Getting a mortgage is one of the most significant decisions any of us will make. It also represents a huge step toward taking control financially. Owning your own home can be an important springboard to growing your personal wealth. It’s easy to be dazzled by the real estate agent, however, and find yourself overstretched. Just as important is the advice of the mortgage lender, so that you sign up to a schedule that is manageable over the long term. Here’s what you need to know about mortgages and how to get started.
What Is a Mortgage?
The average price of a house sold in the United States is around $382,000, which is not a figure most of us can cover out of savings. Bridging the gap between what we have now and what we want to be in the future is the mortgage lender, bank or credit union. With a mortgage, you take out a loan to cover the cost (referred to as “the principal”) of the property plus interest, and make monthly payments over an agreed term until the balance is cleared. The maximum term for most mortgage lenders is usually 30 years, but usually the term is between 20 and 25 years. With a fixed-rate mortgage, monthly payments remain the same throughout the term of the mortgage, making it easier to plan financially. Given that a mortgage is a sizable, long-term commitment, mortgage lenders need to evaluate a borrower’s financial situation carefully before agreeing to a loan.
First Step: Mortgage Pre-Approval
Before you start touring open houses and scouring property websites, it’s a good idea to have pre-approval on your mortgage. Not only will it give you a clear picture of your budget, but it will also mean you’re ready to launch into action if you do find your dream home. First of all, a lender will make a general assessment (called “pre-qualification”) of your budget and creditworthiness using soft searches on your credit score. The lender will also look at your current spending and income to determine your budget. Ideally your debt-to-income should be 36 percent or lower. Next, your mortgage lender will move to formal pre-approval, gathering key documentation and running hard credit score inquiries. If you meet the lender’s criteria, you will be issued a pre-approval letter — with which you may start house-hunting in earnest.
Getting Approved for a Mortgage
Your loan can be approved in a matter of days if you have an ample credit history, a healthy credit score and all of the necessary documentation, including (according to Investopedia):
- 30 days of pay stubs reflecting most recent and year-to-date income;
- two years of federal tax returns;
- statements for at least two months for all asset accounts, including checking, savings and other investments; and
- two years of W-2 statements.
Most mortgage lenders also require a down payment of at least 20 percent of the property value. If you cannot save this amount or borrow from family, some lenders might be flexible, but they will require you to take private mortgage insurance. With the subprime mortgage crisis in mind, lenders are more reluctant to lend 100 percent of property value.
When the Process Takes Longer
In some cases, you might need to allow more time (weeks or months) to achieve your best possible credit score or to save more toward your down payment. However frustrating it might be, the stronger your financial standing when you apply for the mortgage, the better terms you can get. A little patience pays dividends down the line. Once everything is in place and you have an agreement with the lender, allow two weeks or so for final approval on your mortgage. At this point, you can make an offer on the property.
Future Payments and Obligations
Once your offer is accepted, you can look forward to putting your own personal touches on your home and probably paying less each month than when you were renting. Bear in mind, however, that it is not fully your home until the mortgage is cleared. If you don’t keep up monthly payments, your lender can foreclose on the loan, so it’s important from the outset to be realistic about your budget. Your monthly repayments shouldn’t exceed 28 percent of your monthly gross income and most lenders won’t approve mortgages for those whose debt-to-income ratio (including other payments such as credit cards) is likely to exceed this.
Getting approved for a mortgage is a challenging process, and not one to rush into. It’s always worth doing your research, taking your time to prepare the correct documentation and shopping around for the best lenders. Using a tool such as ScoreMaster can help you achieve your best possible credit score, giving you the power and upper hand in the lending process and enabling you to secure the best deal. It’s a decision that will resonate for 20 or so years — make sure you do it right. Contact us today for a free consultation.
*Legal Disclaimer – ScoreMaster is a patent-pending educational feature simulating credit utilization’s effect on credit scores via payments or spending. Your results may vary and are not guaranteed.