With a red-hot housing market and rising mortgage rates complicating the homebuying process, being prepared and knowledgeable about the mortgage process before you start home shopping is more important than ever.
According to a 2021 report by the National Association of Realtors, 87% of recent buyers financed their home purchase, with first-time homebuyers financing 10% more of their home on average than repeat buyers. That means the people who will experience the greatest impact from getting the right mortgage and terms are likely also the ones who have the least experience with the process.
Getting a mortgage is simple in theory: show a lender you are likely to pay back the loan plus the interest. Beneath the surface, though, there are a lot of moving parts. