Taking on a mortgage loan should involve more than using a mortgage calculator to figure out whether you can afford the monthly mortgage payment. That matters, of course, but you also need to consider:
Getting a mortgage takes a lot of work, and it’s important to have some basic things in order before you start the process.
It’s important to know the different kinds of mortgages. For example, there are two common loan terms:
And there are two common types of interest:
You can get a 30-year fixed-rate loan, a 15-year adjustable-rate loan, or any other combination.
Adjustable-rate mortgages can be risky and generally make more sense when you intend to sell the property quickly. A 15-year loan, which is less common, can be tempting, but it means higher monthly payments.
And, of course, there are many different loan amounts, based on your down payment and the price of the house.
In most cases, there's no penalty for paying your loan off in less time than the standard term. You save a lot of money in interest, too. With a mortgage loan, you pay interest for each day you take to pay the loan off. Paying down the principal ahead of time will save you money in the long run.
If you make extra payments, tell your mortgage lender that you want the money applied to the principal balance. You might think the lender should know this, but it’s best to be careful.
People often make one extra payment per year to shorten the life of their loan. One way to do that is to make your payment every two weeks instead of once a month. This results in 13 full payments, rather than 12, in a year. Consult your mortgage lender to figure out the best way to make this happen.
Getting a mortgage loan can be daunting, but it helps to break it down into some basic steps:
That seems like a simple list, but it can get complicated. Don’t let that scare you away. Many people with less-than-perfect finances and mediocre (or even bad) credit can find a financial institution willing to extend them a mortgage loan.
Many people don’t have a clear picture of their finances. That might be because you’re making so much money you don’t have to consider it -- but it's probably because nothing ever forced you to take a hard look.
Before you apply for a mortgage, audit your finances. Look at your income, your fixed costs (car loan, student loan, utilities, rent, food, and anything else you have to pay every month), and your discretionary budget. Once you've done that, you can see if you can follow the unofficial 28/36 rule.
Banks and other financial institutions want your mortgage loan payment to be no more than 28% of your gross monthly income. All of your debts together shouldn't exceed 36%. This isn’t a hard-and-fast rule, but it’s a good guideline as to what you can afford.
You may want to examine what debts with monthly bills you can pay off to improve your financial situation. Paying off a car loan or student loans will improve your standing. Paying off credit card debt will do that, too -- and should raise your credit score (sometimes by a lot).
It may make sense to put off buying a home until you can get your finances in decent shape. This can include paying off debt, saving up for a down payment, or increasing the length of time you've spent in a job (lenders generally want to see two years of salary and employment history).
Your income is important, but even with a solid down payment and a high-paying job, your credit score can keep you from getting an affordable loan. It's important to know the numbers and do as much as you can to raise your score.
Here are some guidelines on how your credit score ranks:
If you want to improve your credit score, it helps to know how it's calculated:
Try not to open new credit card accounts or take out any loans for as long as possible before applying for a mortgage.
There's one major exception: If you don’t have much available credit, adding a new card with a high limit can raise your score by lowering your credit utilization ratio.
This ratio looks at the percentage of available credit you're using. You can lower that number by taking on more credit or paying down existing cards. It's good to get your utilization below 30%, but lenders also consider how much you owe compared to your income. To get a mortgage, it’s best to owe $0.
To figure out the best credit moves for you, try a credit simulator tool. Some mortgage brokers can also look at your application and credit report to see if adding a card makes sense for you or whether paying down balances is a better choice.
Your principal and interest payment is only part of what you'll pay. In most cases, your payment includes an escrow for property taxes and insurance. That means the mortgage company collects the money from you, holds onto it, and makes the appropriate payments when the time comes.
Lenders do that to protect themselves. Financial institutions want the first claim on selling your house if you fall behind on payments. If you don't pay property taxes, the government will have a claim on some of the home's value. That can make things complicated.
Mortgage lenders often make buyers who don’t make a 20% down payment pay for private mortgage insurance (PMI). This is insurance that helps the bank get its money if you can’t afford to pay. It doesn't benefit you in any way.
If you can avoid PMI, do so. It can be hard to get a lender to remove it even if you have 20% equity. There’s no rule saying they have to and sometimes they will only if a new appraisal (an added cost to you) shows that you've hit that mark. You can also refinance when you get to 20%, but that can be expensive, as well.
The last cost to consider is closing costs. These are an array of taxes, fees, and other assorted payments. Your mortgage lender should provide you with a good-faith estimate of what your closing costs will be. It's an estimate because costs change based on when you close.
