How To Get Approved For Your First Mortgage
Buying a house is the biggest purchase you will make in your lifetime. When you buy your first home you will need a mortgage, which is a large loan provided by a financial institution, which you will pay back over a number of years. Due to the size, and time required to pay back your mortgage, it might seem challenging to receive your first mortgage. This article will guide and outline all the necessary steps needed to get your first mortgage.
First, know all the factors that are considered by the financial institution in order to be approved for a mortgage.
Step 1: Know the Financial Factors a Lender will Consider
The following will explain these factors.
First, the financial institution will look at your monthly income. Usually you will need to provide two weeks worth of pay stubs to prove how much money you make. Ensure you have all financial documents ready for your first mortgage consultation. It can also be helpful to have copies of tax returns, and bank account statements with you.
2. Total Debt Payments
Next, the financial institution will need to know the total sum of all your monthly payments which includes: vehicle loan payments, credit card balance and payments, and student loan payments.
The financial institution will then calculate your debt to income ratio, which is a major calculation that factors in getting approved for a mortgage. The debt to income ratio uses a percentage that measures your total debt compared to your income. This ratio is used to see how much of a mortgage payment you would be able to afford. It is calculated by dividing your total monthly debt payments by your gross monthly income. For example, if your total debt per month is $900 and your monthly income is $5000, you would have a ratio of 18%. Lenders like to see a ratio approximately 30% or lower.
Calculate your approximate debt to income ratio before applying for a mortgage. If you notice that it is high, pay down some of your debt before applying for the mortgage. This is very important as it can be the deciding factor in getting approved or not.
3. Credit Score
Before you apply for a mortgage, it is highly recommended to obtain your credit score, a well as a copy of the credit report. Look over your report for any errors and take note of your credit score.
Your FICO credit score should at least be 680, however financial institutions like to see any score 700 or above. If you have a good credit score, you should have an easier time with being approved for your first mortgage. If your credit score is low, not all hope is lost, as you might still be approved, however you would need a cosigner on the mortgage with you.
If you do not want a cosigner, you can improve your credit score and apply for a mortgage once your score rises.
Do not apply for any new credit for the six months leading up to the time you apply for your mortgage. The loan issuer will see this and get the impression that you are looking for different sources of credit and loans. This is important to know, as it could be a big factor when applying for a mortgage.
4. The Down Payment Amount
One of the considerations your mortgage lender will look at is the down-payment amount you put down on the mortgage.
Having a larger downpayment amount means lower interest payments.
Additionally, a larger down payment may also go a long way to swaying your lender to give you a mortgage, compensating for lower credit, lower income, and other factors.
So make sure you have a good amount saved for a down payment at the time you apply for your mortgage — if you can.
The amount of the down payment varies by the lender, however the range is anywhere between 5% to 25%. Most financial institutions require that you put down at least 10% of the total value of the house. For example, if you plan on buying a $150 000 house, you will need to have $15 000 to pay upfront when you get your mortgage.
However, if you have the money, it is best to put down a 20% down payment, as this will avoid private mortgage insurance, or federal mortgage insurance in the US.
Private mortgage insurance is an extra insurance payment that is required, which protects the lender if you any reason cannot afford to pay your mortgage.
U.S. Federal Housing Administration Mortgage Insurance (FHA Loan)
This is federal insurance loan that follows the same principles as private mortgage insurance. This FHA loan allows individuals to put down a down payment that they originally could not afford.
Both private insurance and FHA insurance can be costly, as the costs range anywhere from 0.5 % to 1.5% of the total value of the house annually. This can result in you paying thousands of dollars on interest, that you would otherwise not to have pay if you put down the 20%.
Before you apply for your mortgage, make sure you already have your desired amount of money saved for the down payment. The higher the down payment, the lower your monthly mortgage payments will be, and it will also save you thousands of dollars of interest over the life of your mortgage. It is important to note that if you do not have a great credit score, a 20% down payment can help overcome the credit score issue, and result in you getting approved or denied for your mortgage. If you have an excellent credit score, it will be easier to be approved with a lower down payment.
Step 2: Have A Mortgage Budget
This is a very important factor to understand before you apply for your first mortgage.
Know how much you can afford to spend on a monthly mortgage payment. Remember to consider that, not only do you have the actual mortgage payment, you will also have house insurance, and property tax to pay.
A standard rule of thumb to take note of is that your monthly housing payment (including taxes, and insurance) shouldn’t take up more then 28% of your total monthly income before taxes.
Knowing these amounts will help you get a picture of how much you can afford when applying for the mortgage.
Furthermore, it is important to realize you have many other expenses that are related to owning a home. You will have to pay a energy bill, hydro bill, cable bills and so on. Before you even apply, factor in these expenses, and ensure that you will have adequate cash flow for these expenses.
Step 3: Applying For A Mortgage
Now that you know all the factors that are considered for a mortgage, it is time to apply. When you begin to shop around for a mortgage, you should first get pre qualified for a mortgage, followed by getting pre-approved for a mortgage.
