When interest rates rise and inflation soars, lenders start to get pretty picky about mortgage loans. Buying a home can be an excellent hedge against inflation – but you have to get that mortgage loan to do it.
It’s smart to recognize that lenders are scrutinizing every mortgage application carefully and learn everything you can about the steps you need to take to achieve your goals.
1. Research Loan Programs and Lenders
This is probably the first place you want to start, since you can’t make an informed decision about where to apply for a mortgage until you learn more about your options.
Learning more about the different types of mortgage programs – like the difference between fixed-rate mortgages and adjustable rate mortgages (ARMs) – can also make it easier to converse with a loan officer. You also want to ask about the current interest rates and closing costs for any given lender before you apply, especially in today’s market. Interest rates and closing costs can vary by lender.
You should also investigate the possibility of alternative mortgage options, like those guaranteed through the Department of Veterans Affairs (VA), the Federal Housing Authority (FHA), and the U.S. Department of Agriculture (USDA). Many potential homeowners are completely unaware of the differences between these loans, which can ultimately affect how much income you need to qualify, what sort of credit score you have to have and how much down payment you need.
2. Decide on an Affordable Budget
It can be painful to fall in love with a home and then realize you can’t afford it – so save yourself a little agony by looking carefully at your budget and deciding exactly how much you can afford to spend each month on a house payment.
This is where the pre-qualification process can help. Unlike a mortgage pre-approval (which is much more complicated), lenders just need a snapshot of your financial health in order to estimate exactly how much you can borrow. While there’s no real commitment between the lender and you, it can help steer you in the right direction if a $250,000 home is more feasible than a $350,000 home.
It’s important to remember that if you’re just scraping by with the rent payment you currently have, you want your mortgage to be somewhat lower. As a homeowner, you’ll be responsible for all upkeep and repairs, so you have to factor in a little extra each month to save for those things.
3. Save Up Your Down Payment
Depending on what type of loan you decide you want, you’re also going to need a significant down payment, plus earnest money (the money you put down on the table to show a seller that you’re serious about your offer).
If your goal is to avoid private mortgage insurance and you want a conventional loan, that generally means having 20% or more of the home’s purchase price in the bank for a few months prior to buying. If you’re willing to pay the private mortgage insurance for a while, you can generally get away with 3%-5% of the sale price as a down payment – and some loan programs (like the VA and USDA) may not require anything.
4. Review Your Credit Factors
There are three major credit reporting bureaus that lenders use: Experian, Equifax and Transunion, and you need to know what your credit score looks like before you try to get a mortgage.
If you have a lender in mind, you can ask whether they use one of these or an aggregate score. If they use just Experian, for example, then focus your energies there. If they use the average of all three, then you know to take a broader approach. Generally speaking, though, the higher your credit score the better. Most lenders won’t work with you unless your score is at least 620 or higher, although VA and FHA loans do allow for lower scores.
You also need to take a hard look at your debt-to-income ratio, or DTI. This is basically a comparison between how much you earn every month against how much you owe in fixed payments. While your credit score represents your history as a creditor (and indicates your likelihood to repay the loan), your DTI tells the lender how feasibly you can manage another payment.
5. Gather Up Your Financial Paperwork
When you’re about to apply for a mortgage in earnest, it’s time to start putting your financial paperwork together. You will likely need, at minimum:
- Last 2 years of W2s
- Last 2 paystub or other proof of income
- Last 2 months of asset statements
- A copy of your photo ID
Your lender may also ask for additional items, so check ahead of time to find out exactly what documents are required.
6. Get a Pre-Approval From a Lender
Okay, you’ve done all your research, chosen a lender or two, developed a budget and made certain that your credit is squeaky-clean. Now what? It’s time to get pre-approved.
While a pre-qualification is basically a lender’s “best guess” about what they would be willing to offer, a pre-approval letter is the closest thing you can get to an actual mortgage before you actually find a house. This means submitting all of your records in earnest to the lender and going through the complete underwriting process. In the end, however, you walk away with a letter that basically guarantees you a loan (as long as nothing in your financials change) – which makes you a more attractive buyer.
If you’re still uncertain which lender is right for you, it’s okay to get multiple mortgage quotes before you commit – just make sure that you obtain them all within a few days of each other. Normally “hard” credit pulls lower your credit score a little, but several hard pulls within a two-week window as you shop around will have a minimal impact.
Obtaining a mortgage is probably the most complicated step in your home-buying journey, and it’s absolutely essential that you prepare yourself for the process. Experienced mortgage brokers can help guide you through the process, but the steps you take before, during and after that initial consultation are critical to your success.