Mortgages don’t have to be a mystery. The process should be a simple step that gets you closer to home.
Unless you’re one of the few home buyers who plans to make an all-cash offer, applying for a mortgage is definitely in your future.
But don’t stress, a mortgage is basically a loan. To help guide you through, we’ve broken down all of the most important pieces of the process. Take a deep breath, read on and then get back to planning for your perfect home.
1. Start with the down payment.
As painful as it might be to pull together a hefty down payment, the amount you lay out initially will determine how much you need to borrow. While most lenders are looking for 20 percent down, the minimum requirement is 3.5 percent. Remember that if you put down less than 20 percent, you’ll need to factor mortgage insurance into the cost of your monthly mortgage payments (it could cost between .5% and 5% of the loan amount).
2. Get pre-approved vs. pre-qualified.
If you’ve already started house hunting, you may have heard the terms pre-qualified and pre-approved used interchangeably, which of course, is totally confusing. Let’s break it down. Being pre-qualified is an estimate. Based on some information you share verbally (income, existing debts, credit score), a lender can tell you how much you’ll probably be able to borrow. This will help give you a sense of your price range before you start shopping.
Pre-approval is the same process, but with the documentation to validate the information you give the bank—meaning the borrower and lender both can have more confidence in the estimate. Most sellers won’t accept an offer from someone who hasn’t been pre-approved. Take this step as soon as possible so you can make an offer on the home you love once you find it.
3. What you qualify for isn’t always the same as what you can afford.
When it comes to mortgages, most banks will issue a loan using the 30 percent rule—a benchmark that assumes 30 percent of a borrower’s monthly gross income will go towards their housing costs. But just because you qualify for a certain sum doesn’t mean you should accept the full amount. Buying a house shouldn’t back you into a corner financially.
It’s important for people to evaluate their total housing expenses and make sure that they feel comfortable with their monthly output, especially if they want to achieve other goals, like save for retirement,” says Bungalo Mortgage Expert Berenice Perez.
Start by making a budget that factors in the mortgage payment and projected housing upkeep expenses (~1 percent per year of your home’s value) and your goals, to decide on what kind of mortgage payment you can afford.
4. You have some repayment options.
Mortgage repayment plans are pretty standard, but you have some options here, so it’s worth taking a closer look:
First, you need to choose the term: how many years it will take to pay down the loan balance (including interest). Your can choose short-term (~15 years) or long-term (~30 years). With a short term loan, your payments are much higher but you pay less interest overall. With long-term, you have more financial flexibility because your monthly payments are lower.
Second, you can choose a fixed or adjustable interest rate. While the interest rate itself is determined by the market, a fixed-rate mortgage is a safer bet because the rate at the time of signing will never change—and neither will your monthly payments. With an adjustable-rate mortgage, the interest rates start out lower than average (usually for the first 5-10 years), but can change over remainder of the mortgage (often, increasing). You might be able to save money on interest in those early years, but there will be variability and unpredictability in those payments in the later years of the loan that could make it just as costly as a fixed-rate option.
The most common—for the purposes of financial flexibility and stability—is the 30-year, fixed rate mortgage.
5. More choices: FHA vs. conventional loans.
The “conventional” of conventional loan simply means not insured by a government agency. You’ll probably want to opt for a conventional loan if you can afford a down payment of at least 5 percent and you have a good credit score (620 or more). If not, the Federal Housing Administration (FHA) accepts credit scores as low as 580, down payments as low as 3.5 percent and offer lower interest rates. First-time home buyers often opt for the FHA loan because it requires less money up-front.
FHA loans aren’t always less expensive than conventional loans, though, because of the mortgage insurance premium attached. Depending on the loan terms, an FHA loan can wind up being just as expensive as a conventional loan because it requires both an up-front insurance payment (1.75 percent of the loan amount) and annual insurance payments for 11 years or, more often, for the life of the loan. As of 2013, to remove the mortgage insurance premium, you’ll need to refinance to a conventional loan.
6. Bigger banks don’t necessarily make better lenders.
Though it’s tempting to opt for bigger, more established financial institutions when choosing a lender, shop around. Today the difference in rate and cost between lenders isn’t as significant as it used to be, so it makes sense to prioritize service, as well.
It’s a very stressful transaction, so look for someone that can spend more time with you and give you peace of mind,” Perez says.