If you're new to the mortgage process, it can be a bit overwhelming. Not only are there many different loans to choose from, but knowing what to expect before you get started can make the difference between a hectic and stressful experience and a smooth closing. With that in mind, here are 15 common mortgage questions asked by first timers, and their answers.
1. Should I get a fixed rate or adjustable rate?
A fixed-rate mortgage means that you'll pay the same interest rate throughout the life of your loan. On the other hand, an adjustable-rate mortgages starts out with a low interest rate for a set period of time (three or five years are common), and then adjusts according to market rates. In a low-rate environment, like we're currently in, it's generally beneficial to lock in a fixed rate, unless you only plan to be in the home for a short period of time.
2. Should I get a 15 year or 30 year mortgage?
Not only will a 15 year mortgage allow you to pay off your home faster, but shorter-term loans generally come with lower interest rates. On the other hand, a 30 year loan will produce the lowest payment, and allow you to afford more "house." It's also worth noting that many lenders offer loans with other durations, such as 10, 20, 25, or 40 years.
3. What is an FHA mortgage?
FHA mortgages are backed by the Federal Housing Administration. Because this reduces the risk to the lender, FHA loans generally have more flexible qualifications than conventional loans in terms of credit, income, and employment requirements, but can also be more expensive.
4. Can I buy a home with no money down?
There are several popular loan programs that don't require a down payment, the most common of which is the VA loan, available to veterans. The USDA offers 0% down financing on homes in certain rural areas, provided that the borrower's income falls under specific limits. And some banks have their own 100% financing programs, but you'll need outstanding credit.
5. Do I need to use a mortgage broker?
A mortgage broker acts as a middleman between you and mortgage lenders, and will search for the best possible loan for you. A mortgage broker doesn't really do anything you can't do on your own, but can save you the time and aggravation associated with loan shopping. Mortgage brokers used to be much more common, but only about 10% of homebuyers use a mortgage broker today.
6. How much house can I afford?
This depends on several factors, but a common rule of thumb is known as the "28/36 rule." Basically, your mortgage payment (including taxes and insurance) shouldn't exceed 28% of your monthly pre-tax income, and your total debt loan including the mortgage shouldn't exceed 36%. Whichever ratio results in the lower mortgage payment is the limiting factor.
7. Do I need a pre-approval or pre-qualification?
A pre-approval is an extensive review of your qualifications, and represents an offer of a loan. On the other hand, a pre-qualification evaluates your income and tells you how much you can afford, but is generally based on information you provide (unverified), and doesn't include a credit check. As a result, a pre-approval carries more weight when you're shopping for a home.
8. What documentation should I gather?
At a minimum, you should gather two months' worth of statements for all of your bank and investment accounts, 30 days' worth of paystubs, your last two W-2s and 1099s, your last two tax returns, your drivers' license, and Social Security card. If you have a divorce decree or bankruptcy papers, your lender will request those as well. Check out this article for a more extensive list of the documentation lenders can ask for.
9. What are "points"?
When it comes to mortgages, "points" are an additional fee you can choose to pay in order to obtain a lower interest rate. If you're planning on living in the house long enough for the savings on your monthly payments to surpass the added expense of the points, it may be a good idea.
10. What are closing costs, and how much should I expect to pay?
There are several expenses that can be included in closing costs, including (but not limited to) appraisal fees, title insurance fees, attorney fees, pre-paid taxes and insurance, and documentation fees. Buyers' closing costs generally add up to 2% to 4% of the loan amount, and can be included in your offer if you don't have the cash to pay them.
11. What is PMI?
PMI stands for private mortgage insurance, and you'll probably have to pay it if your down payment is less than 20% of the home's value. There are some loan programs that don't require PMI, such as VA loans and the 100% financing option from Regions. The cost of PMI can vary, so check with your lender to find out how much to expect.
12. Should I lock my interest rate?
A rate lock is an agreement between you and your lender to honor a certain interest rate for a set period of time -- usually 30, 45, or 60 days. This can protect you in the event that interest rates rise between your application and your closing date, and can be worthwhile when interest rates are low. Some rate locks are free, while some cost a few hundred dollars, so this can determine whether it's worth doing or not.
13. What if I don't have a lengthy employment history?
In general, lenders want to see two years of employment in the same field without any significant breaks. For example, if you're a restaurant manager and you quit one job to go to another restaurant, it probably won't cause you any problems. However, if you leave a restaurant management job to become a teacher, it can reset the clock in the eyes of a lender -- even if you were continuously employed. Another common issue with first-time buyers is a limited employment history due to being in school. With most lenders, having less than two years of employment as a result of attending college is an exception to the rule, and won't hurt your application.
14. Is my credit score good enough?
In order to obtain a conventional loan, you'll generally need a minimum FICO score of 620. For FHA financing, you'll need a score of 580 or higher to qualify for the low down payment option, and you could qualify with an even lower score if you have more money to put down. Many credit card issuers give their customers free FICO scores, so check there first. If not, you can buy your score at websites such as myFICO.com and Experian. Keep in mind that even though your score may be good enough, the best interest rates go to buyers with much higher scores.
15. How many lenders should I talk to?
As many as you want. There is a special provision in the FICO credit scoring formula that allows you to shop around for the lowest mortgage rate. As long as all of your applications take place in a "normal shopping period," say two weeks, it will count as a single credit inquiry for scoring purposes. A small difference in interest rates can save you thousands of dollars over the life of a 30 year mortgage, so it's worth contacting at least a few lenders.
The Foolish bottom line
The mortgage process may seem intimidating at first, but it doesn't need to be. As long as you know your options, what you need to do, and what lenders are looking for, there is no reason the process needs to be stressful.