Mortgages are a necessary evil – no one wants a loan that can be several times higher than their annual income, but houses are expensive and homeownership is the dream of many people. Qualified, prepared buyers have stable incomes and good credit scores, know how much they are willing and able to spend on monthly mortgage payments and home expenses, have saved money for the down payment and closing costs, and have taken regular home maintenance and insurance into account.
What buyers quickly learn, or relearn if they are not first-time homebuyers, is that buying a house is a long process. The house hunting process took an average of 10 weeks in 2018, and getting a mortgage typically takes between 45 and 60 days. Understanding the process of getting a mortgage and coming to the table prepared with all the needed documents will make this part of the homeownership journey less stressful and put you one step closer to that first night in your new home.
Good Credit is King
They say actions speak louder than words. In the mortgage world, your past financial actions are judged by your credit score. Your credit report shows lenders your ability to handle and repay debt. The higher your credit score, the less risky you are to lenders, and the more likely you are to get loans and get better rates. This is critical because just a 0.5 percent increase in the mortgage interest rate will cost you tens of thousands of dollars over the life of the loan.
Credit access tightened significantly after the Great Recession in 2008. Before that crisis, median credit scores for purchased mortgages was 692. After the crisis, they increased over 20 points. A credit score below 620 will typically make obtaining a mortgage more difficult. Below is the breakdown of FICO scores according to Experian, one of the three credit reporting agencies (the other two are Equifax and TransUnion):
- 300-579 = poor (16% of people)
- 580-669 = fair (17% of people)
- 670-739 = good (21% of people)
- 740-799 = very good (25% of people)
- 800-850 = exceptional (21% of people)
A credit report is a snapshot over a certain period of time. Negative events like missed payments, accounts sent to collections, and bankruptcies generally stay on your record for about seven years. But remember, the two biggest influences on your credit score are payment history and debt burden. Common debts are credit card debt, student loan payments, and car payments. Your credit score is positively impacted each time you make monthly debt payments or pay a bill on time. Waiting to house hunt while simultaneously working to raise your credit score could pay big dividends in the form of lower interest rates.
Know Your Options
Most people applying for a mortgage choose either a conventional mortgage that is eventually resold to Fannie Mae and Freddie Mac, or government-backed loan. Since conventional loans are eventually resold to Fannie and Freddie, they must have certain loan terms:
- 20% down payment, or private mortgage interest (PMI) to insure the added risk of the lower down payment
- Terms of 30 years or less.
- No interest-only payments or balloon payments
- Maximum loan amount of $510,400 for 2020
Lenders prefer a debt-to-income ratio (DTI) below 43 percent. Your DTI is your total monthly debt obligations divided by your gross monthly income. Knowing your DTI is important, because a higher DTI could lead to a higher interest rate as you are then considered a riskier lender. A current rule allowing conventional mortgages with a DTI above 43 percent is set to expire in 2021. This will have a big impact on the marketplace, as 16 percent of loans in 2018 were given to borrowers with DTIs above 43 percent.
Lenders also like to see that borrowers are spending no more than 28 percent of gross monthly income on mortgages and associated housing costs (property taxes, mortgage principal and interest, mortgage insurance and homeowners’ insurance). Gross monthly income includes child support, pension income, alimony and bonuses or commissions. Sometimes called the front-end ratio, this ratio does not include other housing expenses like utility or cable bills.
Conventional loans are issued by banks, credit unions or other private lenders. They typically have closing costs of between 2 percent and 5 percent of the home price, unless you use lender credits to lower closing costs. You can apply for a loan directly through a bank, or via a mortgage company or mortgage broker. Own Up is a mortgage technology company. Because we negotiate lower commissions fees, we are offered lower interest rates and pass on the savings to you.
There are three government-backed loan programs that offer more flexible terms for qualified buyers. Instead of PMI, these programs include their own mortgage insurance fees that are advantageous to certain buyers. These are:
- Federal Housing Administration (FHA) loans: These loans, issued by the FHA and the Department of Housing and Urban Development (HUD), have down payments as low as 3.5%, low closing costs and looser credit score requirements, making them popular options for first-time home buyers. PMI rates vary by amount and credit score, but are generally cheaper than FHA mortgage rates for borrowers with good credit (generally described at over 670)
- U.S. Department of Veteran’s Affairs (VA) loans: These loans offer as little as no down payment and looser credit score requirements for military veterans, certain reservists and National Guard members, and surviving spouses of deceased veterans.
- USDA Home Loans: These loans are for people buying homes in rural areas. Terms include lower down payments.Crunching the Numbers
Crunching the Numbers
Buyers need to know how much house they can afford before house hunting or applying for a mortgage. In early December 2019, the median cost of a house was $310,900. At this purchase price, buyers should be prepared for the following costs (this list covers the major costs, but is not all inclusive):
- Down payment of 20%: $62,180
- Closing costs (2% of the purchase price): $6,218
- Ongoing maintenance and repairs (1% a year): $3,109 put aside
- Monthly mortgage payment (20% down, 3.68%, 30-year fixed): $1,142
- Property taxes (varies by state and within a state) equal to 1% of property value: $259 a month
- Homeowner’s insurance: About $100 a month
The Mortgage Application Process
If real estate is location, location, location, applying for a mortgage is paperwork, paperwork, paperwork. Below is a list of documents and information needed:
- Income verification: W-2s for salaried employees for the past two years, 1099s for self-employed individuals, two years of tax returns, two recent pay stubs, name and contact information for employers, tax returns for rental properties and business ownership if applicable
- Asset verification: two months of bank statements, including retirement accounts
- Transactional documents: purchase and sale agreement for the home, copy of earnest money deposit (if any), contact information for all real estate agents involved, 12 months of rent receipts (if applicable)
- Identity verification: social security card, driver’s license, copy of H1-B or permanent resident card (if applicable)
Remember, always shop around for a mortgage and get pre-approved before starting your home buying journey. This shows sellers and real estate agents that you can make a serious offer because you know how much you can afford. While a pre-approval letter is not a guarantee you will be approved for a loan, it means that as of the issue date the lender does not see any impediments to approving you for a loan for that stated amount.
If you work with Own Up, we’ll securely collect your information to source personalized quotes across a range of mortgage types that make sense from our exclusive network of lenders. Using a simple online dashboard, and with the help of an unbiased, expert advisor, we will walk you through your total costs for each different lender and product available to you. This unique shopping experience allows you to easily understand the total costs and tradeoffs between each lender and mortgage type. Because we use technology to streamline the process and we charge lenders in our network lower commissions, our lenders pass those savings on to our clients, which means you get great terms.
If you're thinking about applying for a mortgage or have any questions, click the link below. We'll help you understand every step of the process, and help advise you on the best options for your unique home buying scenario.