments.
- Pay all of your bills on time and in full.
- Keep your credit card balances low and without outstanding payments. Do not max out your credit limit.
- Monitor your credit activity and minimize the debt you accumulate. The lower your debt-to-income ratio, the higher your chance of an improved credit score.
While you’re working on improving your credit score, know that there are mortgage lenders who offer loans to homeowners with less-than-stellar credit. The interest rates are naturally higher, but this allows you to buy your own home still.
Ask your mortgage broker or lender if you’d be able to renegotiate your rate once your score improves. Companies rarely advertise this provision, and some may not offer the opportunity. But you won’t know until you ask.
3. Decide how much house you can afford.
Look at your monthly income, debt, and other responsibilities and decide (realistically) how much you can afford to pay for a house. Sometimes your first home isn’t the dream you had in mind. It’s a roof over your head and a gateway to other financial opportunities.
You may fall short of your ‘dream home’ as a first-time homebuyer. There is nothing wrong with a comfortable ‘starter.’
Choose an affordable house with the comforts you and your family require. You don’t want to end up in a debt deficit and cripple your financial future with a single purchase. Remember, each loan you take on chips a bit off your credit score.
Perhaps you’d also like to purchase a car after buying your home. As with your mortgage, your credit history will dictate the rate offered for your car loan. Leave some wiggle room for additional investments.
Don’t let a high approval amount tempt you.
After submitting your mortgage application, lenders will weigh all the information to make their final decision. They may approve you for the maximum loan amount with your upstanding credit. This limit, however, may not coincide with your financial situation.
Stick with your budget and your calculated price range. It’s a financial commitment that will span years. Remember, you have other financial goals and monthly expenses.
Maintain your financial flexibility by accepting a loan that comfortably fits within your means. Additionally, you need to save for the down payment, which we’ll discuss in the next section.
4. Save up for your down payment and closing costs.
Aim for the highest down payment possible. The higher your down payment, the lower your loan, and the better your interest rate and monthly debt payments. Aim for 20% of the overall cost. Paying less than 20% means you’ll have to pay private mortgage insurance (PMI). This insurance usually accounts for 0.05 to 1% of the original loan annually.
If you cannot meet the 20% upfront, the sooner you drop your mortgage to less than 80% of your home’s total value, the sooner you can drop the PMI. Without this additional payment, your monthly payments will decrease.
Save this money in an account separate from your savings and everyday use accounts. On top of the down payment, save for at least six months of advance mortgage payments. This extra cash will give you a tidy cushion in an emergency and hampered cash flow.
Factor in closing costs in your savings. These are the fees you’ll pay to finalize your mortgage.
Calculate how much you’ll need to save for:
- A 20% down payment
- Closing costs
- Six months of backup payments
Your household income will dictate how much and how fast you can save for each. Save as much as possible and stick with your goals. Include home maintenance and other home-related costs in your ongoing budget.
II | Stage 2: Shopping for a Mortgage
~ Note: Now it’s time to do your research so you can make decisions with confidence and shop for the best mortgage rate.
5. Research first-time homebuyer programs.
As a first-time home buyer, you’ll need all the support you can get. Luckily, help is available if you know where to look for it.
First-time home buyer programs are available in many states. They often combine low-interest-rate mortgages with down payments and closing cost assistance. Through these programs, you can also apply for tax credits.
6. Research mortgage options.
There are many mortgage loan products on the market. Among the wide range of options, you should be able to find the one that fits your needs. Here are some of your options:
- A 30-year fixed-rate mortgage with a fixed interest rate for the loan’s duration. It’s one of the most popular choices and comes with lower monthly payments than shorter-term loans.
- A 15-year fixed-rate mortgage also comes with a constant interest rate. Homeowners often use this option when refinancing their long-term mortgage for a shorter period. It has higher monthly payments than the 30-year, but with less total interest paid.
- An FHA mortgage is a home loan offered by the Federal Housing Administration (FHA). It’s backed by the government and designed for home buyers with a modest budget with down payments as low as 3.5%. You can qualify with a credit score as low as 500.
