How Hard is it to Get a Mortgage? The Home Buyer’s Guide

Posted on Oct 08, 2020

Most home buyers need a mortgage in order to afford their home. Not surprisingly, mortgage is a huge industry that backs the U.S. housing market. 

There’s a lot of terminology that’s important to understand before homebuyers embark on their ownership journey. Here’s what you need to know about qualifying for a home loan.

What is a mortgage?

A mortgage is a loan from a lender, given to a borrower, to help with the purchase of a property. The collateral for the home is the home itself - homeowners who don’t pay their monthly mortgage payments risk their bank repossessing, and selling, the home.

Homeowners typically choose a 15, 20, or 30-year mortgage term, but you can opt for a term of any length between 8 years and 30 years. A 30-year mortgage will allow you to make smaller monthly payments, but you’ll ultimately have a higher interest rate - meaning you will have to pay thousands of dollars more in interest fees over the lifetime of the loan - while a 15-year mortgage means higher monthly payments, but less interest. Whatever term length you choose will be determined by how much you feel comfortable paying in monthly payments, and there isn’t necessarily a “right” or “better” term.

  • Down payment: Homebuyers will typically need to pay a percentage of the home’s total value as a down payment. Although 20% is the typical recommendation since it can qualify you for a better loan rate, many first-time homebuyers make a down payment of as little as 6%, and first-time homeowner loan programs (like the FHA) can bring that percentage down to as low as 3.5%.
  • The principal balance: The principal is the original amount of money you take out. So if you borrow $200,000 to buy a home, your principal balance is $200,000.
  • Interest rates: Most home loans today are “fixed” loans, rather than variable/adjustable, which means that your interest rate won’t change over time. 

How is mortgage interest calculated?

Finding a good mortgage rate is important because even half a percentage point can equate to thousands of dollars in interest over the lifetime of your loan. You may notice that many lenders may list “today’s interest rate” for different fixed rate terms. However, this number is not likely to be an exact match to the rates you will personally receive - it’s more of a ballpark. 

Home loan rates are determined by several factors:

  • The overall economy 
  • Inflation
  • Job growth
  • Your credit score
  • Your loan-to-value ratio 

And on top of that, each lender may calculate what they’re willing to pay slightly differently - which is why it’s important to shop around for the right lender.

Should I get pre-qualified or pre-approved?

Your agent will likely recommend getting pre-qualified or pre-approved before looking at homes. Although some people use these terms interchangeably, it’s important to understand that they are two unique processes. 

Pre-qualification is a faster process. You’ll submit information about your credit, debt, and income to the lender, and they will estimate how much you could borrow. Because the pre-qualification doesn’t look into credit history or borrowing ability, it’s not as comprehensive or as accurate as a pre-approval. The loan pre-approval is a deeper dive into your finances and will let you know the exact amount you can borrow. You do not need to get pre-qualified in order to get pre-approved, and pre-approvals are more likely to signal that you’re a serious buyer.

What will I need to submit for a loan?

To receive a loan, you will have to disclose information about yourself and your finances to your potential lender.  

You will generally need the minimal down payment (3% for conventional loans), a credit score of 620 or higher, proof of steady income, and an acceptable debt-to-income ratio (your recurring monthly debt divided by your total income). 

Specifics can vary by lender - though 620 is the minimum credit score, some lenders require closer to 650. A higher credit score can make you eligible for lower interest rates, so in some cases, it might be worth improving your score before applying for a mortgage. Buyers also need to provide personal information such as social security number(s) and employer information.

Why should I get my mortgage pre-approved?

A mortgage pre-approval is a letter from a lender indicating the type of loan you qualify for. The pre-approval is important for signaling to home sellers that you’re serious - and that you actually have the means to purchase the house. If you’re pre-approved for a smaller amount than you expected, you may need to adjust your home search accordingly. And yes, your credit will be pulled when you apply for a mortgage pre-approval.

There’s five basic things you’ll need to get pre-approved by your lender:

  • Proof of income (W-2 statements, pay stubs) for the last two years
  • Proof of assets (bank statements, etc)
  • Good credit (620 or higher)
  • Employment verification (a call to your employer)
  • Additional verification (driver’s license, social security card)

One of the most important things you can do to qualify is getting your credit in order.

“It generally takes a long time, maybe months or years to get bad credit, and you usually don’t get out in a couple days,” explains Hansen. “It’ll take months at least to improve your credit - sometimes people think there’s a quick fix but there isn’t really.”

Generally speaking, it’s best to avoid any large unexplained deposits to your bank account, significant new debt (like car payments), or new mortgages before applying for a loan.

How do I get a better mortgage rate?

Many first-time home buyers don’t realize that shopping around for mortgage rates is essential for getting the best loan option.

To successfully shop around, you should look for well-reviewed lenders with positive referrals from friends, family, or other people who have had a good experience. Ask three to four lenders for a quote in order to see who’s responsive, who answers your questions, and who gives you an itemized estimate. You’ll want to be able to compare their loan products, interest rates, closing costs, and lender fees. It’s important that you get answers about each lender’s closing costs and fees or you might be in for a big surprise at closing. Someone might have a really good rate but never answer their phone, respond to your emails, or seem to know what they’re doing - in which case, you may want to pass.

Buyers who are working with a Houwzer agent can also use our in-house mortgage team to make this process easier. Our salaried mortgage advisors shop around on behalf of clients, finding them the best loans for their goals and budget. Home buyers can choose from a variety of lenders, including credit unions, banks, and mutual savings banks. Your advisor can help you get pre-approved in just 24 hours, talk through any questions or concerns, and make sure you don’t run into any delays that could throw off closing.

