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For most Americans, taking out a mortgage makes buying a home possible. This guide breaks down the process so you’ll know what to expect.
What are mortgage lenders looking for?
Mortgage lenders are looking for creditworthy applicants with sufficient income, consistent repayment histories and manageable levels of debt. Ultimately, they want reassurance you’ll pay back the money you borrow.
The factors that go into a lender’s decision on whether or not to approve your mortgage application include:
- Credit score: Credit scores are based primarily on your credit history, pattern of repayment, credit utilization and credit mix. Depending on the type of mortgage, you might qualify even with a lower credit score. A higher score, though, gets you a better interest rate.
- Income and employment: To qualify for a mortgage, you’ll need to show evidence of a steady employment history and income high enough to afford the monthly payments.
- Low debt-to-income (DTI) ratio: Your DTI ratio is a measure of your monthly debt payments compared to your earnings. The lower your DTI ratio, the better. In general, a DTI ratio of 36 percent or less is ideal, though you might be able to qualify for a mortgage with a DTI ratio of up to 50 percent.
- Assets: Your lender will want to look at your bank accounts and the value of any other assets you hold. Though it’s not the norm, your lender might require you to have up to six months’ of mortgage payments in cash reserves, depending on the type of loan and your financial situation.
Steps for getting a mortgage
Step 1: Strengthen your credit
The best loan offers go to borrowers with credit scores in the 700s. That’s because a strong score demonstrates you can responsibly manage your debt.
“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 on the lower side, you could still get a loan, but you’ll likely pay a higher interest rate.
To improve your credit before applying for your 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 for free at AnnualCreditReport.com. Check for errors on your credit reports, and contact the reporting bureau immediately if you spot any. An error might be a paid-off loan that hasn’t been recorded as such, or an incorrect address, for example.
- Check your credit score: Check your reports and score well in advance of 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
One way to determine how much house you can afford is to figure out your DTI ratio. The DTI ratio is calculated by summing up all of your monthly debt payments and dividing that figure by your gross monthly income.
The lower your DTI ratio, the more room you’ll have in your budget for expenses not related to your home. That’s why Andrea Woroch, a Bakersfield, California-based personal finance and budgeting authority, says it’s essential to take into account all your monthly expenses and your set-asides for far-off plans.
“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,” says Woroch— a condition known as “house poor.”
Step 3: Build your savings
Your first savings goal should be enough for a sufficient 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,” says Woroch.
However, know that you can still get a house with a low down payment. For example, conventional mortgages require a minimum of 3 percent down, FHA loans require 3.5 percent down and VA and USDA loans have no down payment requirements.
It’s equally important to build up your cash reserves. One rule of thumb is to have the equivalent of roughly six months’ worth of mortgage payments in a savings account, even after you fork over the down payment. This cushion can help safeguard you if you lose your job or something else unexpected happens.
Also, don’t forget closing costs, which are the fees you’ll pay to finalize the mortgage. They typically run between 2 percent to 5 percent of the loan’s principal. They don’t include escrow payments, either, which are a separate expense. Generally, you’ll also need around 1 to 4 percent of the home’s price for annual maintenance and repair costs.
Step 4: Compare mortgage rates and loan types
Once your credit score and savings are in an adequate place, start searching for the right kind of mortgage for your situation. You’ll also want to have an idea of how mortgages work before moving forward. The main types of mortgages include:
- Conventional loans: These are best for homebuyers with solid credit and a decent down payment saved up. They’re available at most private lenders: banks, credit unions, independent mortgage companies. The requirements include a credit score of at least 620 and a minimum down payment of 3 percent to 5 percent.
- FHA, VA and USDA loans: These can be great options for borrowers who do not qualify for a conventional loan or who meet specific criteria, such as being a member of the military (for a VA loan) or buying in a rural area (for a USDA loan). FHA loans require a down payment of 3.5 percent with a credit score of 580 or better. VA and USDA loans have no down payment requirement and credit score requirements vary by lender, but many lenders require at least a score of 620.
- Jumbo loans: These loans are for more expensive properties, whose price tags exceed the federal threshold set for conforming loans ($726,200 in most parts of the country or $1,089,300 in more expensive areas). If you need to finance more than that for your home, you’ll need to get a jumbo loan from a commercial lender. Note that these loans often come with stricter financial requirements, including a higher minimum credit score and down payment in many cases.
Look at the interest rates and fees for each loan, which collectively amount to its annual percentage rate (APR). Even a small difference in interest rate can result in a big savings over the long run. Also consider things like whether you’ll have to pay for mortgage insurance, and for how long.
Mortgages can have a fixed or adjustable rate, meaning the interest rate stays the same for the duration of the loan term or fluctuates over time, respectively. Most home loans have 15- or 30-year terms, although there are 10-year, 20-year, 25-year and even 40-year mortgages available.
Adjustable-rate mortgages (ARMs) are 30-year mortgages that start with a lower, introductory interest rate. After their intro period, the rate adjusts based on a specified market index. You may see these loans referred to as 5/6 ARMs, 7/6 ARMs,10/1 ARMs or another combination of numbers. The first number refers to the amount of years you’ll be locked in at an introductory rate. The second number is how frequently the rate adjusts once the intro period is over — “6” meaning every six months and “1” meaning yearly. Many people who get ARMs do so with the plan to sell or refinance to a lower fixed-rate before the intro period ends.
