How to get a mortgage

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Eager to take advantage of historically low interest rates and buy a home? Getting a mortgage can constitute your biggest and most meaningful financial transaction, but there are several steps involved in the process.

How to get a mortgage, step by step

1. Strengthen your credit

Your credit score tells lenders just how much you can be trusted to repay your mortgage on time — and the lower your credit score, the more you’ll pay in interest.

“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.

To improve your credit, Griffin recommends these tips:

  • Make all payments on time and reduce your credit card balances.
  • Bring any past-due accounts current, if possible.
  • Review your credit reports for free at AnnualCreditReport.com as well as your credit score (often available free from your credit card or bank) at least three to six months before applying for a mortgage. When you receive your credit score, you’ll get a list of the top factors impacting your score, which can tell you what changes to make to get your credit in shape.

Check for errors on your credit reports, as well. Contact the reporting bureau immediately if you spot any.

2. Know what you can afford

It’s fun to fantasize about a dream home with all the trimmings, but you should try to only purchase what you can reasonably afford.

“Most analysts believe you should not spend more than 30 percent of your gross monthly income on home-related costs,” says Katsiaryna Bardos, associate professor of finance at Fairfield University in Fairfield, Connecticut.

Bardos says one way to determine how much you can afford is to calculate your debt-to-income ratio (DTI). This is determined by summing up all of your monthly debt payments and dividing that by your gross monthly income.

“Fannie Mae and Freddie Mac loans accept a maximum DTI ratio of 45 percent. If your ratio is higher than that, you might want to wait to buy a house until you reduce your debt,” Bardos suggests.

Andrea Woroch, a Bakersfield, California-based finance expert, says it’s essential to take into account all your monthly expenses — including food, healthcare and medical costs, childcare, transportation, vacation and entertainment expenses — and other savings goals.

“The last thing you want to do is get locked into a mortgage payment that limits your lifestyle flexibility and keeps you from accomplishing your goals,” Woroch says.

You can determine what you can afford by using Bankrate’s calculator, which factors in your income, monthly obligations, estimated down payment, the details of your mortgage like the interest rate, and homeowners insurance and property taxes.

3. Build your savings

To be able to afford your monthly housing costs, which will include payments toward the mortgage principal, interest, insurance and taxes as well as upkeep, you should prepare to salt away a large sum.

Your first savings goal, however, should be your down payment.

“Saving for a down payment is crucial so that you can put the most money down — preferably 20 percent to reduce your mortgage loan, qualify for a better interest rate and avoid having to pay private mortgage insurance,” Woroch explains.

One general rule of thumb is to have the equivalent of roughly six months of mortgage payments in a savings account, even after you fork over the down payment.

Don’t forget that closing costs, which are the fees you’ll pay to close the mortgage, typically run between 2 percent to 5 percent of the loan principal. You’ll also generally need around 3 percent of the home’s price for maintenance and repair costs annually.

Overall, aim to save as much as possible until you reach your desired down payment and reserve savings objectives.

“Start small if necessary but remain committed. Try to prioritize your savings before spending on any discretionary items,” Bardos recommends. “Open a separate account for down payment savings that you don’t use for any other expenses. This will help you stick to your savings goals.”

4. Choose the right mortgage

Once you have your credit and savings in place and a good idea of what you can afford, it’s time to start searching for a lender, comparing interest rates and terms and finding the right kind of mortgage for your situation.

The main types of mortgages include:

  • Conventional loans
  • Government-insured loans (FHA, USDA or VA)
  • Jumbo loans

These can be either fixed- or adjustable-rate, meaning the interest rate is either fixed for the duration of the loan term or changes at predetermined intervals. They commonly come in 15- or 30-year terms, although there may be 10-year, 20-year, 25-year or even 40-year mortgages available.

A first-time homebuyer, for instance, might consider an FHA loan, which requires a minimum credit score of 500 with a 10 percent down payment or a minimum score of 580 with as little as 3.5 percent down.

To find the right lender, “speak with friends, family members and your agent and ask for referrals,” advises Guy Silas, branch manager for the Rockville, Maryland office of Embrace Home Loans. “Also, look on rating sites, perform internet research and invest the time to truly read consumer reviews on lenders.

