A mortgage is one of the largest investments you will make during your lifetime so it is important that you make this decision with care. Before you jump in headfirst when you find a home you absolutely love, you should take the time to do these 10 things before you apply for a mortgage so that you are fully prepared for home ownership in the future.
Know your Credit Score
The more informed you are going into the mortgage process, the less stressful it will be for you. This starts with knowing your credit score. When you know what your credit report shows you will have a general idea of what you qualify for in terms of mortgage programs. For example, if you have perfect credit with no late payments and a low credit utilization rate, chances are you will not have to pay high origination fees or many discount points in order to get an affordable interest rate.
Unless you take a look at your credit report ahead of time, though, you will not know what it reports. In some cases, there could be mistakes reporting on your report, showing your credit in a negative light even if that is not correct. It is to your benefit to know exactly what your credit report shows and to determine if it is accurate so that you know exactly what you should qualify to receive.
Fix your Credit Score
Once you look at your credit score/credit history, you might find that you have to fix your credit score slightly. This is the number one reason it is a good idea to pull your credit score well before you are ready to shop for a home. If you have a low score, typically lower than 680, you will have a harder time finding a mortgage. If you do find one, chances are you will pay higher interest rates and fees as a result of the risk you provide the lender.
When you know ahead of time that you have late payments reporting; have collections, or have too much outstanding debt, you can start to fix the situation. It does not take too terribly long to fix your credit score and even a few minor changes can help to better your credit history. The earlier you start on this process, the better off you will be in the long run.
Start Gathering your Income Information
You will need to provide the lender with plenty of information regarding your income in order to apply for a mortgage. Before you apply, gather your W-2s from the last two years and your most current paystubs that cover the last month of your employment. If you are self-employed, you will also need to provide your last two years’ worth of tax returns.
If you have a unique circumstance, such as you changed jobs within the last 2 years, you had an employment gap, or you received a promotion recently, you will need to provide letters of explanation regarding your unique circumstances as well as plenty of proof showing the history of events that led up to your circumstances. Generally, the more paperwork you have to prove your situation, the better off you will be when you apply.
Saving money is a given when you want to apply for a mortgage. The more money you have for a down payment, the better off your chances of getting approved will be. Not every program requires a 20 percent down payment, but the more money you have to put down, the lower risk you pose to the lender.
You will also have to save for closing costs on the loan, as every mortgage has closing costs. The amount you will need depends on the lender you use as well as the program you qualify to receive. There are ways to negotiate the closing costs including taking a slightly higher rate so the lender will pay the costs or negotiating with the seller to get them paid too.
Understand your Options
There are a great number of mortgage programs available out there, so do not jump at the first one you hear about. Evaluate all of your options including FHA, VA, USDA, and conventional financing. For example, if you are a veteran, start with the VA financing. If you only have a little bit of money to put down and will be moving into a rural area, look into USDA financing. You have to evaluate your circumstances to determine which program would be the best fit or talk to a lender about the options available to you.
Lower your Debt Ratio
Your debt ratio can be the determining factor in your ability to obtain a mortgage. If your debt ratio is too high, which for the new Qualified Mortgage Rules means 43% on the back end. This 43% must include all of your debts, such as the new mortgage, taxes, and insurance payments along with any monthly payments you have on a regular basis including credit cards, student loans, and car loans. If your debt ratio is above that 43% ratio, start getting things paid off now so you can get it lowered.
Determine what you can Afford
What you can afford on paper and in reality are two different things. You do not have to take a mortgage for the full amount that you qualify to receive if you are not comfortable with it. Before you start crunching numbers and shopping for houses, determine how much you want your mortgage payment to be and then work around that. If you do it the other way around you could wind up taking on a mortgage that you are not comfortable affording every month simply because you fell in love with a house that was too expensive for you.
Choose a Few Lenders Before you Apply
Typically, if you apply for the same type of financing within a short amount of time, your credit score is not dinged multiple times for the inquiries. However, this does not mean you should apply with a large number of lenders. Before you apply, choose 3 to 5 lenders that look like they would have the programs that will fit your needs and stick with them. The key is to do your research before you start the application process – each lender has their own specialties as well as their own reputations. When you know which ones you are most comfortable with, you can limit your applications and the hit that your credit score takes.
Even the most knowledgeable person in regards to the mortgage process does not know for sure what they qualify to receive. The only way you will know is to get pre-approved for the specific program you want to use. Once you know the general lenders you want to use, what you can afford, and the general price range of the house you wish to purchase, you can go through the pre-approval process. This simply means you fill out an application and provide the lender with all of the pertinent details surrounding your ability to qualify for the mortgage. The lender will provide you with a pre-approval letter which you can then use as you shop for a home.
Shop for a Home
Of course, the final thing that you will do, which might be the most fun is shop for a home! You can do this before you apply for a mortgage because you will need to know how much you need to get approved for. If you are already preapproved, you will have a general idea of where you need to be in terms of your budget, which will help you stay focused and not fall in love with a home you cannot afford.
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.