01 Jan Everything You Need to Know About Mortgage
Mortgage is a term used to describe any type of loan that allows consumers to purchase a home without paying the entire price in cash. Getting a mortgage is a lengthy process, and lenders want to make sure they’re lending to people who can repay the debt.
To do this, they review many aspects of a borrower’s finances, including income and debt.
What is a mortgage?
Mortgages are loans that are used to purchase or maintain a house, land and other types of real estate. In exchange for the money borrowed, the borrower agrees to pay back the lender, including interest, over a specific period of time, usually a set number of years. The property is used as collateral to secure the loan, meaning that if the borrower fails to make payments, the lender has legal rights to claim the property. Unlike other types of loans, mortgages typically have much lower interest rates because the bank has more confidence that the borrower will repay their debt.
There are several different types of mortgages, and the process of obtaining one can seem overwhelming for first-time homebuyers. The most common type of mortgage is called a conventional mortgage, which is any home loan that is not offered or guaranteed by a government agency. This includes mortgages that are issued by private lenders such as banks and credit unions, or by nonbank mortgage lenders.
A conventional mortgage can be fixed- or adjustable-rate, and the interest rate may be fixed for a period of time, or it may fluctuate over the life of the loan, depending on market conditions. In either case, the monthly payments are made up of principal and interest. During the early years of the mortgage, most of each payment goes toward interest, while in later years, more of each payment is applied to principal.
When a borrower applies for a mortgage, the mortgage lender will review all aspects of their finances, including income, debts and past payment history. They will also consider the borrower’s credit score, debt-to-income ratio and other factors to determine if they are eligible for a mortgage loan and how much they will be able to afford each month.
In addition to the loan amount, borrowers should focus on a mortgage that fits their budget and long-term financial goals, rather than just on how much they can qualify for. A higher loan amount does not necessarily mean that it will be easier to repay, and if the borrower is not able to manage a larger monthly payment, they could find themselves in trouble down the road.
How do I apply for a mortgage?
The mortgage process can be overwhelming for homebuyers. But getting a clear understanding of how it works can help you prepare for what’s ahead. The first step in applying for a mortgage is to work out what type of loan you’re looking for and how much you can afford to pay.
Lenders will look at your credit history, income, debt-to-income ratio and assets to determine if you’re eligible for a mortgage. To speed up the application process, you should get all your paperwork in order beforehand. Lenders will usually ask for the following documentation:
You’ll need to provide proof of your employment, including the name of your employer, the date you started your job and your salary. If you’re self-employed, lenders will also want to see your tax returns. Your lender will also need to verify any other sources of income you might have, such as child support or alimony payments.
Your lender will also check your rental history, as it’s a big indicator of whether you’ll be able to make regular mortgage repayments. If you’ve been late on rent payments or missed them altogether, your lender might write you off as a risky investment. In that case, you may not be able to get the loan you’re after.
Personal financial statements
Your mortgage lender will also need to examine your personal finances, which will include a complete list of all the money you have in savings and investments as well as details about any other debts you might have (such as credit card or student loans). This will help them decide if you’ll be able to comfortably afford the mortgage you’re applying for.
It’s important to avoid taking on any new debt during this time, too. Doing so could negatively impact your credit score and affect your debt-to-income ratio. It’s also a good idea to stay current with your credit monitoring service, like Experian’s free credit monitoring, to ensure your credit is safe and sound during the mortgage process.
Once you’ve provided all the necessary documentation, your mortgage lender will approve or decline your loan application. If the latter, they might offer you a different interest rate or ask you to provide additional information.
What are the different types of mortgages?
There are many different types of mortgages available to potential homebuyers. Choosing the right one depends on the property, its value and location, as well as the borrower’s financial situation and goals. The most common type of mortgage is the fixed-rate loan, which features a consistent monthly payment and interest rate throughout the term of the loan. This option is best for borrowers who plan to remain in their home for a long time and want to avoid fluctuations in their monthly payments due to changes in benchmark interest rates or other economic factors.
Conventional mortgages are funded by private lenders and can be used to purchase a primary, secondary or investment property. They’re classified as conforming or nonconforming, with the latter referring to whether they meet funding criteria set by Fannie Mae and Freddie Mac or FHFA loan limits (for 2022, single-family homes can’t be more than $647,200). Nonconforming loans are often referred to as “jumbo” mortgages and can be difficult to qualify for unless you have exceptional credit.
The 30-year fixed-rate mortgage is the most popular type of mortgage in the United States, representing over 75% of all mortgages. This is the longest term length that’s available and comes with a low initial interest rate. However, the total cost of the loan will be higher over the long term than a shorter-term option because you’re paying interest for a longer period of time.
Another mortgage loan type is the adjustable-rate mortgage (ARM), which features an initial introductory rate that’s lower than what you’ll pay on a fixed-rate loan. However, the rate will adjust over time according to current market interest rates. This type of mortgage may be a good choice for borrowers who plan to stay in their homes for only a few years or those who want to take advantage of low current interest rates.
Finally, there’s the reverse mortgages, which is a type of loan that allows homeowners age 62 or older to tap into their equity without selling their home. This type of loan is only available on the primary residence and has specific lending guidelines, including a minimum credit score of 620 and debt-to-income ratios of 36% or less.
How do I know if I’m approved for a mortgage?
Before a lender will approve you for a mortgage, they will run your credit and verify the information in your financial documents. Once this process is complete, they will issue you a preapproval letter with the loan amount you’ve been approved for and the expiration date of your approval. This will also include the loan type and term. This is an important step to take before you start shopping for homes since it will let you know your range of home purchase options.
There’s some variation in specific requirements from lender to lender, but there are some basic criteria that all lenders must consider. This includes:
Credit score and history
The lender will look at your credit to assess the likelihood of you paying your mortgage payment regularly. They will take into account your credit utilization ratio, which is the amount you owe on your cards compared to your total credit limit. They will also look at your credit report to check for errors. Incorrect information on your credit can lower your score, and if you have missed payments in the past, that can negatively impact your ability to get a mortgage.
Lenders want to be sure that you earn enough money to pay your mortgage and cover other expenses, as well as have a reasonable amount of savings in reserve. They may ask to see tax returns, bank statements, and pay stubs. They will also check if your employment is steady and stable, and they will want to know if you’ve changed jobs recently. If you work on commission, or if you have a variable source of income (like a side hustle), it’s important to let the lender know ahead of time, so they can factor this into their analysis.
Avoid opening new credit lines for several months before you apply for a mortgage, and throughout the application process. Taking on new debt can negatively impact your credit, and it will increase your DTI, making you less likely to be approved for a mortgage. It’s also a good idea to save up an emergency fund that can cover 3-6 months of expenses.