The Road to Homeownership
The Basics
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Chapter 3: Getting a Mortgage

When to apply
Some people wait until after they make an offer on a home to get approved for a mortgage, but it is best to do it beforehand. Why?

  • It lets sellers know you are a serious buyer. Many sellers will not consider offers from those without pre-approval.

  • It gives you a limit as to what homes to look at. Why put an offer on a house that would require a $500,000 mortgage if you can only get a $300,000 mortgage?

  • You do not have to rush to find financing after your offer is accepted.

A lender can either pre-qualify you or pre-approve you. With pre-qualification, you are given an estimate of what you can afford. It is not a guarantee. When you are pre-approved, you get a commitment from the lender to provide a mortgage for up to a specific amount, barring any major financial changes or problems with the house. If you are just starting to look and not sure when you are going to buy, getting pre-qualified is sufficient. However, once your home search turns serious, it is a good idea to get pre-approved. The pre-approval typically lasts for 60-90 days.

Finding a lender

Applying at financial institutions where you already have a pre-existing relationship is often a good place to start. Some lenders let you apply for a mortgage on-line, but if you have questions, you may want to apply in person with a loan officer. Be careful with whom you choose. Most lenders are honest and legitimate, but there are some who are not. Avoid lenders who ask you to falsify information, sign blank documents, ignore your questions and concerns, or put excessive pressure on you.

Application criteria

Lenders consider many factors when deciding whether or not to approve a loan and how much to approve you for. They typically include:

  • Your credit score: As discussed previously, many lenders require a score of at least 680 for approval and mid 700s for the best interest rate.

  • The down payment amount and your other assets: Lenders typically set a maximum allowable loan to value ratio, which measures how much of the home purchase can be financed through the mortgage. For example, if a lender sets a 95% loan to value ratio, the loan cannot be for more than 95% of the purchase price of the house, meaning you need a down payment of at least 5%. Aside from the money for the down payment, most lenders like to see that you have additional assets that can be used to pay the mortgage in case of emergencies.

  • Your employment history: In order to know that you are capable of handling a mortgage, lenders usually want to see a stable employment history (at least two years of consistent employment in the same field).

  • Your income: Traditionally, lenders have required that the mortgage payments, including taxes and insurance, not exceed 28-33% of your gross income. This is called the housing expense or front ratio. However, in recent years, many lenders have raised that ratio. You will likely have to provide two years worth of Form W-2s and/or paystubs to document your employment and income. If you are self-employed, you usually need to provide two years worth of tax returns and balance sheets.

  • Your existing debt: Many lenders require that your existing debt payments plus your mortgage payment not exceed 36-38% of your gross income, although some allow a higher percentage. This is called the total debt or back ratio.

After collecting the necessary information, the lender will approve the loan or deny it. Many lenders use an automatic, computerized system and can tell you right away if your loan is approved. With other lenders, a person makes the decision, and you may have to wait a few days or weeks before hearing back. If the loan is denied, the lender is required to tell you the reason why. You will probably be disappointed, but use the feedback provided to make changes. If the loan is approved, the lender will tell you the amount you can borrow.

Within three business days of receiving your loan application, the lender must give you a Truth in Lending Statement, which shows the amount financed (borrowed), annual percentage rate (yearly cost of the loan expressed as a percentage), finance charge (total cost of the loan expressed as a dollar amount), total amount that will be paid back over the life of the loan, number of payments, payment amount, late payment policy, and if there is a prepayment penalty. Be sure to read the statement carefully, and ask for clarification from the lender if you have any questions.

Examining your budget

If the lender approves you for a $350,000 mortgage, that means you can afford a $350,000 mortgage, right? Not necessarily. Lenders typically only look at a few factors, namely your income, debt, and down payment. However, you have more expenses than your debt. If you have to pay $1,000 a month in daycare, that reduces the money you have available for your mortgage. While your income and expenses can change after the home purchase (for example, net income often increases due to the tax benefits of owning a home, and utilities often increase too since houses tend to be larger than apartments), creating a budget gives you a better idea of what you can afford to spend than just basing it on a pre-approval amount. Subtract your expenses (minus what you are spending now for rent) from your income to get an estimate of the monthly payment you can afford. Don’t forget that you will have to pay property taxes and homeowners insurance.

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