When you buy a home, you’ll probably pay part of the purchase price, called the down payment, in cash, and use a mortgage loan to provide the rest of money you need to finalize, or close, the purchase.
You can apply for a mortgage loan from a bank, credit union, mortgage bank — also called a mortgage loan company — or other financial services company.
Before you apply, you should check your credit report so that you know about any potential credit problems. You might also want to purchase your credit score, since lenders use that information as an important part of evaluating the risk you pose as a borrower. Ask the lenders you talk with about which credit score they use, and buy that one.
It’s smart to shop around to find the lowest annual percentage rate (APR) for the term, or length, of the mortgage you want. If you already have an account with a potential lender, you may want to check there to see if you would be eligible for a preferred rate.
A WORD OF WARNING
In some cases you may not qualify for the lowest rate that a lender is offering. This may happen if your down payment is less than 20% of the purchase price, your credit score is lower than the lender’s cut-off, the loan you want is very large, or certain other reasons. If the rate you’re offered is higher than the rate the lender is advertising or that you expected based on average current rates, ask for an explanation. You may want to look elsewhere for your loan or make a complaint if you think discrimination is a factor.
WHAT LENDERS WANT TO SEE
Lenders evaluate, or underwrite, your application to see if you’re a good risk. Though there may be some flexibility, in general what they want to see is:
- No more than 28% of your total income needed to pay principal, interest, homeowners insurance, and property taxes (known as PITI)
- A strong credit history, without late payments or defaults
- A debt-to-income (DTI) ratio of no more than 36%, which means that you need no more than 36% your total income to pay your mortgage plus your other debts
- A history of regular employment at a full-time job
THE BIG THREE
You may hear the criteria that lenders look at in evaluating your application for a mortgage loan described as the big three.
Capacity is your ability to keep up with the payments that your loan contract requires, have enough cash for the down payment and closing costs, and still have assets in reserve. In general, capacity depends on your current monthly income, your investment assets, and your other financial obligations.
Collateral is the value of the property that you plan to buy. A lender requires that it be worth at least as much as you are borrowing to buy it. To make that judgment, the lender hires a professional appraiser to evaluate its value both on its own merits and in relation to comparable properties.
Credit, expressed as a credit score, measures whether you have regularly paid the type of bills that a credit reporting company tracks, including other loans and credit or charge cards. Some lenders may use information on your rent and utility payments, cell phone contracts, and other contractual spending to evaluate the risk you pose. This is known as alternative documentation.
The customary approach to applying for a mortgage is to wait until you find the home you want to buy and then go looking for a lender. But you may want to investigate preapproval. This means you apply for a mortgage loan before you have settled on a property. If you’re successful, the lender will let you know how much you can borrow and confirm that the money will be available.
Preapproval is probably a good idea if you’re serious about buying since you can shop with more confidence if you know how much you can afford to spend. It’s also possible that it will make you a more attractive buyer, as the seller can be confident that the deal will go through. But there are fees involved, as there are with any loan application, so you don’t want to take this step until you’re serious.
Another approach is to seek prequalification. In this case, a mortgage lender confirms that you will probably be approved but does not make a commitment to lend.
THE WAITING GAME
Within three days of applying for a mortgage loan you should be mailed a good faith estimate (GFE) of what the closing or settlement fees will cost you if you use that lender. On average, these costs are between 3% and 5% of the purchase price, though they may be higher in some areas. In addition, you’ll receive a Truth in Lending (TIL) form that states the APR and other details about your costs.
You may want to apply to two or perhaps three lenders and use the GFE and TIL forms they provide to compare the offers. Remember, though, that these are estimates and the charges they quote could change at the actual closing.
It can take up to 30 days after you’ve submitted a completed application to get an answer from a lender, though the wait may be shorter. If you’re approved, you’ll get a written commitment letter stating the terms of the loan agreement and how long you have to set a closing date.
If your application is successful, you should try to lock in the rate that’s available at the time, with the understanding that if rates drop you’ll actually finalize the purchase at the lower rate. Some lenders charge a fee for a lock-in. That’s something you can ask when you do your initial research.
SETTLING THE DEAL
When the sale is finalized and just before you become the owner of the property, you’ll receive a settlement statement or closing statement officially known as HUD-1. In most cases, you have the right to see the document one business day before the closing to be sure there are no errors or unexpected costs. You should compare this document with your GFE and be sure to ask for an explanation of any differences that will cost you more than you expected.
IF YOU’RE TURNED DOWN
If your application is turned down, there are a number of steps you can take.
- You might look for a different lender, as loan criteria do vary.
- You might ask the seller to reduce the price so that you have to borrow less. That may not work in a strong real estate market, but may be more successful if properties are selling slowly.
- Or you might decide to look for a less expensive home that will still meet your needs.