Deciding that you’re ready to buy a home is a big decision that you probably won’t take lightly.
When it’s time to apply to lenders, they’ll want to get a full and complete picture of your finances.
It’s very different from casualness check your background. Lenders are required to inform you that they are checking your credit and that you have rights under the Fair Credit Reporting Act.
A lender’s priority is to make sure you have the money to repay the loan, and they want to reduce their exposure to risk as much as possible when lending to you.
The following is a guide to what you need to know about the process before you begin.
The basics of a mortgage
A mortgage is an agreement between you, if you are the borrower, and a lender, to buy or refinance a house without having the money up front. The agreement gives the lender the legal right to repossess a property if you fail to meet the terms of your mortgage. Typically, what triggers repossession is not the repayment of what you borrowed plus interest.
A mortgage is a secured loan. Secured loans mean that borrowers promise the lender a guarantee if they stop making payments. With a mortgage, the security is the house. If you don’t make payments on your mortgage, your lender can take possession of it, which is a foreclosure.
When you apply to a mortgage lender, the latter undertakes to grant you a certain amount of money to buy a house. You then agree to repay that loan with interest over a period of years. The lender has rights to the home until you fully pay off your mortgage, and fully amortized loans have a repayment schedule where your loan is paid off at the end of the term.
The biggest difference between a mortgage and other types of loans is that if you don’t pay off your mortgage, the lender can sell your home to make up for the losses.
The process of getting a mortgage
If you want to get a mortgage, the process can be simple, but there are certain scenarios where it can be more complex.
First, you will need pre-approval. Many real estate agents will require you to have pre-approval before working with you, and this is also something that sellers want.
When you get pre-approved, you’ll know what you’re entitled to, so you don’t waste time looking for homes that are more than you can afford.
In sellers’ markets, again, you may not even be able to ask a real estate agent to meet with you until you receive a pre-approval letter.
A prequalification is not the same as a preapproval. A prequalification is a verbal or written estimate of income and assets with a lender, who may check your credit, but not always.
The numbers in a prequalification are unverified, so there is not much weight in the eyes of a seller or agent.
Pre-approval means the lender has verified the financial information you provided and has shown that you are substantially approved, pending an appraisal to verify the value and condition of the home.
Some mortgage lenders will check your finances beforehand, making you as strong as a cash buyer.
For someone who is actually going to buy with full money, they will enclose a proof of funds letter with an offer.
Once you have a pre-approval in hand, you start shopping for homes.
Then you’ll negotiate the price, sort out the paperwork and details, and finalize your financing. At this stage, the lender verifies all the details of your mortgage if this has not been done in advance. They will also check the details of the property and engage a title company to check and make sure there are no issues that could be problematic for the sale.
Once your loan is fully approved, you meet with your lender and a real estate professional to close it, and you can take possession of it. At closing, you pay a deposit and closing costs and sign all documents.
Types of mortgages
The term conventional loan refers to any loan not backed or guaranteed by the federal government. They are also called conforming loans. Conventional loans indicate that the private lender is willing to provide a loan without government backing, and compliance means that the home loan meets a set of requirements set by Fannie Mae and Freddie Mac.
Fannie Mae and Freddie Mac are government-sponsored organizations that buy loans, keeping mortgage lenders liquid so they can make more loans.
With a conventional loan, you may be able to afford as little as 3% down payment. On a conventional loan, with a down payment of less than 20%, you will likely need to pay for private mortgage insurance, protecting your lender in the event of default. You’ll have higher monthly costs, but some people accept the trade-off of buying a home sooner.
Understanding your credit scores
Your credit and personal financial history Key determinants again are whether you are approved for a loan and, if approved, what your interest rate will be. A three-digit credit score measures, at least in the eyes of a lender, how well you manage your finances.
FICO scores are a type of score that lenders use to decide whether or not to give someone credit.
The credit score is a quick way to determine your financial health. The higher your score, the more likely you are to repay what you owe on time. A lower credit score may indicate that you have a limited credit history or are having difficulty managing your debt.
Your credit report contains not only scores, but also identifying information about you, such as your date of birth and social security number. It will include details of your existing credit accounts, including lines of credit, credit cards and loans.
Credit reports have public records such as judgments, bankruptcy filings, and liens, and there are inquiries from organizations and people who have checked your credit.
The three main credit bureaus that keep reports are Equifax, Experian and TransUnion. Credit reports include information that creditors report to bureaus as well as information that is part of the public record.
Your FICO score is generated by the Fair Isaac Corporation. These scores were developed in response to the need for an industry-wide standardized credit score.
These numbers are three digits, based on information in consumer credit reports.
Five factors play a role in your FICO score: payment history, credit usage, credit age, credit mix, and credit inquiries.
A type of score, FICO specifically develops its numbers based on a proprietary model.
Most lenders use FICO credit scores, but a lender may use another model.
What you will need for pre-approval
To get pre-approved for a mortgage loan, you will generally need five things.
proof of income
If you are going to buy a house, you will have to view your W2 statements for the last two years and perhaps your last payslips showing your income. You may also need to submit your tax returns for the past two years and proof of additional income.
If you are self-employed, it may be more difficult to show your income. Your loan decision will likely be based on your tax returns, but some self-employed people take large deductions for business expenses. You should talk to your lender if this is your case.
Proof of Assets
The bank will want to see your investment account statements, bank statements, and anything else showing your assets. They want you to have enough cash for the down payment and closing costs.
The down payment is a percentage of the sale price, and the amount you need to pay depends on the type of loan you are applying for.
Some government-backed loans require very little or no down payment, such as Veterans Affairs (VA) loans.
Most lenders require borrowers to have a FICO score of at least 620 to approval of a conventional loan. Lenders typically reserve the best and lowest interest rates for customers who have a credit score of at least 760. FHA guidelines require credit scores of at least 580, with a down payment of 3 .5%.
If you have a lower credit score, you may need to pay a larger down payment.
A the lender wants to see a stable job. The lender will likely ask to see your pay stubs, and they might also call your employer to verify your employment and the salary you claim.
Independent borrowers will have to provide more papers. According to Fannie Mae’s guidelines, self-employed borrowers must be able to demonstrate stable income, they must have a product or service with stable demand, and the business must demonstrate its ability to continue to generate enough income to enable the borrower to make mortgage payments.
Finally, you will need to provide the lender with a copy of your driver’s license, and you will need to provide your signature and social security number.
The more prepared you are with all the necessary documents and the quicker you respond, the faster you can go through the process and get approved for a mortgage.