Applying for a mortgage doesn’t have to be stressful, if you are prepared. Before you apply, you need to get your finances in order first.
- Credit Score – This comes from the credit reports from each of the 3 major credit bureaus.
- Credit Standing – Make sure you have low credit card balances and have paid all your bills on time!
- Credit Accounts – Avoid closing current accounts or applying for new ones.
- Down Payment – The more money you’re prepared to pay up front, the more likely you are to be approved.
- Income – Lenders want to see that you have a steady job with steady income. If you are self-employed, be prepared to provide tax returns and income statements.
- Interest Rates – These generally won’t determine whether or not you’re approved, although they will determine your monthly payments.
- Available Funds – Lenders want to make sure you have money set aside to pay for closing costs and points (if necessary).
Once you’ve selected a lender (make sure to get estimates from a few different lenders), you’ll probably be asked to pay in advance for your credit report (usually around $70), and sometimes for the appraisal (around $400). If the home doesn’t appraise for the con- tract amount, then either the seller will need to agree to reduce the price to the appraisal amount or you will need to be prepared to increase your down payment.
So, how much house can you afford?
To determine how much you’re allowed to borrow, the lender is going to use a number of different ratios. Those ratios are:
- Front-End Ratio – This is the monthly percentage of your yearly gross income that’s dedicated to mortgage payments. Your PITI (principal, interest, taxes, and insurance) should not exceed 28% of your gross income (although some lenders will lend to borrowers with PITI over that number). Also, some lenders will quote you based only on PI (principal and interest). Make sure to inquire as to which method they’re using.
- Back-End Ratio – This is the percentage of your gross income that is required to service your debts, i.e. car payments, credit cards, student loans, other loans, etc. Most lenders will require that this ratio not exceed 36% of your gross income, (al though it is possible for lenders to still approve a loan above this number, you’ll probably get stuck with a higher interest rate).
- Down Payment Percentage – Your down payment should be at least 20%. With a down payment under 20%, you’ll probably pay a higher rate, and you’ll also probably have to purchase mortgage insurance, which can cost up to .5% of the loan amount.
There are two major categories of mortgages, FRM (fixed-rate mortgage), and ARM (adjustable-rate mortgage).
- FRM- Fixed Rate Mortgage – The interest rate will remain the same throughout the entire loan term, or for a stated length of time. Fixed rate loans are an especially good idea during times where rates are low, as you can lock yourself in for a 10, 15, or 30 year term at a low rate.
- ARM- Adjustable Rate Mortgage – After the initial “fixed” period, the interest rate you’re paying will change and adjust on a specified schedule. A one-year adjustable rate mortgage is a 30 year loan in which your rate (and thus the amount of the monthly pay- ment), will change on the loan date of each successive year. This is considered the riskier of the two options, as the payments can fluctuate substantially. The reward for this risk is an initial rate that is significantly below market rates for comparable 30 year fixed-rate mortgages.
How much are closing costs?
Closing costs for a buyer are considered to be everything outside of the purchase price that a buyer would pay to complete a real estate transaction. These costs can include fees paid to title, escrow, or lawyers; city/county transfer or property taxes, credit reports, appraisals, recording or notary fees, inspections, and loan fees (such as prepaid interest or points).