“[Your] decision should be based on more than simply price and interest rate,” however, says Silas. “You will rely heavily on your lender for accurate preapproval information, assistance with your agent in contract negotiations and trusted advice.”

Remember that interest rates, fees and terms can vary substantially from lender to lender.

“That’s why it’s important to shop around carefully and ask questions,” Woroch says.

5. Get preapproved for a loan

Early in the process, it’s also a good idea to get preapproved for a mortgage. With a preapproval, a lender has determined that you’re creditworthy based on your financial picture, and has issued a preapproval letter indicating it’s willing to lend you a particular amount for a mortgage.

“Getting preapproved before shopping for a home is best because it means you can place an offer as soon as you find the right home,” Griffin says. “Many sellers won’t entertain offers from someone who hasn’t already secured a preapproval. Getting preapproved is also important because you’ll know exactly how much money you’re approved to borrow.”

6. Begin house hunting

With preapproval in hand, you can begin seriously searching for a property that meets your needs. Take the time to search for and choose a home that you can envision yourself living in.

When you find a home that has the perfect blend of affordability and livability, however, pounce quickly. In a competitive market where available homes go fast and bidding wars are common, you’ll need to be aggressive.

“It’s essential to know what you’re looking for and what is feasible in your price range,” Bardos notes. “Spend time examining the housing inventory, and be prepared to move quickly once the house that meets your criteria goes on the market.

“Utilize social media and ask your agent for leads on homes going on the market before they are listed on the MLS,” Bardos also recommends.

7. Submit your loan application

If you’ve found a home you’re interested in purchasing, you’re ready to complete a mortgage application. These days, most applications can be done online, but it can sometimes help to have a loan officer walk you through it over the phone or in person.

The lender may require you to submit several documents and information, including:

  • Recent tax returns, pay stubs and other proof of income (e.g., bonuses and commissions, overtime, Social Security)
  • Employment history from the past two years
  • Financial statements from your bank and other assets, such as retirement accounts or CDs

The lender will also pull your credit report to verify your creditworthiness.

8. Wait out the underwriting process

Even though you may be preapproved for a loan, that doesn’t mean you’ll ultimately get financing from the lender. The final decision will come from the lender’s underwriting department, which evaluates the risk of each prospective borrower, and determines the loan amount, how much the loan will cost and more.

“After all your financial information is gathered, this information is submitted to an underwriter — a person or committee that makes credit determinations,” explains Bruce Ailion, an Atlanta-based real estate attorney and Realtor. “That determination will either be yes, no or a request for more information from you.”

There are a few steps involved in the underwriting process:

  • First, a loan processor will confirm the information you provided during the application process.
  • After you make an offer on a home, the lender will conduct an appraisal of the property to determine whether the amount in your offer is appropriate. The appraised value depends on many factors, including the home’s condition and comparable properties, or “comps,” in the neighborhood.
  • A title company will conduct a title search to ensure the property can be transferred, and a title insurer will issue an insurance policy that guarantees the accuracy of this research.
  • Finally, you’ll get a decision from the underwriter: approved, approved with conditions, suspended (meaning more documentation is needed) or denied.

9. Close on your new home

Once you’ve been officially approved for a mortgage, you’re nearing the finish line — all that’s needed is to complete the closing, which is when you’ll pay closing costs.

“The closing process differs a bit from state to state,” Ailion says. “Mainly it involves confirming the seller has ownership and is authorized to transfer title, determining if there are other claims against the property that must be paid off, collecting the money from the buyer, and distributing it to the seller after deducting and paying other charges and fees.”

The closing costs you’re responsible for can include:

  • Appraisal fee
  • Credit check fee
  • Origination and/or underwriting fee
  • Title services fee

In the closing process, the closing agent will provide a detailed statement to the parties of where the money came from and went. The agent will also record the transaction in the public record and deliver the deed to the buyer.

Bottom line

They say you shouldn’t put the cart before the horse. The same is true in the homebuying process. You’ll need to complete several steps to obtain a mortgage, so the more you learn about what’s required, the better informed your decision-making will be.

And if you’re denied a loan?

“If you are unable to qualify for a loan with favorable terms, it may make more sense to simply wait until you can make the necessary changes to improve your credit history before trying again,” Griffin suggests. “A bit of patience and planning can save a lot of money and help you get the home you want.”

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