For most Americans, taking out a mortgage makes buying a home possible. Obtaining this sort of financing — never a stress-free procedure — has gotten even more stressful of late, given the lightning rise in mortgage rates. You might even wonder if it’s still possible to qualify for a mortgage and buy a home.
Don’t fret: Getting a mortgage can take some time and effort, but we’re here to help. This guide to getting a mortgage breaks down every step of the process so you’ll know what to expect.
What are mortgage lenders looking for?
Mortgage lenders, like any lender, want reassurance that you will pay back the money that you borrow. That means they’re looking for reliable, creditworthy applicants with sufficient income, consistent repayment histories and manageable levels of debt. Safe bets, in other words.
They’re also looking at the value of the property you want to buy, making sure it’s worth enough to serve as collateral for your new loan.
Factors that go into a lender’s decision on whether or not to approve your mortgage application include:
- Credit score. If your credit history shows a pattern of reliable repayments, low credit utilization, a good mix of credit accounts and a reasonable number of credit inquiries, you probably have a credit score that will earn you one of the best interest rates. It is possible to get a mortgage with a low credit score, though, so don’t rule out homeownership before talking to a lender about your situation.
- Income and employment. How much money you’re bringing in and a steady work history are key factors in mortgage approval. Stable employment and income high enough to afford the monthly payment will help you qualify for a mortgage.
- A low DTI. Everyone has debts; the key, as far as lenders are concerned, is how your obligations stack up against your earnings, a figure known as a debt-to-income (DTI) ratio. If your debts make your DTI ratio too high, you may have trouble qualifying, even if you have a healthy income: the lender might doubt your ability to manage the monthly payments.
- Assets. Your lender will want to look at how much is in your bank account and how much any other assets (like a second home or investments) are worth.
Steps for getting a mortgage
Step 1: Strengthen your credit
A robust credit score (in the 700s, preferably) demonstrates to mortgage lenders that you can responsibly manage your debt. “Having a strong credit history and credit score is important because it means you can qualify for favorable rates and terms when applying for a loan,” says Rod Griffin, senior director of Public Education and Advocacy for Experian, one of the three major credit reporting agencies.
If your credit score is on the lower side, you could still get a loan, but you’ll likely pay a higher interest rate.
To improve your credit before applying for your mortgage, Griffin recommends these tips:
- Make all payments on time and reduce your credit card balances. Your payment history on your report goes back two years or longer, so start now if you can.
- Bring any past-due accounts current, if possible.
- Review your credit reports for free at AnnualCreditReport.com. Check for errors on your credit reports, and contact the reporting bureau immediately if you spot any. An error might be a paid-off loan that hasn’t been recorded as such, or an incorrect address, for example.
- Check your credit score (often available free from your credit card or bank) at least three to six months before applying for a mortgage. When you review your score, you’ll see a list of the top factors impacting it, which can tell you what changes to make to get your credit in shape, if needed.
If your score isn’t the strongest, there are financing options, such as FHA loans, that can offer approval for people with scores as low as 580 or even lower.
Step 2: Know what you can afford
It’s fun to fantasize about a dream home with every imaginable bell and whistle, but it’s much more practical to purchase only what you can reasonably afford. Rising interest rates make monthly mortgage payments even higher, so you might have to adjust your expectations (if not your budget) to find an affordable home.
Katsiaryna Bardos, finance department chair at Fairfield University in Fairfield, Connecticut, says one way to determine how much you can afford is to figure out your debt-to-income ratio (DTI) — a criterion lenders often look at, as noted above. DTI is calculated by summing up all of your monthly debt payments and dividing that figure by your gross monthly income.
“Fannie Mae and Freddie Mac loans accept a maximum DTI ratio of 45 percent. If your ratio is higher than that, you might want to wait to buy a house until you reduce your debt,” Bardos suggests. Many financial advisors recommend keeping the ratio closer to 36 percent, especially for conventional loans (that is, non-government ones).
Even with the 45 percent threshold, the lower your DTI ratio, the more room you’ll have in your budget for expenses not related to your home. That’s why Andrea Woroch, a Bakersfield, California-based personal finance and budgeting authority, says it’s essential to take into account all your monthly expenses and your set-asides for far-off plans.
