Buying a Home Step 1: Shop for a Mortgage Loan

Highlights

  • Get a loan before you look for a house.
  • Pre-qualify so that you can move quickly.
  • Mortgage shopping online can save you time and help you find a great rate.
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6 Factors to Consider When Shopping for a Mortgage

Before you begin looking for a home you may need to ask yourself: “How much can I pay for a house and still have a life?” You do not have to figure this out on your own. Consider getting pre-loan counseling from a Department licensed nonprofit credit counselor or an approved high-cost home loan counselor registered with the U.S. Department of Housing and Urban Development (HUD) (or call (800) 569-4287).

In most cases, a potential homeowner will need to obtain a mortgage loan — an advance of funds from a lender to a borrower for the purchase of real estate. The mortgage itself is a legal document that sets forth the conditions of the loan, the manner and duration of repayment, and which pledges the borrower’s property (home) as security for the loan. The mortgage principal, the amount of the loan required to buy your home, and interest, the fee charged for borrowing the money, will typically be large enough to require mortgage payments for a significant period of time — often 15 to 30 years.

Following a personal assessment of your financial situation, you need to find out how much house you can afford.

To help determine the amount you may be eligible to borrow for a mortgage loan, consider getting pre-qualified with a mortgage lender. This free service generally takes about two days and involves providing income, asset and debt information to a lender who may issue a letter to the home shopper.

Taking this process a step further, a potential home buyer may get pre-approved for a mortgage. This means getting a guaranteed loan for a certain amount that generally lasts for 60 to 90 days from the date issued. A pre-approved loan may involve a nonrefundable fee, but is often considered an advantage for a buyer because it speeds up the closing process.

Be sure to ask the lender about the types of loans available to you and if there are any qualifying guidelines; what is the minimum down payment; and what would be included in the monthly mortgage payment — typically, the principal and interest of the loan, property taxes, and homeowner’s insurance, or PITI. Your payment may also include Private Mortgage Insurance and any homeowner’s association dues, if applicable.

Debt to Income Ratio (DTI)

One of the first factors a lender may consider when deciding how large a mortgage loan you qualify for is your debt to income ratio, or DTI. To calculate your DTI, add up your current monthly debt (credit card payments, car loans, etc.) and divide it by your total monthly pre-tax gross income. This percentage ratio is a simple way of showing how much of your income is available to make a mortgage loan payment after all other continuing debt obligations are met.

Lenders often call this the 28/36 qualifying ratio. The first number, 28 percent, indicates the maximum amount of your monthly pre-tax gross income that the lender allows for monthly housing expenses. This amount will include principal and interest of the loan, property taxes, and homeowner’s insurance, or PITI. The second number, 36 percent, refers to the maximum percentage of your monthly pre-tax gross income that the lender allows for all monthly housing expenses plus all recurring debt.

If your ratio numbers are higher than 28/36, you may want to consider reducing debt by paying off credit cards or other loans before starting your home search. When calculating and relying on your DTI to determine loan affordability, be confident with your numbers and do not be afraid to stick with them as you shop around. Some lenders may allow higher ratios and be willing to loan you amounts that will take you beyond the traditional qualifying ratio and what you can afford. This could lead to more costly monthly payments and might cause financial hardship if you find that your loan is not affordable once you have moved into your new home.

Down Payment

The down payment is part of the purchase price of a property that the buyer pays, usually in cash, and is not included in the loan amount. Most lenders require five to 20 percent of the purchase price of the home, depending on the type of mortgage loan.

Review your budget and make a decision about how much of a down payment you can reasonably afford to pay. If you do not have enough, you may be able to qualify for a loan under various government programs that are available.

Private Mortgage Insurance (PMI)

Any down payment less than 20 percent generally will require Private Mortgage Insurance (PMI), which protects the lender against loss if a borrower defaults on a loan. While it does not protect the borrower, it may allow the borrower to qualify for a loan they could not otherwise get. The premium (the amount of money charged for insurance) is paid up front or financed as part of the mortgage.

PMI usually can be canceled when the homeowner builds up enough equity in the home. Under federal law, PMI on most loans made on or after July 29, 1999, will end automatically once the mortgage is paid down to 78 percent of the original value of the house.

Interest Rate

As you know, the interest rate is the cost of borrowing money. Mortgage loans have repayment terms in the general form of a fixed rate, where the monthly interest payment does not change over time. This is often called a “conventional mortgage.” Another common type of mortgage loan is the variable or adjustable rate mortgage (ARM). An ARM has an interest rate that changes periodically during the loan’s life.

Conventional loans are generally thought of as more stable as they are not subject to fluctuating interest rates that can make dramatic swings over a long period of time. This accounts for the popularity of fixed rates, which often attract borrowers who plan to stay in one place for a considerable amount of time. The length of these loans most frequently selected is the 30-year mortgage, but 15-year and 40-year have grown in popularity.

Also more popular is the ARM, which will lock the borrower into a lower fixed-rate for a specific period of time, often five years, and then will rise according to terms agreed to in the loan. An ARM and another type of loan more popular today, interest-only mortgages, make owning a home more affordable early in the ownership period and drive up costs later. These types of mortgages may work well for first-time home buyers who are reasonably confident of an income increase that will compensate for the rise in loan payments. It also attracts those who expect to sell a home before the fixed-rate portion of the ARM ends.

Your lender will give you the option to “lock in” a rate quote for a specific period of time, often 60 days. A rate lock fixes the rate against a rise in rates, but rates may also fall in the time between the quote and your closing date. When filing your mortgage application, make sure you review your loan terms carefully to make certain you understand the rates and fees charged. Should you decide to lock in a rate, be certain to allow enough time so that you close before your lock-in expires.

