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Deciding that you’re ready to buy a house is a huge decision and not likely one you take lightly.
When it’s time to actually apply with lenders, they’re going to want a full, complete picture of your finances.
It’s a lot different than casually checking into your background. Lenders are required to inform you that they’re checking your credit, and you have rights under the Fair Credit Reporting Act.
A lender’s priority is making sure you have the money to pay back the loan, and they want to reduce their risk exposure when lending to you as much as possible.
The following is a guide to what you should know about the process before getting started.
The Basics of a Mortgage
A mortgage is an agreement between you, if you’re the borrower, and a lender, to buy or refinance a home without having the cash upfront. The agreement gives legal rights to the lender to repossess a property if you don’t meet your mortgage terms. Typically, what triggers repossession is not repaying what you borrowed plus interest.
A mortgage is a secured loan. Secured loans mean borrowers promise the lender collateral if they stop making payments. With a mortgage, the collateral is the home. If you don’t make payments on your mortgage, then your lender can take possession, which is a foreclosure.
When you go to a mortgage lender, they agree to give you a certain amount of money to buy a home. You then agree to pay that loan back with interest over a period of years. The lender has rights to the home until you fully pay your mortgage off, and fully amortized loans have a payment 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 if you don’t repay your mortgage, the lender can sell your home to make up for losses.
The Process of Getting a Mortgage
If you want to get a mortgage, it can be a straightforward process, but there are some scenarios where it can be more complex.
First, you’ll need a preapproval. Many realtors will require you to have preapproval before they work with you, and it’s something sellers want as well.
When you get an upfront preapproval, you’ll learn what you qualify for, so you aren’t spending time looking at houses that are more than what you can afford.
In seller’s markets, again, you might not even be able to get a real estate agent to meet with you until you have a preapproval letter.
A prequalification isn’t the same as a preapproval. A prequalification is a verbal or written estimate of income and assets with a lender, who might check your credit, but not always.
The numbers on a prequalification aren’t verified, so there’s not a lot of weight in the eyes of a seller or agent.
Preapproval means the lender has verified your provided financial information, and they’ve shown that you’re basically approved, pending an appraisal to check the home’s value and condition.
Some mortgage lenders will verify your finances upfront, and that makes you as strong as a cash buyer.
For someone who’s actually going to buy with all cash, they would attach a Proof of Funds letter with an offer.
Once you have a preapproval inhand, you’ll start shopping for homes.
Then, you’ll negotiate the price, deal with the paperwork and details, and you will finalize your financing. At this point, the lender verifies all of your mortgage details if that wasn’t done upfront. They’ll also verify property details, and they’ll hire a title company to check and make sure there aren’t issues that could be problematic for the sale.
After your loan is fully approved, you meet with your lender and a real estate professional to close it, and you can take ownership. During the closing, you pay a down payment and closing costs and sign any documents.
Types of Mortgages
The phrase conventional loan refers to any loan not backed or guaranteed by the federal government. They’re also called conforming loans. Conventional loans indicate the private lender is willing to make a loan without the support of the government and conforming means the home loan meets a set of requirements set by Fannie Mae and Freddie Mac.
Fannie Mae and Freddie Mac are organizations the government sponsors that buy loans, keeping mortgage lenders liquid so they can make more loans.
With a conventional loan, you might be able to make a down payment as small as 3%. On a conventional loan, with a down payment of less than 20%, you’re probably going to have to pay private mortgage insurance, protecting your lender if you default. You’ll have higher monthly costs, but some people are okay with the tradeoff to buy a home sooner.
Understanding Your Credit Scores
Your credit and personal financial history are key determinants of again, whether you’re approved for a loan and, if you are 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 one type of score lenders use to decide whether or not to extend credit to someone.
The credit score is a quick way to determine your financial health. The higher your score, the more you tend to pay back what you owe on time. A lower credit score can show you have a limited credit history or that you have a hard time managing your debt.
Your credit report contains not only scores but identifying information about you, like your date of birth and Social Security number. It’ll include details of your existing credit accounts, including lines of credit, credit cards, and loans.
Credit reports have public records like judgments, bankruptcy filings, and liens, and there are inquiries listed from organizations and individuals who have checked your credit.
The three main credit bureaus that keep reports are Equifax, Experian, and TransUnion. Credit reports include information creditors report to the bureaus and also information that’s 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 a standardized, industry-wide 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 utilization, 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 it’s possible a lender will use another model.
Also Read: What is the difference between a Roth 401(k) and a Roth IRA?
What You’ll Need for a Pre-Approval
To get pre-approved for a mortgage, you’ll usually need five things.
Proof of Income
If you’re going to buy a house, you’ll have to show your W2 statements from the past two years and possibly your recent pay stubs that show your income. You might also need to show your tax returns for the past two years and proof of additional income.
If you’re self-employed, showing your income can get trickier. Your lending 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 situation.
Proof of Assets
The bank will want to see statements for your investment accounts, bank statements, and anything else that will show your assets. They want to see you have cash on hand and enough for the down payment and closing costs.
The down payment is a percentage of the selling price, and how much you have to pay depends on the loan type you’re applying for.
Certain government-backed loans require very little or no down payment at all, such as Veterans Affairs (VA) loans.
Special Purchase Program for Seniors
Reverse mortgage loans can be a valuable tool for seniors who wish to stay in their homes while accessing the equity they have built up over time. However, there is another option available to eligible borrowers known as a reverse mortgage for purchase. This type of mortgage enables individuals aged 62 or older to buy a new home in a single transaction, by combining the reverse mortgage loan and home purchase into one process.
The Home Equity Conversion Mortgage (HECM) for purchase program is a popular option for those considering a reverse mortgage for purchase. It allows borrowers to use the proceeds from the sale of their previous home, along with additional funds from the reverse mortgage loan, to purchase a new home. This program may also be a viable alternative for those who may not have enough cash on hand for a down payment on a new home.
Overall, a reverse mortgage for purchase can provide a way for seniors to achieve their desired lifestyle and living situation, while also accessing the equity in their homes. However, it is important to carefully consider the costs and fees associated with this type of mortgage, as well as the long-term financial impact on the borrower and their heirs.
Good Credit
Most lenders require borrowers to have a FICO score of at least 620 for approval of a conventional loan. Lenders usually 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 might need to pay a larger down payment.
Employment Verification
A lender wants to see stable employment. The lender will probably ask to see your pay stubs, and they might also call your employer to verify your employment and the salary you report.
Self-employed borrowers will have to provide more paperwork. According to Fannie Mae guidelines, self-employed borrowers need to be able to show a stable income, they need to have a product or service with stable demand, and the business should demonstrate the ability to keep generating enough income to allow the borrower to make mortgage payments.
Finally, you’ll have to provide the lender with a copy of your driver’s license, and you’ll need to provide your signature and Social Security number.
The more prepared with all the necessary documentation, and the faster you respond, the quicker you can get through the process and get approved for a mortgage.
Photo by Tierra Mallorca on Unsplash