Step 1: Preparing Your Finances
Before you begin searching for a home, the best plan of action is to get your finances in order and understand what lenders will look for when determining whether to issue a loan commitment. The four areas to focus on as you prepare to purchase a home are credit, cash, income, and debt.
Credit
Know your credit score and address any issues on your credit report. Most lenders require a minimum credit score of 680 for a conventional mortgage and 620 for an FHA mortgage, according to the Home Loan Learning Center. However, due to COVID-19 regulations at the time of this writing, many are currently requiring at least a 640-680 score for FHA loans. To ensure your best chances of securing the best mortgage loan for you, monitor your credit and address any issues early on in the process.
Cash
Depending on your lender, you will need at least 3.5% down if the full 20% isn’t a possibility for you. You will also need to calculate closing costs (which are typically 2-4% of the loan), moving costs, and a cash reserve for emergencies. Lenders will check your bank statements to verify that you have enough liquid funds to close and to continue paying the loan.
Income
In addition to how much cash you have in savings, lenders will also be looking to make sure that you have enough steady income to support the purchase over the long-term. This can be particularly challenging if you are self-employed because most lenders look to see that you’ve kept the same job over the past two years. You may need to do a little more asking around to find a lender that works with self-employed clients. If you are employed, don’t decide to quit your job anytime between loan approval and closing, as lenders want to be sure that you will be able to continue making mortgage payments once they fund the loan.
Debt
Lenders will evaluate your debt-to-income ratio and consider your student loan debt, credit card debt, and personal loan debt when determining which loan products to offer you. Doing what you can to reduce these debts before beginning the home loan process can result in more options for you to consider. If you can do so without dipping too far into your down payment and cash reserves, try paying off smaller loans and paying down the larger ones now.
Step 2: Weigh Your Options
Contrary to popular belief, rates aren’t the ONLY factor in choosing a mortgage or a lender. It’s always about finding what works for you. Make sure you feel comfortable with the people you’re working with—and look at the full picture of your mortgage payment. Ready to get started?
Comfort
When you speak to a loan officer or loan advisor, do they answer your questions clearly and competently? Do they present you with a reasonable sense of your options without applying pressure in any direction? Based on your evaluation of other mortgage offers, do you feel this lender is working to give you the best deal possible for your situation?
Interest Rate
Lenders offer different interest rates based on the current market and the risk of the loan. The lower the interest rate, the faster you can pay down the principal to build equity in your home. (That’s why we created Lower.)
Rate Type
In addition to the interest rate itself, determine whether it is a fixed or adjustable rate. Fixed rates stay the same for the life of the loan, whereas adjustable rates may fluctuate with changes in the market. Adjustable rates are attractive to some borrowers because they tend to be much lower at first. Fixed-rate mortgages may be higher, but with the increased rate, you’re essentially paying for more security over the long term. It’s worth noting that you can also refinance if rates drop.
Mortgage Term
Most mortgage terms are either 15 or 30 years. The longer the mortgage term, the lower the monthly payments, but the slower you build equity and the more you’ll pay in interest. It’s all about what your monthly payment and what you can afford.
Type of Mortgage
The type of mortgage available to you will depend on the size of your down payment, your debt-to-income ratio, and a few other key factors. For example, an FHA, or federally-backed, mortgage loan may require a lower credit score than a conventional mortgage, but carries a mortgage insurance premium (MIP) that may be significant and does not count toward the principal of your loan.
Monthly Payment
How much you pay monthly on your mortgage has a big impact on the affordability of your home, but you also want to look carefully at exactly how that monthly payment is broken down. For example, is a big chunk of it going to MIP or private mortgage insurance (PMI) rather than toward the principal? And how much is going toward interest? You’ll most likely receive estimate of what you would pay in property taxes from escrow each month, but you’ll want to verify these numbers to ensure that you can reasonably afford them with your current budget.
Five-Year Projection
All of the terms of your loan will be spelled out in detail on what’s called a loan disclosure document. Included in the details, you will see a five-year projection of how much you will have paid on the loan overall and how much will have been paid toward the principal after five years. If you have multiple Compare the loan offers, you’ll want to determine which of them allows you to pay down the principal soonest and therefore build up the most equity.
