For most people, buying a house takes years of planning and preparation. The whole process can be overwhelming, especially for first-time homebuyers. Below we’ll guide you through the steps and important decisions that go into homeownership. When it's over, you could have the keys to your dream house and the biggest investment you make in your lifetime.
1. Check your financial and credit history
Your financial history and credit score affect your overall loan options, and a higher credit score usually will get you a lower interest rate. To avoid any surprises down the road, know what your credit score is before you start the mortgage preapproval process. Most mortgage lenders like to see credit scores in the mid-700s for a conventional home loan, but you might be able to qualify for FHA or other government-backed loans with a lower credit score.
In addition to your credit score, you'll need to figure out your debt-to-income (DTI) ratio — simply divide your total monthly debts by your total monthly income. A lot of lenders don't like to see a potential borrower's DTI above 36 percent, though some will approve loans for borrowers with DTI ratios of up to 43 percent or higher.
You should stay current on all your bills and pay down your credit card balances as much as possible before you start trying to get a mortgage. Lenders expect you to have a solid employment history and enough cash on hand for a down payment. If you're already a homeowner, you might need to buy and sell a house at the same time to have enough liquid assets for a new home.
2. Determine your mortgage budget
When you buy a house, total upfront costs include your down payment, closing costs, various fees and your first month's mortgage payment. A down payment is the amount of money you pay upfront to secure a mortgage. Many buyers put down about 20 percent, but the amount you need to save for a down payment depends on the total price of the home and the type of mortgage loan you get. Keep in mind that if you make a lower down payment you could have to pay an annual private mortgage insurance (PMI) premium. If a portion of your down payment comes from a friend or relative as a cash gift, you'll need to have the funds electronically transferred or provide copies of the checks or a signed gift letter.
3. Put 20% or more down to avoid paying private mortgage insurance
Your maximum monthly mortgage budget should be less than 25 percent of your total household monthly income. For example, if you make $3,000 a month and your spouse makes $2,750, then your total income is $5,750 and your budget for maximum monthly mortgage payments should be $1,438.
Remember that monthly mortgage payments include principal and interest on the loan, plus you'll be responsible for property taxes, mortgage insurance and other expenses, so it's helpful to use an online tool to calculate how much you can afford. Don't forget about all the regular ongoing costs of homeownership, including utilities, furnishings, maintenance, repairs and sometimes homeowners association (HOA) fees.
4. Research mortgage loan options
Your finances and your budget will likely determine the type of mortgage loan that’s best for you. FHA, VA and USDA loans are insured by a government agency and come with lower down payments and more lenient credit score requirements than most conventional loans.
Mortgage interest rates can be either fixed or adjustable. Adjustable-rate mortgages (ARMs) might start with low rates and change over the term of the loan, causing your monthly mortgage payments to fluctuate. Fixed-rate mortgages lock in the same interest rate during the life of the loan. The most common type of home loan is the fixed-rate mortgage — it provides a lower monthly payment for the same loan amount.
The term of the loan is how long you have to pay it off. Most homebuyers get a 15- or 30-year mortgage, but some mortgage lenders offer other terms. A longer loan term will generally mean lower monthly payments. However, a shorter loan term means you'll pay less in interest over the life of the loan.
5. Get preapproved for a mortgage loan
Many sellers require a preapproval letter before they'll accept an offer. Preapproval means your lender has reviewed your financial statements, income records and credit history and then decided you can afford the house. You'll need to provide information relating to your income, assets and personal history, plus a photo ID, Social Security number and tax records. Getting preapproved can take as little as three days or as long as several weeks, and preapprovals are usually valid for up to 90 days.
Preapproval doesn’t guarantee you’ll receive financing from a mortgage lender, but it is a good early step. In fact, it's sometimes risky to look at houses before getting preapproved because sellers might not take you seriously. Also, in many housing markets, you have to act quickly when you find an affordable house in a nice neighborhood.
6. Find your house
After you're preapproved, it's time to look for your new home. A good place to start is a real estate website. As you compare one house against another, it's often worth it to drive through the neighborhood at different times to see what traffic and neighbor interactions are like. Consider your daily commute. Don't forget to check neighborhood crime stats and school ratings if you have children.