Step 5: Find a mortgage lender
Once you’ve decided on the type of mortgage, it’s time to find a mortgage lender.
“Speak with friends, family members and your agent and ask for referrals,” says 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,” says Silas. “You will rely heavily on your lender for accurate preapproval information, assistance with your agent in contract negotiations and trusted advice.”
If you’re not sure exactly what to look for, you might want help. A mortgage broker can help you navigate all the different loan options available to you and possibly help you get more favorable terms than you’d be able to secure by applying on your own. Remember that interest rates, fees and terms can vary substantially from lender to lender. That’s why you should always compare rates from different lenders.
Step 6: Get preapproved for a loan
Once you’ve settled on a lender, get preapproved for a mortgage. With a preapproval, the lender will review your finances to determine if you’re eligible for funding and an amount they’re willing to lend you.
“Many sellers won’t entertain offers from someone who hasn’t already secured a preapproval,” says Griffin. “Getting preapproved is also important because you’ll know exactly how much money you’re approved to borrow.”
Be mindful that mortgage preapproval is different from prequalification. A preapproval involves much more documentation and a hard credit check; mortgage prequalification is less formal and is essentially a way for a lender to tell you that you’d be a good applicant.
Still, preapproval doesn’t guarantee you’ll get the mortgage. That has to wait until you’ve made an offer on a house and successfully gone through mortgage underwriting.
Step 7: Begin house-hunting
With preapproval in hand, you can begin seriously searching for a property that meets your needs. When you find a home that has the perfect blend of affordability and livability, be ready to pounce.
“It’s essential to know what you’re looking for and what is feasible in your price range,” says Katsiaryna Bardos, finance department chair at Fairfield University in Fairfield, Connecticut. “Spend time examining the housing inventory, and be prepared to move quickly once the house that meets your criteria goes on the market.”
Step 8: 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 be more efficient to apply with a loan officer in person or over the phone.When you apply, your lender will perform a credit check and request documents from you, such as:
- Proof of identification: Including your driver’s license, Social Security card and/or other forms of government-issued ID
- Proof of income: Including paystubs, W-2s, 1099s, receipts of alimony and/or child support and rental income
- Proof of assets: Bank statements, investment and/or retirement account statements, bonds, stocks, etc.
- Gift letters: If a friend or relative gives you money for a down payment, you’ll need to submit a gift letter
Step 9: Wait out the underwriting process
Even though you’ve been 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, the nature of the property, and determines the loan amount, interest rate and other terms.
“After all your financial information is gathered, this information is submitted to an underwriter — a person or committee that makes credit determinations,” says 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.”
Here are some steps involved in the underwriting process:
- A loan officer will confirm the information you provided during the application process.
- After you make an accepted offer on a home, the lender will order 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.
Step 10: Close on your new home
Once you’ve been officially approved for a mortgage, you’re nearing the finish line. All that’s needed at that point is to complete the closing.
“The closing process differs a bit from state to state,” says Ailion. “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.”
There are a variety of expenses that accompany the closing. These typically include:
- Appraisal fee: Fee you pay to a professional appraiser to determine the value of the property you’re purchasing
- Credit check fee: Fee for running your credit report, usually less than $30.
- Origination or underwriting fee: Fee that covers the cost of creating and processing your loan, usually 0.5 percent to 1 percent of the amount you’re borrowing
- Title insurance fees: Fees that cover title and settlement services, including for a lender’s insurance policy equal to 0.5 percent to 1 percent of the purchase price
- Prepaids: Expenses you’ll cover upfront, such as property taxes and homeowners insurance premiums
- Attorney fee: Usually a flat fee
- Recording fees: Flat fee to record the transaction with the proper local authority
Along with paying closing costs, you will review and sign lots of documentation at the closing, including details on how funds are disbursed. The closing or settlement agent will also enter the transaction into the public record.
FAQ about the mortgage process
The process to get a mortgage — also known as the “time to close” — takes 43 days on average as of August 2023, according to ICE Mortgage Technology.
The income required to get a mortgage depends on how much mortgage you need and and how much debt you already have. Lenders like to see a debt-to-income (DTI) ratio of no more than 45 percent (up to 50 percent in some cases), so knowing this figure, along with your house budget, can help you determine whether your income would be sufficient. A loan officer can also help you do the math.
The minimum down payment ranges from 3 percent to 3.5 percent of the home’s purchase price for fixed-rate conventional loans and FHA loans, respectively. On a $400,000 home, for example, that range equals $12,000 to $14,000. If you qualify for a VA or USDA loan, you won’t need to make a down payment.
You’ll need to meet the eligibility criteria for the specific type of mortgage you’re getting. This includes parameters around credit score, debt and down payment. For an FHA loan, for example, you’ll need a credit score of at least 580 and a down payment of at least 3.5 percent.
Mortgage insurance covers the lender’s losses in the event you were to stop repaying your loan. It’s a requirement when you put down less than 20 percent with a conventional or FHA loan. Although it covers the lender, you, as the borrower, have to pay the mortgage insurance premiums, which vary based on your credit score and other factors. For a conventional loan, you’ll pay these premiums until you reach 20 percent equity in your home. For an FHA loan, you’ll most likely pay them for the life of the loan.
How much mortgage you can afford depends on many factors, including your income and homebuying budget. Use Bankrate’s mortgage calculator to estimate your buying power.