Review Your Credit History

Your current debt is not the only factor used in the lending process. Your credit history will also impact the interest rate and terms of your loan, the minimum amount of your down payment, or even if you will receive a loan at all. Get a copy of your credit report from one or all three major credit reporting agencies (Equifax, Experian and TransUnion). Federal law entitles residents to one free report from each agency per year.

A credit report gives potential creditors a “snap shot” of your credit worthiness. It will show what types of credit you currently have and/or what you have had in the past. It also shows if you have paid your bills on time, filed for bankruptcy, or if you have ever been evicted from a rental property. It is important to make repairs to your credit history before you apply for a mortgage loan.

Check your credit report(s) for any discrepancies that may have a negative impact on your ability to secure financing. If you find any errors, contact the reporting agency immediately and request a correction.

You can establish good credit by:

  • Having a steady source of income; this usually means working consistently for two to three years.
  • Having a good record of paying your bills on time.
  • Keeping outstanding long-term debts low.
  • Putting money in a savings account.

If your credit is not in good shape, you may want to wait to purchase a home and spend the time needed to repair your credit instead. You may wish to consult a certified credit counselor who can help you get back on track.

What’s the Score?

Your credit score or FICO (for Fair, Isaac and Company, which created the system) is a number that indicates the health of your credit. The higher the score, the healthier your credit and the more likely a lender will approve a loan with good terms.

Scores can range from 300 to over 800, with the typical credit score falling between 600 and 700. You can receive your credit score from the credit reporting agencies for a reasonable fee.

Shopping for a Mortgage Loan

As with any major purchase, it pays to shop around when looking for a mortgage loan. Different lenders will offer different terms, have different requirements, and offer varying levels of service.

Following a personal assessment of your financial situation, you need to find out how much house you can afford.

To help determine the amount you may be eligible to borrow for a mortgage loan, consider getting pre-qualified with a mortgage lender. This free service generally takes about two days and involves providing income, asset and debt information to a lender who may issue a letter to the home shopper.

Taking this process a step further, a potential home buyer may get pre-approved for a mortgage. This means getting a guaranteed loan for a certain amount that generally lasts for 60 to 90 days from the date issued. A pre-approved loan may involve a nonrefundable fee, but is often considered an advantage for a buyer because it speeds up the closing process.

Be sure to ask the lender about the types of loans available to you and if there are any qualifying guidelines; what is the minimum down payment; and what would be included in the monthly mortgage payment — typically, the principal and interest of the loan, property taxes, and homeowner’s insurance, or PITI. Your payment may also include Private Mortgage Insurance and any homeowner’s association dues, if applicable.

Here are the six factors to consider when shopping for a mortgage loan:

Loan first, house second

Find out how much house you can afford before you fall in love with a house that you will struggle to purchase and maintain.

Consider getting pre-qualified or pre-approved

A written commitment from a lender puts a potential home buyer in a better position.

Know the application costs

There may be a fee required to apply for a mortgage. This fee might be charged when you apply, when the loan is approved, or at closing. Be sure you know how much this fee is and when it will be charged.

Look for a reputable lender

Remember, a lender makes a commission from closing or “selling” the loan, not from looking out for your best interest. Consider the lender’s stability and service record.

Understand the interest rate

Remember to ask if the loan has a fixed or adjustable rate of interest. A fixed-rate mortgage charges a set rate of interest that does not change over the life of the loan. An adjustable rate mortgage varies over time. This could make a big difference in what your monthly payments will be.

Consider getting the interest rate locked in

Rates quoted prior to closing are subject to change unless they are locked in. Locking in your interest rate on an application is often preferable to waiting until the loan is approved.

Tip!
Collect the financial records you will need to complete a mortgage loan application. These include your job history, income records (W2 and pay stubs), a list of your assets (investments, property, bank account statements), and liabilities (auto loans, installment loans, other mortgages, credit card debt statements). Download a Uniform Residential Loan Application (Form 1003), complete it, and start shopping.

You can shop for a mortgage online. Visit the Bills.com Mortgage Savings Center for quotes from up to five pre-screened lenders. Bills.com also recommends Home Account, a Web site where you can apply for a mortgage, compare rates, get quotes and actually lock a low mortgage rate for free.

Predatory Lending

Predatory lending can mean any type of abusive lending practice where the lender benefits through unworthiness, deceit, misrepresentation, bad faith, or dishonesty. These practices can occur in the subprime lending market and often target lower-income and minority borrowers. Subprime lending is not synonymous with predatory lending, however, and loans with subprime features are not necessarily predatory in nature. See the Bills.com article Subprime Mortgages to learn more.

Here are the five common forms of predatory lending:

Unaffordable loans

Loans that are based on equity or assets rather than the borrower’s monthly income and ability to make payments.

Loan flipping

Encouraging repeated refinancing, which requires additional fees and points from the borrower each time, thus draining the borrower’s assets. You could become burdened with higher payments, larger debt and ultimately face the possibility of losing your home.

Fraud or deception

Concealing the true nature of the loan obligation from the borrower.

Bait and switch

Verbal representations of favorable terms are made to sell a loan and different, less favorable terms are presented at the closing.

Pressure

Aggressive sales tactics are used to induce a borrower to sign an expensive, or unaffordable loan contract.

Everything You Need to Know About Buying a Home
Step 1: Shop for a Mortgage Loan: It pays to shop when looking for a loan.
Step 2: Find a Home Create a list of must-haves and nice-to haves.
Step 3: Make an Offer Get advice before you place an offer.
Step 4: Home Inspection, Title Search and More Buy your home with open eyes.
Step 5: Insure Your Home The right insurance protects you from financial ruin.
Step 6: Seal the Deal Understanding your Settlement Statement (HUD-1).
Get Mortgage Rates!
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