One of the most important sources of housing finance is a mortgage loan. Before applying for a mortgage loan, you should check your credit score or credit report from the credit reporting agencies. A credit score represents an individual’s financial habit of paying back creditors or lenders. This is one of many factors that a lending institution will take into consideration when making the decision of approving your mortgage loan. The three credit reporting agencies in the United States are TransUnion, Equifax, and Experian. You can check your credit report by calling us at 888-262-0715 or get started by filling out an inquiry here. Credit reporting agencies are the organizations that collect consumers’ information from a variety of sources including credit grantors, banks, mortgage institutions and public records etc. and they score each individual based upon this information. So, it is essential that you check whether your credit report contains favorable information before you apply for a loan or mortgage in order to avoid the risk of getting turned down.
The amount of mortgage that you can borrow will depend upon, but not limited to, your assets (401K, IRA, Savings, Checking etc…), credit score, and monthly gross income (average 2-year adjusted gross monthly income for self-employment income). Banks normally calculate your debt-to-income ratio before they can sanction a loan. A debt-to-income ratio reveals your overall monthly liabilities (i.e. credit card payments, installment loans, car loans, revolving debt etc…) divided by your gross monthly income. For most lenders, the ideal debt to income ratio should be below 36%. However, there are many mortgage programs available that allow higher debt to income ratios as well as unique programs, which allow strong compensating factors in lieu of a higher-than-normal debt to income ratio.
Choosing your ideal mortgage is one of the most important financial decisions that you will make before purchasing your home. If you select a longer term mortgage (usually for 20 to 30 years), you can opt for a fixed-rate mortgage where your interest rate will remain unchanged through the maturity of the loan. On the flip-side, an Adjustable Rate Mortgage (ARM) interest rate will vary in tandem with an index (normally LIBOR) and the interest rate will normally reset annually. ARM’s that come with a lower initial interest rate known as a teaser rate that is fixed for a temporary period of time versus a fixed rate mortgage throughout maturity, is known as a Hybrid ARM. A hybrid adjustable rate mortgage’s (ARM) teaser rate is usually fixed for the first 3 (3/1 ARM), 5 (5/1 ARM), 7 (7/1 ARM), and 10 (10/1 ARM) years depending on the Hybrid ARM program you choose. The Hybrid ARM product may be favorable if you plan on selling your home within the teaser rate time period, or some borrowers might opt for this program if they speculate that rates will be lower in the future when the rate becomes variable. There are many mortgage options to choose from besides ARM’s, Hybrid ARM’s, and fixed-rate mortgages. There are option ARM’s (monthly adjustable rate mortgage that allows the borrower to choose between several monthly payment options), interest-only mortgages (borrower only pays interest on the mortgage every month for a temporary period on a fixed rate) and balloon mortgages (short term mortgages of usually between 5-7 years but the payment is calculated using a 30 year amortization and contains a “balloon” element that calls the loan balance due at the end of the term). Whatever mortgage you choose, you need to weigh your options and decide which is best suited for your financial situation as well as your intention towards the new home.
It may be very beneficial for you to get a prequalification letter so that you have an idea of the highest home price you can afford with your current liquid assets and the amount of mortgage you can carry. For a prequalification, the bank/lender will analyze your current assets (both liquid and retirement), income, and liabilities. However, a prequalification does not guarantee a mortgage. In order to receive a more guaranteed approval of the issue of a mortgage, you need to obtain a pre-approval letter. With a pre-approval letter, the lender or bank will submit your asset, income, and liability documentation to their underwriting department for a more accurate examination of your debt-to-income ratio and check against their lending guidelines with all of your documented information such as paystubs, bank statements, retirement statements etc… Even with a pre-approval, there’s never an 100% guarantee because there are still items such as appraisal and other things that cannot be foreseen without going through the actual process. The pre-approval is usually valid for a certain period of time, in which case updated documentation will need to be provided if the original pre-approval expires.
One of the important things to also know about obtaining a mortgage while you are shopping for a home is that mortgage interest rates fluctuate day-to-day. You cannot start the actual mortgage process and work towards closing without a purchase contract, which eventually comes after finding your home, submitting an offer, and negotiating with the sellers. As a result of this uncertainty, you never know what interest rate is available once you are ready to start the real process. As a result, you might find it beneficial to lock-in your interest rate with your lender/bank at the time of pre-qualification or pre-approval.
Before you go to closing, you should receive the final settlement sheet which breaks down and itemizes all the figures, costs, and numbers for both the buyers and sellers. This is known as the HUD-1. It is on this HUD-1 closing statement that shows the amount the buyer brings and the amount seller receives (there are cases where the seller ends up paying money as well). Besides the HUD-1, there will be additional supporting paperwork outlining the terms, recording info, title insurance, late payment penalty, etc… After you sign everything and hand over your check, you are officially a new homeowner!
After moving into your home and living there for some time, you should regularly check on the interest rates. If the interest rates drop, it might be beneficial for you to refinance your mortgage to save money with the lower interest rate.
Step 1: Credit Score
Buying a new home is a great financial decision in terms of building equity. A mortgage is the only way many people can afford to purchase a home. With that being said, it is key to know where you are financially before you make such a big investment. One of the most important things that weigh in your ability to borrow a mortgage will be your credit score and the information it contains. Your credit score will play a part in determining the interest rate you will be offered on your loan. The better your credit score, the more favorable you interest will be. Contrarily the lower your credit score, the less favorable it will be. If however your credit score is too low, you might not be able to get a mortgage altogether depending on the bank/lender. At RateWinner, we can work with credit scores as low as 500 FICO.
A free credit report is offered once every year from the major credit reporting agencies (TransUnion, Equifax, and Experian). Once again, these three companies collect data about your borrowing and payment history, which together form your credit score. The credit score is generated from the information reported by your creditors, lenders, or any company that owns your loan/debt in which you make payments to.
After receiving your credit report, it is imperative that you look it over for errors or mistakes, as credit reports aren’t 100% correct all of the time. If you do find inaccurate information, make sure to inform the credit bureau immediately to have them correct the problem. This may take some time so the sooner you start the dispute, the sooner these issues get resolved.
Step 2: How Much Can You Borrow?
When getting a pre-approval or prequalification, it might not be in your best interest to take out the maximum amount you are approved or qualified for. You will have to budget for your lifestyle expenses and find it more reasonable to take out a smaller mortgage, if that means buying a house that’s less costly, in order to maintain your quality of life.
Once again your debt-to-income ratio will be one of the key factors for a lender or bank to determine the maximum amount they are willing to lend. Debt-to-income is calculated by taking the total of your monthly revolving debt (student loan payment, credit card payment, car payment, installment loan payment etc…), the new proposed monthly principle and interest mortgage payment, monthly taxes and insurance divided by your monthly gross income. Another ratio banks and lenders look at is the housing expense ratio. This is determined by simply taking the total of the proposed monthly principle and interest mortgage payment, monthly taxes and insurance, mortgage insurance (if applicable) and monthly association fees (if applicable) divided by the monthly gross income. Usually lenders and banks are looking for the debt-to-income ratio to be below 36% and the housing expense ratio below 28% simultaneously. However, there are lending institutions out there that are willing to go as high as 55% debt-to-income ratio granted there are other strong compensating factors such as high reserves (liquid and retirement assets), excellent credit scores etc.. For government insured mortgages such as Federal Housing Authority Mortgages and Veterans Administration Mortgages, it is much more common for lenders and banks to allow up to 55% debt-to-income.
Step 3: Finding The Right Mortgage
Deciding which mortgage program to go with will be one of the most important decisions you can make as a borrower. There are several to choose from, and it’s in your best interest to select the mortgage that not only best fit your current needs and financial situation, but it has to also make sense financially with what your future plans are in terms of your home, work, and family.
Fixed rate mortgages – A fixed rate mortgage, will bear the same interest rate throughout the life of the loan. These mortgages usually carry a 30 year term. However if you want to build equity, you could opt for a 20 year loan, or perhaps a 15 year loan. These shorter term loans usually carry a lower interest rate, as the lenders will be paid back more quickly. There are 40 year fixed mortgages for home-buyers who want the lowest possible monthly payment but very few lenders or banks still provide this product.
You will want a fixed rate mortgage if you are planning to keep your home for several years, want the security of the same payment every month, or think interest rates are likely to rise.
Adjustable rate mortgage (ARM’s) – With an ARM, your interest rates will change periodically. Your payments may go up or down in intervals of one, three or five years. All ARM’s are tied to an index that changes regularly to reflect the current economic conditions. This type of mortgage could possible make your monthly payments go up quite a bit throughout the life of your loan.
There is some upside in going with an ARM. ARM’s will offer a lower initial rate than a fixed rate mortgage, and if the ARM-index allows the interest rates to stay the same or decrease, you could be rewarded with lower monthly payments throughout the life of the mortgage. You will want to consider an ARM if you plan on being in your home for less than 3 years, believe interest rates will go down, or just want the lowest interest rate possible knowing there is some risk involved.
Hybrid mortgages – A hybrid mortgage is a blend of an ARM and a fixed rate mortgage. The mortgage will start out as a fixed-rate then defer to an adjustable rate mortgage for the remainder of the term. These types of mortgages are usually referred to a 3/1, 5/1 or 7/1 ARM. The first number in a 3/1 ARM will refer to the fixed rate term and then will become adjustable after the initial fixed rate period of 3 years. You may consider a hybrid mortgage if you do not plan on keeping the home for more than the fixed term.