There is a big difference between these terms, which are explained below:
This is the first step in the approval process of a mortgage. Basically, provide your income, expenses, and total debt to a financial institution, and they will give you the amount of a mortgage that you would qualify for. This process is just to see the amount that you would qualify for, and is not binding, or official in any way. It does not even look at your credit report and score, or the amount of the mortgage payments. However, this should be the first step you take in the approval process as it allows you to discuss your mortgage goals, as well as painting a picture of how much you can afford.
This is the next step in getting approved for your first mortgage, which is a lot more formal and detailed then the prequalified step. Here, you will fill out the actual mortgage application, which sometimes charges a fee. When completing the application, the property sections will be left empty for now, as you do not have a property chosen. Next, once you finished with the application, the lender will then take an in-depth look at your debt to income ratio we talked about earlier in this article, as well as your credit score, and credit report. After this is complete, you will then be given a detailed amount for which you are approved, as well as the interest rate that you will be paying. You will receive in writing a conditional commitment detailing the amount you can you are pre-approved for.
Completing the pre approval process will definitely speed up the process with that lender, as you will already have a lot of the paperwork completed.
Another advantage with the pre-approval process is it can prevent you from losing out on the house you want, as a lot of the financing will already be completed. Once you have find what you believe to be the right house, you will complete the property section of the mortgage application.
Carefully Consider Interest Rates
Interest rates are a very important factor when your are going through the approval process. Generally, the lower the interest rates, the more you will save over the course of your mortgage.
It is a good idea to shop around, even by going online, exploring all the different interest rates offered by the financial institutions.
Factors That Affect Your Interest Rate
- Credit Score — better credit score means lower interest rates
- Home Location — interest rates may change depending on your state
- Home Price & Loan Amount – the larger your loan amount, the more interest you pay
- Downpayment — the higher the downpayment, the lower your interest rate
- Loan Term – shorter loan terms = lower interest but higher payments per month; longer loan terms = higher interest but lower payments per month
- Interest Rate Type – variable or fixed rate
- Loan Type – Conventional, FHA, and VA loans.
These factors all impact your interest rate amount, though some more than others.
One important factor to look for is whether the mortgage term is fixed or variable.
A fixed term is preferred, as the interest rate is locked in for usually a 5 year term without having to worry about the interest rate increasing.
A variable interest rate means the interest will vary based on the prime interest rates. For example,if you are paying a 2.99% interest rate, it could increase to 3.3% costing you more money on interest charges.
However this is a double edged sword, because if the prime rate falls your interest rate would also fall, allowing you to save money.
Overall, it is safer to choose a variable interest rate. Also keep in mind that, many financial institutions will compete with each other, so if there is a lower interest rate at another financial institution, notify your preferred financial institution and they will sometimes match or beat the interest rates.
Putting It Together
Some key tips for getting the cheapest interest rate:
- try to put down a 20 percent down payment for lower interest rates
- choose variable interest rate for a usually better interest rate over time
- Make sure you have good credit when applying — this can really drop your interest rate and save you money
Now that you have this information, you can start looking at houses within your price range and hopefully choose an acceptable mortgage rate option.
Step 4: The Loan Commitment Step (Final Step)
Now that you have a home chosen, we move on to the final step in the mortgage approval process, which is the loan commitment, or the mortgage commitment steps.
This is a legal document from the financial institution, which states that they have been approved you for the mortgage amount specified.
There are two variations of this document, the conditional loan commitment, and the final loan commitment.
1. Conditional loan commitment
Once you are approved, most financial institutions will have a conditional loan commitment, which is only binding if certain conditions are met. For example, it might specify that an appraisal of the property is needed in order to move on on to the loan commitment, as well as a inspection of the house. Once all these conditions are met, then it would be time for the final loan commitment.
2. Final loan commitment
This is the final document, which is a legally binding document that states that the financial institution is obligated to close the loan, based on you making the proper payments. This is a very important document that many real estate agents might require as proof, before they help you search for a home.
The Summary of Steps
- calculate your debt to income ratio to see if you need to pay down more debt, or if you are ready to apply for a mortgage
- retrieve a copy of your credit report, and take note of your credit score, if its low, take the proper steps to increase your credit score
- know approximately how much you will need for a down payment, remember if you don’t have 20% of the amount of the house for a down payment, you will need to get private or Federal mortgage insurance, which will cost you more money
- shop around and look for low, fixed interest rates, compare the rates with other financial institutions
- begin your approval process by getting pre-qualified, allowing you to get a good picture for the amount of a mortgage you can get
- begin looking for houses in your price range based on the information you received in your pre-approval
- continue your approval process by getting pre-approved for your mortgage by filling out a formal mortgage application
- choose a house and finish the property section of your mortgage application
- provide any information needed in the conditional loan commitment in order to receive your final loan commitment
- receive your final loan commitment, which you can show to real estate companies, to prove you are officially approved. Congratulations, you are approved for your first home!