For many people, the most daunting part of the homebuying process isn't finding the right house. It's getting a mortgage.
It's easy to understand why that's the case. Asking a bank or other financial institution to lend you hundreds of thousands of dollars isn't something most people do very often. In fact, for many Americans, buying a home represents their biggest-ever purchase and the most they will borrow.
That makes buying a house a rare event for most people -- something that happens once or only a few times in a lifetime. It's therefore understandable that many homebuyers aren't prepared for the mortgage process.
Still, even if you've never gotten a mortgage before, it's not that hard to make the whole endeavor less miserable. By making some simple moves before you apply, you can take some of the pain away.
1. Start early
When a lender looks at your creditworthiness for a mortgage loan, time matters. If you can start paying down debt well before you apply and pay off things like car loans, that can help.
Lenders approve loans at least partly based on your debt-to-income ratio. That's how much debt you have compared with how much income you have coming in. In general, a lender doesn't want to see this ratio go over 43%, according to the United States Consumer Financial Protection Bureau, but lower is better.
Paying off a credit card or eliminating another term loan will improve your ratio. That could increase how much you can borrow as well as improve your chances of getting an approval.
2. Know your credit
Your credit score will also affect whether you get approved. Scores, which go from 300 to 850, are derived from how you use credit and how you pay your bills. There are three major credit bureaus: Equifax, Experian, and TransUnion. Each uses slightly different criteria, so your numbers with each won't be the same, but this is the rough breakdown of how your score is determined.
- Payment history (35%).
- Amounts owed (30%).
- Length of credit history (15%).
- New credit (10%).
- Credit mix (10%).
3. Fix your credit
Only some parts of your credit can be fixed in the short term. The big one you can have an impact on is amounts owed. Pay off your balances in full, and your score will go up.
In addition, avoid opening new accounts or doing anything that triggers a credit check during the mortgage application process. A new account can hurt you, because lenders don't want to see a customer have too much available credit, as that lets them run up debt -- which could interfere with the ability to pay their mortgage.
4. Know how much you can borrow
In a broad sense, mortgage lenders use the 28/36 rule. That means your total mortgage payment, including taxes and insurance, shouldn't exceed 28% of your pre-tax income, while your total debt shouldn't exceed 36%. That's not a hard and fast number, but it's the basic guideline most lenders use.
5. Have your paperwork in order
Most mortgage lenders will want to see the two most recent pay stubs, two years of taxes, and at least 90 days of bank account statements for anyone on the mortgage. In many cases, they will also want to see documentation of any investments and retirement accounts.
Put this package together before you start applying, and update it as you go. You should also remember that your lender may ask for bank statements and pay stubs after an approval has been granted but before the loan has closed.
6. Be ready to defend your finances
Your lender will almost certainly ask about any income that shows in your bank account that your pay stubs don't explain. If you, for example, got a large gift from a family member to help with a down payment, you may have to fill out paperwork, and get your relative to sign, documenting that it's not a loan.
You'll also have to explain everything from a work bonus to a scratch-card win if the amount looks at all suspicious. Basically, your lender wants to make sure the financial picture you present reflects reality.