Option ARM’s – These are often called ‘pick a payment’ mortgage. Every month you will receive a statement with up to four options for payment. These mortgages will often start by providing the borrower with the option of making very low monthly payments, but could become quite more costly towards the end of the mortgage term causing the borrower to choose between much higher monthly payments. Also, if you choose the lowest payment option, you may never build any equity in the home. This type of mortgage would be good for you if you are self-employed or work on commission, or are financially trained and will not select the lowest payment option every month.
Interest-only and balloon mortgages – These type of mortgages will offer you to pay only the interest for a fixed period of time. After the set time has come to an end, you will need to pay the principal in a lump sum, or refinance again. These loans may help for a short period of time, but you may never build any equity in your home. Also when the principal is due, it would be a large amount of money to pay and may cause financial difficulty. These type of loans are for people who expect some improvement in their financial situation and may be used for something such as buying time to pay off other debt obligations. If you are in a financial bind such as starting school or taking some time off to stay with your children at home, then this type of mortgage may be right for you.
No matter what, it is your responsibility as the borrower to always take into consideration the interest rate and to read the fine print, as a lot of information regarding loan terms is buried between the lines; it is very important to understand the type of mortgage you get yourself into.
Step 4: Prequalify For A Mortgage
Getting prequalified for a mortgage loan before starting your home search is a great idea. This would entail supplying lenders with basic information regarding your financial debt, income, and any assets you may have. This usually can be done at no cost, and lenders will prequalify you for a certain amount, which takes the guesswork out of what price range to stay in when searching for your new home.
Not only will a prequalification carry yourself one step closer to finding your dream home, but it also shows you are a serious shopper to your realtor and a serious buyer to the seller when making an offer. Once you are ready to make an offer, the prequalification document is usually included with your offer.
By obtaining a pre-qualification, you can have a discussion with your lender about your financial objectives for your ideal mortgage. Based on this information, the lender will then be able to present to you some mortgage/loan options and will be able to recommend the mortgage that best match with your needs and goals.
Step 5: Compare Mortgage Quotes
When shopping for a new home, you take the time to scour the market in search for your ideal home. When picking a mortgage product, you should treat comparing mortgage quotes the same way.
One of the first things to consider will be the interest rate. A small difference in the interest rate could mean quite a bit of money through the term of the loan. A good way to battle this would be putting more money down up front to keep your interest rate on the lower side of the spectrum. You will also want to consider the APR (Annual Percentage Rate). This is the combined cost and any other fees by the lender calculated over the term of your loan, and the APR is expressed as a yearly percentage. It’s important to understand the APR calculation and be fully aware of the terms provided by your lender/broker so you can fully comprehend the mortgage loan. You will want to keep in mind that every lender is different in calculating their fees into the APR.
An example of some questions you may want to ask as a consumer are “Is there a pre-payment penalty?”, “Do the terms vary?”, “What are the final closing costs and fees?”, etc.… Make sure to also request a GFE (Good Faith Estimate) and of course, don’t be afraid to ask questions about items that are unclear.
Oddly enough, many people forget customer service is an important aspect during the mortgage process. You will be creating a working relationship with the mortgage company of your choosing, so it is imperative that you work with a lender/broker who is friendly and will return your calls promptly.
Step 6: Obtain Pre-Approval From Your Lender/Broker
After choosing your lender/broker, you will want to be pre-approved. Basically, a pre-approval means an underwriter from the mortgage company has examined your documents related to your assets, liabilities, income, and credit score and has approved you for a mortgage under these circumstances. There is usually an expiration date for the pre-approval in which you’ll have to renew some information to the underwriter if you were to renew this expiration date. In addition, the pre-approval usually provides the maximum price of the home you are able to afford.
Getting pre-approved will make your job searching for a home much easier as now you have sent your documents to the mortgage company and have been verified by underwriting. To your realtor or any realtor that will present your offer to their seller, a pre-approval will be taken more seriously than a pre-qualification. Furthermore because you are pre-approved, you will have to provide less paperwork once your offer is accepted since much of the loan paperwork was already provided for the original pre-approval.
A pre-approval and pre-qualification is not the same. A pre-qualification can be accomplished with just the information provided on the mortgage application with no document verification. The mortgage company is assuming the information provided on your mortgage application is correct and the pre-qualification is issued based on this. Therefore, a pre-qualification is by no means a guarantee of the issuance of a mortgage. A pre-approval is still not 100% guaranteed, but since it is hard-verified against documents, it is more close to a guarantee than a pre-qualification. It is safe to say that you should take everything on a pre-qualification with a grain of salt because unless you are pre-approved, everything from the approved loan amount to the quoted interest rate can change.