Once you find a house and begin negotiating to purchase it, you can ask the current owner about property taxes, utility bills, and any homeowners association fees. Even if you get the actual bills, your numbers will vary. But it’s important to learn as much as you can about the real cost of owning the property.
Once you have a sense of your personal finances, you should know how much you can afford to spend. At that point, it may be time to get a pre-approval from a mortgage lender. This is a letter from a lender that says, based on what it has seen, it would approve you for a mortgage.
This isn’t a real approval, though it’s still important. It’s not as good as being a cash buyer, but it shows sellers that you have a good chance of being approved.
You don’t need to use the mortgage company that offered you a pre-approval for your loan. This is just a tool to make any offers you make more attractive to sellers.
In a competitive market, sellers may get multiple offers. Being the highest offer helps, but that’s not the only factor a seller considers. The seller also wants to be confident that you'll be able to get a loan and close the sale. A pre-approval isn't a guarantee of that, but it does mean it’s more likely. If you have a pre-approval and someone else making an offer doesn't, you may have your offer accepted over theirs.
Mortgage lending is a crowded, competitive space. Because of that, don’t automatically go with the bank you have your checking account at or the lender your real estate agent suggests. Get multiple offers and see which lender offers the best rate, terms, and closing costs.
The easiest way to do that is to use an online service that brings back multiple offers or to use a broker who does the same. In some cases, a broker will know many of the companies making offers and can let you know which ones are easier to work with than others.
If you have problems in your mortgage application -- like a low credit score or a minimal down payment -- a broker might help you find a sympathetic bank. In those cases, you may also want to talk to credit unions, especially if you've been a long-term member of one. They sometimes have looser standards than traditional banks do.
A good mortgage broker should be able to find out if you qualify for any government programs and explain to you which type of mortgage is best for you.
The last piece of the mortgage loan process is the home itself. Your lender can’t approve a loan without knowing the details of the house you plan to buy. Once you find a home, make an offer, and have your offer accepted, the approval process begins.
This is where you'll need all of the paperwork mentioned above. You'll need your most-recent pay stubs. Let your employer know that your potential lender may contact the company to verify your employment, too.
The mortgage lender will also order an appraisal. An appraisal sets the value for the home in the eyes of the mortgage lender. It doesn't matter what you’re planning to pay for the property. The important factor is the value the appraiser assigns.
In recent years, appraisals have gotten more pessimistic. Lenders don’t want to loan you money they can’t recoup, so if the appraisal values the home below what you're paying, your lender may want a larger down payment.
On top of the appraisal, you'll also have a home inspection. This protects both you and the mortgage lender. In most cases, you'll hire an inspector (though your lender or real estate agent can suggest one). Find someone with good reviews and accompany them while they inspect the property.
A good inspector will notice things you don’t. Maybe they see signs of past water damage or think the roof needs to be repaired. While the inspector is doing his or her work, you also want to check on some basic things:
That’s not an exhaustive list, and the inspector may check some of those things. Go into the inspection with a critical eye. If minor things are wrong, you may be able to get the current owner to fix them. When something major pops up, your mortgage lender may insist that changes are made or that the price is lowered.
You’re not looking to be a jerk here. The goal is to identify things that are truly wrong and address them. Don't let your excitement about buying the home cause you to overlook things that should be repaired or replaced.
Assuming you find a home and get it appraised and inspected, it’s time to close the loan.
When you've found a home, placed it under contract, and received a mortgage commitment -- a promise to lend you the money -- from your lender, it’s time to close the loan. But there are a few things you need to do first.
Do a walkthrough of the property once the current owner has moved out (or mostly moved out). Make sure any required repairs were completed and that no new damage was done during the move. It’s not fun to ask for compensation for damage or incomplete repairs at closing, but you should if something's wrong.
Before the closing, check in with your lender to make sure you have everything that’s needed with you. You don’t want to get to the closing and learn that your lender wants to see a current pay stub or bank record.
It’s also very important to check over the closing statement. Your real estate agent can explain where it’s different from the estimate and why. In many cases, you'll pay interest on the loan based on the number of days left in the month and you may have some other full or prorated charges.
Here's the last thing: Don't do anything before your closing that changes your financial situation. Don’t open a new credit card, buy a car, or spend a significant amount of money. You don’t want your credit score to fall or your lender to change its mind at the last minute.
Once you close your mortgage loan -- which generally involves a lot of signatures -- it’s time to take a minute to congratulate yourself. Buying a home isn’t easy and it’s almost certainly the biggest purchase you'll ever make. That deserves a bit of celebration -- even if you still face the challenges of moving into and getting settled in your new home.