Common Misconceptions

  • “A lot of people ask,‘I paid my current mortgage/rent on time for X amount of years, why don’t I qualify?’” says Casey Hansen, Houwzer’s Director of Lending. “That’s one that comes up quite a bit, and it goes back to your debt-to-income ratio. There are three main things lenders are going to consider: adequate credit, adequate savings for down payment/closing costs, and adequate income to cover your liabilities. If you’re missing one, you’re not going to qualify.”
  • “Another misconception is that the lender is somehow making a judgment call on whether to lend you money or not,” notes Hansen. “The truth is it’s not that subjective; there’s a rulebook that most lenders follow and if you don’t follow it, you don’t qualify…. It’s just basically, setting guidelines.”

How do I figure out the maximum I can afford?

Many people approach mortgage advisors asking the maximum amount they can qualify for. 

“That’s not really the question that you want answered,” says Hansen. “The real question is: what’s the maximum monthly payment that I can qualify for? And that includes mortgage, property taxes, insurance, possibly PMI (private mortgage insurance). Property taxes have a big influence on how much you can qualify for, and sometimes people forget about that when they’re only focused on the purchase price. Because that’s your monthly payment.”

Someone might qualify for a $400,000 home in Philadelphia, for example, but not in New Jersey just across the river, because Jersey property taxes are higher. This is why it’s important to evaluate your home price holistically, rather than just focusing on the purchase price. And just because you qualify for a certain amount doesn’t mean it’s prudent to go for the max. Most homeowners don’t end up opting for their maximum monthly payment since it leaves little wiggle room in case something unexpected happens.

Do student loans prohibit home ownership?

Considering that over two-thirds of graduating students today have student debt, it’s not unusual for them to wonder whether their student loans will prevent them from qualifying for a home loan. The good news is that plenty of homeowners successfully juggle paying a mortgage and paying off student loans. 

“Just having a lot of student loan debt in itself does not disqualify you because it’s not the amount, it’s the total monthly payment that matters,” explains Hansen. In other words, it comes back to the loan-to-value ratio once again.

Potential buyers with deferred loans are often curious as to whether they need to actually include those loans on their mortgage application since there’s no monthly payment. 

“If your loans are in deferment, we can’t assume the amount is zero,” says Casey. In other words, you will need to note this in your application. “We have to calculate some payment, and that amount will differ depending on what kind of loan you’re doing. We can’t assume zero ever because eventually, you’ll still need to pay it back.”

Mortgage letters you may encounter

What is a letter of explanation?

Your lender may ask you for a letter of explanation; this is a document that will clarify any questions that may have arisen during the loan approval process. Quite simply, they want you to explain something before they will approve your mortgage. They may require a letter of explanation if you have, for example:

  • Gaps in employment
  • Other names on your credit report
  • Additional addresses on your credit report
  • Former delinquencies
  • Overdraft fees on a bank account
  • And other common financial events 

When you write the letter, it should include clear details relevant to the request. Don’t offer any additional information the lender hasn’t requested, and keep your language formal. 

What is a gift letter for a mortgage?

Sometimes relatives will give new home buyers money in order to help them cover the down payment or closing costs. In order to use this money toward the house, though, the gifters need to submit a gift letter to the lender. This letter helps ensure that the assets are legitimate. 

What is proof of funds?

The proof of funds is a document that shows you have the liquid funds needed to purchase a home. Sometimes it’s enough to have a bank statement; other times, you may need an actual letter from your bank detailing the funds you can access.

“Anytime you need assets to close a loan, you need to source where those funds came from,” says Hansen. 

“Can I pay my mortgage with a credit card?” Although you can borrow against yourself once you have a mortgage, you can’t qualify for a mortgage approval using unsecured debt like a credit card.

Liquidity is important: assets like life insurance, shares, and mutual funds don’t count because they can’t be immediately used. Unsecured debt – like a cash advance on a credit card or a personal loan – can’t be used as proof of funds. 

You will need to show enough money to cover escrow, closing costs, and the down payment. A proof of funds is not a loan pre-approval; however, it does help assure home sellers that you’re serious about buying.

More mortgage and loan terminology 

What is PMI?

Private mortgage insurance protects your lender in case you stop paying your mortgage - but PMI is your responsibility. Typically, PMI is required for a conventional loan for homebuyers putting down less than 20%. Read more about it here: Private Mortgage Insurance: Why Do I Need It, and How Can I Get Rid of PMI?

What are mortgage points?

Points are fees the borrower can pay to the lender at closing that help keep down the total cost of the loan. One point is equal to 1% of the mortgage cost - for example, on a $400,000 loan, 2 points equates to $8,000. The goal of paying points is to lower the buyer’s interest rate, which can save you a lot of money over the lifetime of your loan. 

Keep in mind that mortgage points are less valuable if you plan to sell the home or refinance it within several years - in which case, you’re unlikely to save enough on the interest rate to realize the full benefit of the loan rate reduction.

What are seller concessions?

When you buy a house, you have to pay closing fees that can cost up to 5% of your home’s value - for property taxes, inspection fees, appraisal fees and more. Frequently, you can get the seller to pay for some of these closing costs - and this is known as seller concessions. 

What is a land contract? 

A land contract is essentially a rent-to-own home - rather than opting for a mortgage with a traditional lender, the buyer makes a contract with the existing owner to pay for the home in installments. The buyer then owns the home once the installments are completed. 

These were popular in the 70s and 80s but have fallen out of favor since they are more risky for the buyer - if the seller defaults on their mortgage payment, the buyer can end up losing the home through no fault of their own (since they don’t legally own it yet).

What is a mortgage note? 

A mortgage note is the loan document you sign in order to make your deal official. It lays out the details of your loan, including your interest rate, the loan term (such as a 15 or 30 year loan) payment due dates, and penalties/fees for late payments. Keep track of your mortgage note since this is an important legal document related to your home.

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