Fees
Most closing costs are pretty standard and set by the state or county, but there can be differences among third-party fees, like appraisal, loan processing, and underwriting fees. If you are working with more than one lender and receive multiple loan disclosures, these fees should all be detailed on your loan disclosures. You’ll want to check if there are any significant differences that will impact the amount of cash you need to close.
Step 3: Get Pre-Approved
A pre-approval for a mortgage loan gives you a sense of how much home you can afford. It also allows you to start familiarizing yourself with the various mortgage products that may be available to you and which rates various lenders are offering. For example, you can consider taking advantage of the assistance programs for first-time homebuyers through the U.S. Department of Housing and Urban Development (HUD).
There are a lot of moving parts to the mortgage application process from approval to closing, and you want to work with someone who is reliable, trustworthy, transparent, and knowledgeable.
Do some comparison during the pre-approval process. Here at Lower, we don’t require a hard credit check to get pre-approved, so you can shop around without it impacting your credit. (You can also compare rates at lower.com between the Bankrate national average and a few of the top lenders, including Lower.)
Once you get pre-approved, you should also develop your own sense of what you can afford. Mortgage pre-approval letters tell you how much you can borrow—not necessarily how much you can comfortably afford, although the amounts could be similar.
You will feel far more comfortable embarking on your home search if you determine for yourself how much house you can afford. You can do this by sketching out a monthly budget that includes your mortgage payments, home insurance, taxes, utilities, commuting costs, and other expenses. Then, once you begin talking to a loan advisor, you can make sure your
Be sure to build savings into your budget. Once you’re a homeowner, there will be unexpected repairs and routine maintenance, and you will need a plan to cover these costs.
Step 4: Making an Offer
Aside from the closing, this is the most exciting step in the entire mortgage process. Armed with the knowledge of your options and budget, you can find the perfect home and make an offer. Along with your real estate agent’s expertise and the mortgage products you have reviewed, you will have a sense of what you can afford and what kind of offer you can make. Once you have an accepted offer, you will select your lender and sign the purchase contract.
Step 5: Loan Processing, Appraisal, and Underwriting
Your purchase contract will trigger the loan processing, appraisal, and underwriting process. This is a more thorough check into all aspects of your loan.
During loan processing, all of your necessary documentation will be verified (and checked a few times again). At any point, you may be asked to provide additional pay stubs, bank statements, and other financial records to compile a complete picture of your loan portfolio. This is completely normal.
During this process, you’ll also need to have a home appraisal, which will usually cost you anywhere from $450 to $650 and is set up by your loan team. Your appraiser will evaluate the condition of the property and compare it to other homes on the market to ensure the appraised value matches the loan amount. If the appraised value is a little higher, that’s great news (free equity!) but if the appraised value is lower than the accepted offer, you may have to restart negotiations with the seller or consider whether it’s time to move on to a different property. It’s all about balance—if the appraisal comes in low, you can always make up the difference by increasing your down payment, but that comes with its own risks.
As your appraisal is being done, your loan will go through underwriting, which can take anywhere from a few days to a week before you’re approved to move forward.
Step 6: Closing
Three business days before closing, your lender will provide you with the closing disclosure, which details and confirms the terms of the loan and the cash to close. You’ll soon have the keys to your new home and be able to enjoy the benefits of homeownership.
Although it may be tempting to start making large purchases, like buying furniture for your new home, it’s best to wait until after you close.
Just keep in mind your financial details are still being reviewed—all the way up until you sign on the dotted line and the home is yours. Although it may be tempting to start making large purchases, like buying furniture for your new home, it’s best to wait until after you close. These major changes can impact your credit usage or cash reserves that you submitted for review at the beginning of the mortgage process.
Another major change you’ll want to avoid in the time before your loan closes is changing jobs if it can be avoided. If you do have a major change, be sure to tell your loan team as soon as possible so they can help you get in front of it.
Home Sweet Home
If you’ve read this far, you’re doing great! You’re taking the time to learn more about the homebuying process, and the more you know and understand, the easier the process will be! If you have any specific questions, we’re here to help you the entire way!