Remember to think about the monthly payments rather than just the total loan amount, and don't try to buy more house than you can afford. Keep in mind that you don't have to take out a massive loan just because you qualify for one.
7. Compare mortgage lenders
To get the best possible rate on your mortgage, you should compare Loan Estimates from at least three potential mortgage lenders. There usually isn't a fee to get a Loan Estimate, but some banks might charge $15 to $50 to pull your credit report as part of the application process. Review the loan amount, interest rate, projected monthly payments and origination fee information provided with each mortgage Loan Estimate you receive.
8. Submit your mortgage application
If you're already preapproved, the steps to complete a mortgage application are similar to those in the preapproval process, but this time it really counts. When you submit your mortgage application, your loan officer will deliver a file with all your financial information to an underwriter. No matter what kind of mortgage you apply for, underwriting is often the most stressful part of the process. Approval takes anywhere from a few days to several weeks but can be delayed if there’s even a single missing document.
The underwriter first evaluates your credit and job histories, debts, assets, income and savings to determine how likely you are to repay the loan. Then they’ll do a home survey to record the legal property lines of the house, and a title search company will verify there aren't any liens, claims, judgments or unpaid taxes or dues on the property already before providing insurance. Next, an appraisal will confirm the value of the house matches the amount you're asking to borrow. Finally, if everything checks out, the mortgage will be approved and you can start preparing for closing.
9. Prepare for closing
After you've been officially approved for the loan to get the house you want, you're in the homestretch. There's not much for you to do but get ready for closing day as you wait:
- Request and review closing documents. You’re legally required to receive your closing disclosure at least three business days before closing on a house. Your closing disclosure lists all the final terms of the mortgage loan, total closing costs and other details of the final transaction. You'll want plenty of time to review all contractual documents, including:
- Promissory note: The legal document that requires you to repay your mortgage loan.
- Deed of Trust: Sometimes called the mortgage or security instrument, this document gives your lender the legal right to foreclose on the property if you stop making payments on it.
- Initial Escrow Disclosure: This specifies charges you’re obligated to pay into escrow, including insurance premiums and estimated taxes, each month as part of your mortgage agreement.
- Decide if you want to pay upfront or use discount points. Mortgage points, or discount points, are fees that you pay to your lender directly at closing to lower your interest rate. One mortgage point is equal to one percent of your loan amount, so one discount point on a $200,000 mortgage is $2,000. Figure out how long it’ll take you to break even by dividing the cost of your points by how much you'll save each month. If you plan on staying in your home for longer than this period, then it's worth paying the upfront discount points to save over the life of your loan.
- Find out if you're eligible for a homebuyer rebate. Also known as a commission rebate, a homebuyer rebate is available in some states for up to 1 percent of a home's selling price. The rebate comes from the agent's commission, so see if your agent is willing to provide this rebate at closing. It's worth asking about if you're not sure — on a $300,000 house, the rebate can be up to $3,000.
- The final walk-through. The final walk-through is usually done within 24 hours before your scheduled closing. Hopefully there aren't any surprises at this point, as you confirm the previous owner has moved out and double-check that the property is in the condition you and the seller previously agreed upon.
10. Close on your house
Closing is the final step in financing any property. Sometimes called settlement, closing is when you sign all the documents that officially complete the mortgage loan transaction. You should be prepared to pay 2 to 5 percent of the total price of the property in closing costs and fees and possibly more if you require private mortgage insurance (PMI).
Be sure to bring your home inspection reports, a copy of your contract with the seller and any other paperwork your lender requires to approve your mortgage, a government-issued photo ID and proof of homeowners insurance.
Your loan officer, real estate agent, closing agent and an attorney could be present, as well as the seller, the seller's real estate agent and attorney and a title company representative. It's likely you’ll never have this group of people in the same room at the same time again, so now is the time to ask any questions you have. Remember that you should understand 100 percent of every document you sign. It's not too late to back out at closing if something doesn't feel quite right.
Bottom line: What do I need to get a mortgage?
To get a mortgage, you really just need a good credit score, your finances in order, enough savings to cover the upfront costs and a good loan officer. Be sure to spend enough time researching your mortgage loan options, and don't be afraid to ask questions when you don't understand something.
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