Obtaining a mortgage, especially for the first time, can be one of the more stressful events that the average person endures. Just thinking about the scrutiny, mountains of paperwork, countless pages of fine print, and the time and stress involved tends to make most of us shutter.
However, getting a mortgage need not be so stressful with the right approach and information. In this article, we will go through 10 tips that can help take the edge off of getting a mortgage so you can be better prepared and approach this process with confidence and peace of mind.
1. Check Your Credit Report
If there are mistakes on your credit report, that could shoot you in the foot before you even apply. Know that mistakes do happen fairly often, and they are correctable by contacting the major credit bureaus with proof of their mistake. Also know that not all errors are your fault or the bureaus. Sometimes things happen and accounts get mixed up, or worse yet, identity thieves strike and use your information to falsely apply for credit. All these things can be corrected with the right evidence and a little patience. Fixing your credit report can raise your credit score if there were false derogatory marks on it. A boost in the credit score of 40 points could save you nearly $100 a month on your mortgage payment!
2. Only Buy A Home You Can Afford
This should go without saying, but unfortunately it does not. We live in a world where people routinely sign mortgages that they were approved for, but which they couldn’t truly afford. Your maximum mortgage approval is the amount that the bank is willing to lend you. It is not the amount you can afford to spend. Remember, just because the bank is ready to give you a certain amount, doesn’t mean you should spend it. You will have to repay every dollar of that loan, with considerable fees and interest tacked on!
The more you take out, the higher your monthly cost of living will be, which will put additional stress on you and your family. It may mean you need to work longer hours or hold down two or more jobs to make ends meet if things change in your life. Is this the future you want? Try to leave some margin in your budget to account for changes that life throws your way.
On a related note, most lenders will only approve you for a debt-to-income ratio of 41 percent, while an ideal DTI ratio would be 36 percent. Remember, when figuring out how much home you can afford, you should take into account other debts such as credit cards, car loans, and student loans as well, as you will need to meet all of those obligations each month too.
3. Save As Much Of A Down Payment As Possible, Ideally 20 Percent
Generally speaking, the more of a down payment you can bring to the table, the better off you’ll be. A down payment of 20 percent is ideal because this will mean you don’t need to carry private mortgage insurance (PMI), which increases your monthly payments. PMI can cost between 0.35 percent and 1 percent of your mortgage value annually, depending on what type of mortgage you choose. For FHA loans, the PMI is 0.85 percent. A conventional mortgage PMI is 0.51% and is required until your loan balance reaches 78 percent LTV. The bottom line is, a larger down payment saves you significant money in the long run.
4. You Don’t Need Perfect Credit To Get Approved
While having a higher credit score will save you money on your mortgage by reducing the interest rate you’ll pay, don’t be afraid if your credit score isn’t perfect. Having a lower credit score will likely not get in the way of your getting approved. As a general rule, a credit score of 620 is the minimum most lenders will accept for any home loan. However, FHA loans can be approved with as low as a 580-credit score. Keep in mind your credit score is not the only determining factor. You will also need to have a good credit history and adequate income with no late payments or collections over the past year.
5. If You Can’t Afford A Down Payment, Don’t Fret
Along the same lines as the previous tip, don’t be worried if you can’t afford a monthly payment. While most conventional mortgage lenders will require between 5 and 20 percent down, government programs exist that will allow you to put less down. FHA loans, for example, require only a 3.5 percent down payment. Loans issued through the VA or USDA don’t need any down payment whatsoever. The most popular option for people with either a low credit score or not enough of a down payment in savings is the FHA loan. To come up with that 3.5 percent, the FHA also allows you to use a gift from an outside source.
6. Improve Your Credit Score As Much As Possible Before Applying
There are many things you can do to improve your credit score. One of the best things you can do is to reduce the outstanding balances on your credit cards. This lowers your credit utilization ratio, which is the ratio of your credit card balance to your credit card limit. Another way to improve your credit utilization ratio is to request credit limit increases on your cards. Keep in mind that you should not spend more on those cards once the limits have gone up, as this would be self-defeating and undo any positive effect raising the limit had on your score.
7. Have 2 Months’ Worth Of Payments In Your Bank Account When You Apply
Usually lenders want to see at least a couple of months’ worth of mortgage payments in the bank when they approve a loan, so they know you will be on track to repaying the loan. They don’t want to issue loans to people who are barely able to make the first payment and who are entirely draining their savings to qualify for the loan. Banks like to avoid risk, and approving people with insufficient cash reserves is a risk they want to avoid. These cash reserves can also help if you have less than ideal credit, as the lender will factor this into their risk calculations and, therefore, your interest rate.
8. Comparison Shop Mortgage Lenders And Loans
As with any purchase of goods or services, comparison shopping pays. If you accept the first loan you find, you will almost certainly be overpaying. Comparing two or three different lenders and loans could potentially save you over a thousand dollars. Comparing five or more could save you a few thousand!
9. Make Sure You Get The Correct Type Of Home Loan
There are many types of loans, and you should pick the one that is best suited to you and your financial situation. If you are a veteran, for example, it may not make sense to go with anything other than a VA loan because you would be needlessly complicating things by going with a conventional loan. On the other hand, if you are a non-veteran with great credit and a 20 percent down payment, a conventional loan would make perfect sense for you. If you have poor credit and can’t save much for a down payment, applying for a traditional loan may only lead to disappointment, stress, and frustration. Applying for an FHA loan, however, could be just the ticket for you.
10. Have Your Documents In Order When You Apply
Lenders like to see everything organized for them when you apply. If you can present them with all the relevant documents upfront, this will make things go a lot more smoothly for you. Here are some things they like to see:
- Pay stubs
- Bank statements
- W2s for past and present
- Credit report
- List of debts
- List of assets
- Proof of other income
- Signed sales agreement
- Gift letter (if applicable)
- Two years of tax returns
If you have any other tips which might prove helpful to others, feel free to share them in the comments below!