- VA mortgage is another government-backed financing option for military service members and veterans. This loan doesn’t require a down payment or mortgage insurance.
- USDA mortgage loans provide rural homebuyers who are income-qualified with no-pay down financing. Grants and loans for home improvement are also available.
This is not a complete list of mortgage options but the top picks you’ll encounter. Whether you choose a 30-year mortgage versus a 15-year term depends on whether you want affordable mortgage payments over paying off the loan as quickly as possible.
All mortgage options have specific credit and down payment requirements, interest rate setups, and other pros and cons. Know the features of each and how they fit into your financial situation for a wise, informed decision.
7. Decide if you want to continue the process through a mortgage broker.
There are arguments against getting a mortgage broker. But some financial advisors recommend having one.
There are advantages and disadvantages to working with a broker.
- A broker can save you time and money with fee waivers during the loan application process.
- They can also help you save money on loans by helping you qualify for low rates.
- Some mortgage lenders work exclusively with mortgage brokers.
- By offering expert advice, brokers can reduce the legwork of obtaining a mortgage.
Some disadvantages:
- Brokers have their own interests, which may not align with yours as some gain lender-paid commission from offers. Bigger loans equal higher commissions.
- Working with a broker might be an additional expense if you’re responsible for paying the broker instead of the lender.
- Not all brokers have the expertise or the connections to source the best deal for you.
- Brokers can’t always guarantee the lender will adhere to the “good faith” loan estimates they provide. Lenders will carry out their assessment of your information and may offer an amount lower than the estimate.
- Some mortgage lenders don’t work with brokers and may offer you better rates than a broker can.
Weigh the pros and cons and do your research. Ask your social circle for recommendations for reputable brokers and lenders.
Use financial calculators.
Online calculators and interactive tools are available if you decide to proceed alone. They’ll help calculate estimates and compare various companies’ rates at your convenience.
Take a calculated approach to mortgage applications.
“Hard inquiries” into your credit history temporarily lower your credit score. If you apply to multiple lenders over two weeks, their inquiries will count as one. But, if you scatter out your applications over a longer period, each will register individually, causing greater damage to your score.
8. Look at the prepayment penalties.
Believe it or not, some lenders penalize borrowers for paying off their loans earlier than scheduled. Paying off a loan early means fewer interest payments for lenders.
Choose a company that doesn’t restrict you from clearing off your mortgage (debts) before the term stipulated. There may be months where you earn extra cash and can double your monthly payment. Make sure you can clear off your mortgage balance ahead of time without incurring penalty fees.
9. Get a pre-approval letter.
Gaining mortgage pre-approval comes before house hunting. This pre-approval is the lender’s offer of the loan amount you can access under the determined terms. It sets your preliminary price range for the house you can afford, narrowing down your shopping options.
Home sellers and real estate agents will take your efforts seriously when presented with this letter, putting you ahead of other home buyers who skip this step.
Applying for pre-approval from multiple lenders shouldn’t hurt your score as long as you stay within a limited time frame. 14 – 30 days is a safe window.
Conclusion
Tackle the mortgage process in stages and better your chances of a beneficial outcome.
- Get a credit report from each of the three credit rating agencies.
- Aim for a healthy credit score; the higher the score, the better your chances of avoiding costly borrowing terms and rates.
- Before mortgage or house hunting, consider what you can afford based on your income status, debt, and other financial obligations.
- Save up for your down payment and closing costs. Try saving for advanced monthly payments in case of emergencies.
- Research first-time home buyer programs in your area for added support and tax incentives.
- Research current mortgage products on the market. You can choose between a conventional mortgage loan or one backed by the government for specially qualified future home buyers.
- Decide if you want to continue the process through a mortgage broker or tackle it alone.
- Look at the prepayment penalties and ensure you’re safe to clear off your mortgage earlier than the noted term timeframe.
- Get a preapproval letter from a lender before shopping for a house. This will show home sellers and real estate agents you’re placing a serious inquiry.