“The last thing you want to do is get locked into a mortgage payment that limits your lifestyle flexibility and keeps you from accomplishing your goals,” Woroch says — a condition known as “house poor.”
Step 3: Build your savings
Your first savings goal should be: enough for a sufficient down payment.
“Saving for a down payment is crucial so that you can put the most money down — preferably 20 percent to reduce your mortgage loan, qualify for a better interest rate and avoid having to pay private mortgage insurance,” Woroch explains.
It’s equally important to build up your cash reserves. One rule of thumb is to have the equivalent of roughly six months’ worth of mortgage payments in a savings account, even after you fork over the down payment. This cushion can help safeguard you if you lose your job or something else unexpected happens.
Also, don’t forget closing costs, which are the fees you’ll pay to finalize the mortgage. They typically run between 2 percent to 5 percent of the loan’s principal. They don’t include escrow payments, either, which are a separate expense. Generally, you’ll also need around 1 to 4 percent of the home’s price for annual maintenance and repair costs.
Step 4: Compare mortgage rates and loan types
Once your credit score and savings are in an adequate place, start searching for the right kind of mortgage for your situation. You’ll also want to have an idea of how mortgages work before moving forward.
The main types of mortgages include:
- Conventional loans – These are best for homebuyers with solid credit and a decent down payment saved up. They’re available at most private lenders: banks, credit unions, independent mortgage companies.
- Government-insured loans (FHA, VA or USDA) – These can be great options for borrowers who do not qualify for a conventional loan or who meet specific criteria, such as being a member of the military for a VA loan.
- Jumbo loans – These loans are for more expensive properties, whose price tags exceed the federal threshold set for ordinary, aka conforming, loans ($726,200 in most parts of the country or $1,089,300 in more expensive areas). If you need to finance more than that for your dream home, you’ll need to get a jumbo loan from a commercial lender.
Look at the interest rates and fees for each loan, which collectively amount to its annual percentage rate (APR). Even a small difference in interest rate can result in a big savings over the long run. Also consider things like whether you’ll have to pay for mortgage insurance, and for how long.
Mortgages can have a fixed or adjustable rate, meaning the interest rate stays the same for the duration of the loan term or fluctuates over time, respectively. Most home loans have 15- or 30-year terms, although there are 10-year, 20-year, 25-year and even 40-year mortgages available.
Adjustable-rate mortgages (ARMs) might come with a lower rate and monthly payment initially, but can become more expensive over time if rates rise. If it’s an interest-only ARM — meaning for a set period, your payments only go towards interest, not the loan principal — it’s almost guaranteed that your payment will increase once your rate-lock period ends. If you can’t afford that risk, the fixed-rate is the way to go.
Step 5: Find a mortgage lender
Once you’ve decided on the type of mortgage, it’s time to find a mortgage lender.
“Speak with friends, family members and your agent and ask for referrals,” advises Guy Silas, branch manager for the Rockville, Maryland office of Embrace Home Loans. “Also, look on rating sites, perform internet research and invest the time to truly read consumer reviews on lenders.
“[Your] decision should be based on more than simply price and interest rate,” says Silas. “You will rely heavily on your lender for accurate preapproval information, assistance with your agent in contract negotiations and trusted advice.”
If you’re not sure exactly what to look for, you might want help. A mortgage broker can help you navigate all the different loan options available to you and possibly help you get more favorable terms than you’d be able to secure by applying on your own. Remember that interest rates, fees and terms can vary substantially from lender to lender.
Step 6: Get preapproved for a loan
It’s a good idea to get preapproved for a mortgage once you’ve found a suitable lender. With a preapproval, the lender will review your finances to determine if you’re eligible for funding and an amount they’re willing to lend you.
“Many sellers won’t entertain offers from someone who hasn’t already secured a preapproval,” Griffin says. “Getting preapproved is also important because you’ll know exactly how much money you’re approved to borrow.”