Step 7: Lock In Your Rate
Because the actual process can take several months between getting pre-qualified and closing on your new purchase, it would definitely be wise to consider locking in your quoted interest rate by your lender or by the lender through your broker.
Now you might ask, “what is a rate lock?” It is a commitment made by the lender that will secure your quoted rate plus any fees or credits at the time. Normally, there is a time period associated with a rate lock. For example, the lender may lock you’re quoted rate of 3.75% for a 30-year fixed mortgage for 30 days with zero points or maybe 3.5% 30-year fixed mortgage with one point for 60 days.
The time frame available for a lock period is usually provided by the lender. The options are normally 15 days, 30 days, 45 days, or 60 days (and sometimes beyond). Keep in mind that the longer the lock period, the more expensive it will be. In other words the shorter the lock period, the better it will be for you to receive the lowest rate. Some lenders will offer rate lock options beyond 60 days, however this is not to be considered without a cost as you are asking the lender to hold your quote for a longer than normal time period. This can result in higher fees or possibly translate into a higher interest rate by opting for extended rate lock periods.
If you don’t lock your interest rate unintentionally, your mortgage could possibly cost you more money than it would need to. Make sure you receive a lock commitment and understand all the details about the lock (i.e. fees, points, or credits) as well as the time frame you are given.
Step 8: Close On Your Mortgage
After locking in your interest rate, you are one step closer to the American Dream of homeownership and being done with the mortgage process. The final and probably the most crucial step is the actual closing itself.
Once you have culminated to the closing process, make sure to get your pen ready because it will entail signing a good amount of paperwork. The closing agent that witnesses your signature will make sure to keep the closing documents organized and also ask of you to provide any additional documentation required by the lender such as ID or passport. If is your right as the borrower to request the closing statement at least a few days before closing, so you can review it with the necessary parties for any corrections or confusions.
This closing/settlement statement is known as the HUD-1. Make sure to review and compare this against all of your other mortgage documents to make sure it’s consistent. The HUD in “HUD-1” stands for the US Department of Housing and Urban Development and this is their formatted stylesheet for the breakdown of all costs and figures that is associated with your home purchase. Most of the fees on the HUD-1 have been disclosed in your Good Faith Estimate but the HUD-1 is final. In addition, the final figures on the HUD-1 are not to be greater than the original quoted amounts disclosed on your Good Faith Estimate by 10% or the lender would be breaking consumer law.
The HUD-1 figures could possibly differ from the GFE (Good Faith Estimate). There are several reasons why this may occur. One of which for example, the homeowners insurance premium could have ended up higher than the estimate. Another example is if the appraisal fee increased relative to the original figure on the GFE. Should you be concerned about a difference in amounts from the GFE to HUD-1, you are more than welcome to contact your lender to clear up any confusions or possible mistakes if you are uncomfortable. Just make sure to have them correct any errors before you continue. After you hand over your cashier’s check for the specified amount on the HUD-1 and sign all the mortgage/loan documentation, you are officially a homeowner!
Step 9: Assess Your Mortgage
Now that you have officially purchased a home, it is not uncommon to be distracted with things that come with being new homeowners such as arranging furniture or getting accustomed to the neighborhood. One thing you should definitely get into the habit of is checking on the interest rate every so often. Because now that you carry a mortgage, you might benefit from refinancing.
After living in your newly purchased home, changes in your life and finances do happen and these changes can have a dramatic impact on your mortgage. For example, you could have accepted a new job that increased your pay, you and your spouse gave birth to another child, or perhaps you started your own business. If you experience any changes in your life, it is always wise to reassess your mortgage/loan. Now that you are able to afford a higher monthly payment, it might make sense to refinance your mortgage into a shorter term saving you a substantial amount on interest than you would have not refinancing.
As a homeowner and mortgage holder, you should always keep an eye on interest rates. If the interest rates drop and you have a fixed-rate mortgage, you may consider refinancing. This could possibly save you a good chunk of money on your monthly mortgage payments as well as interest over the life. Should you decide to refinance, make sure to review the new rate and terms carefully and verify that they provide a net tangible benefit. As you can see, it is very important to keep an eye on the market to see how the interest rates are doing in order to stay up to date with your mortgage.
If you have an ARM (Adjustable Rate Mortgage), rising interest rates in the market could possibly augment your monthly mortgage payments. Are you able to afford the monthly mortgage payment should your ARM hit its lifetime rate cap? If your budget will not allow this sort of increase, consider refinancing to a fixed-rate mortgage. Once again make sure that the money saved from refinancing always outweighs the cost or else it doesn’t make sense to refinance. Over time as you gain more and more equity in your home, the more costly and less attractive refinancing will be.