Applying for a mortgage can be the most important and difficult part of buying a home, and a great deal of care, preparation, and planning must be taken in this endeavor. But where do you even start? How can you ensure that you get the best possible mortgage for your situation? Here we break down the mountain of mortgage into something more manageable and far less frightening.
What banks will want:
Here are key factors that lenders will consider during the application process:
• Credit report Incorrect information can cause higher rates or prevent the borrower from getting a mortgage altogether. Obtain credit reports from the three major credit bureaus and carefully look them over for errors.
• Credit standing & accounts Pay off credit card balances and bills before applying for a mortgage. Avoid closing accounts or opening new ones right before applying for a mortgage, as this can make lenders suspicious.
• Down payments The more money a borrower can put down upfront, the better. More money means more likelihood of being approved for a loan, and also results in a lower loan.
• Income Steady income is a must, so try not to change jobs or quit right before applying for a mortgage.
• Available funds In addition to down payment, the borrower should have funds set aside for closing costs or other costs. Avoid making big purchases that would deplete funds (such as buying a car) before applying for a mortgage.
• Price ranges Know your debt-to-income ratio and don’t try to buy a house out of your price range.
• The lender Do your research about the lender. Learn its reputation and history; how many mortgage applications does it accept? Deny?
How much mortgage can you afford?
The lender uses several ratios to determine how much can be borrowed. It’s important to understand these ratios and understand how high of a loan the borrower could be taking on.
• Front-end ratio The monthly percentage of your yearly gross income that can be dedicated to mortgage payments. Generally the taxes, interest, insurance, and principal should not take up more than 28% of your yearly income, though some lenders go as high as 30 or 40 percent.
• Back-end ratio Also called debt-to-income ratio. The percentage of your gross income required to pay off debts. These include car payments, child support, mortgages, and other loans. Most institutions recommend that this ratio does not exceed 36%.
• Down payment percentage Paying at least 20% of the home’s cost upfront will minimize the need for insurance from the lender.
Different types of mortgages
There are many types of mortgages available, and it’s important to know the advantages and disadvantages to each when applying for a mortgage.
• Fixed-rate mortgage The interest remains the same during the entire life of the mortgage. The most popular type of mortgage and also the most predictable.
• One year adjustable rate mortgage (ARM) The interest rate changes based on a specific schedule after a “fixed period” at the beginning of the loan. Can be risky because payment amount can change drastically.
• 10/1 ARM Initial rate is fixed for the first 10 years of the loan. After that, the rate adjusts each year for the remainder of the loan.
• 2-Step mortgages ARM with the same rate for one part of the mortgage and a different rate for the rest. The change is based on current market trends.
• 5/1 and 5/5 ARM Interest rate and monthly payment are the same for 5 years. Starting with the 6th year, interest rate is adjusted every year or 5 years for 5/1 and 5/5, respectively. (Similar concept with 3/1 and 3/3)
• 5/25 mortgage Also called “30-due-in-5.” Monthly payment and interest change don’t change for 5 years, but will be adjusted during the 6th year and remain consistent after that.
• Balloon mortgages Monthly payments are smaller because of a large balloon payment due at the end of the loan.
• Check your credit score and ensure that your credit report is accurate.
• Try to get credit card balances between 30 and 50 percent of your credit limit, or pay them off entirely.
• Do some comparison shopping with lenders
• Know how much home you can afford
• Save money for a down payment
• Change your job or career
• Apply for new credit cards or close credit card accounts
• Buy a new car
• Make unusually large bank deposits
Above all, consistency is key! Don’t make major changes in your credit or how you handle your finances. This could jeopardize your chances of securing a mortgage.