Be mindful that mortgage preapproval is different from prequalification. A preapproval involves much more documentation and a hard credit check; mortgage prequalification is less formal and is essentially a way for a lender to tell you that you’d be a good applicant.
Still, preapproval doesn’t guarantee you’ll get the money or any particular loan terms. That has to wait until you’ve actually found a place to purchase.
Step 7: Begin house-hunting
With preapproval in hand, you can begin seriously searching for a property that meets your needs. When you find a home that has the perfect blend of affordability and livability, be ready to pounce.
“It’s essential to know what you’re looking for and what is feasible in your price range,” Bardos notes. “Spend time examining the housing inventory, and be prepared to move quickly once the house that meets your criteria goes on the market.
“Utilize social media and ask your agent for leads on homes going on the market before they are listed on the MLS,” he also recommends.
Step 8: Submit your loan application
If you’ve found a home you’re interested in purchasing, you’re ready to complete a mortgage application. These days, most applications can be done online, but it can sometimes be more efficient to apply with a loan officer in person or over the phone. You might be better able to establish a relationship with the loan officer in person, too, which can work to your advantage if you have questions in the process or issues come up.
The lender will also pull your credit report to verify your creditworthiness.
Step 9: Wait out the underwriting process
Even though you’ve been preapproved for a loan, that doesn’t mean you’ll ultimately get financing from the lender. The final decision will come from the lender’s underwriting department, which evaluates the risk of each prospective borrower, the nature of the property, and determines the loan amount, interest rate and other terms.
“After all your financial information is gathered, this information is submitted to an underwriter — a person or committee that makes credit determinations,” explains Bruce Ailion, an Atlanta-based real estate attorney and Realtor. “That determination will either be yes, no or a request for more information from you.”
There are a few steps involved in the underwriting process:
- First, a loan officer will confirm the information you provided during the application process.
- After you make an accepted offer on a home, the lender will order an appraisal of the property to determine whether the amount in your offer is appropriate. The appraised value depends on many factors, including the home’s condition and comparable properties, or “comps,” in the neighborhood.
- A title company will conduct a title search to ensure the property can be transferred, and a title insurer will issue an insurance policy that guarantees the accuracy of this research.
- Finally, you’ll get a decision from the underwriter: approved, approved with conditions, suspended (meaning more documentation is needed) or denied.
Step 10: Close on your new home
Once you’ve been officially approved for a mortgage, you’re nearing the finish line. All that’s needed at that point is to complete the closing.
“The closing process differs a bit from state to state,” Ailion says. “Mainly it involves confirming the seller has ownership and is authorized to transfer title, determining if there are other claims against the property that must be paid off, collecting the money from the buyer, and distributing it to the seller after deducting and paying other charges and fees.”
There are a variety of expenses that accompany the closing. Common closing costs include:
- Appraisal fee
- Credit check fee
- Origination and/or underwriting fee
- Title insurance and services fees
- Attorney fees
- Recording fees
You will review and sign lots of documentation at the closing, including details on how funds are disbursed. The closing or settlement agent will also enter the transaction into the public record.
What documents do you need to get a mortgage?
Getting a mortgage involves a lengthy process. Your lender is likely providing hundreds of thousands of dollars to purchase a home, so it wants to make sure that you’ll be able to repay that loan.
Expect to need the following documents for the underwriters, who are evaluating your application:
- Previous years’ tax returns
- Proof of income
- Proof of employment and employment history
- Bank statements
- Brokerage statements
- Documentation of other assets and debts
- Documents outlining any gifts you’ve received to help pay for the home
- Rental history
Your lender will request the specific documents it wants to see.
Bottom line on getting a mortgage
They say you shouldn’t put the cart before the horse. The same is true in the homebuying process. You’ll need to complete several steps to finance a home, so the more you learn about what’s required, the better informed your decision-making will be.
If you’re denied a mortgage, there’s no barrier against trying again in the future.
“If you are unable to qualify for a loan with favorable terms, it may make more sense to simply wait until you can make the necessary changes to improve your credit history before trying again,” Griffin suggests. “A bit of patience and planning can save a lot of money and help you get the home you want.”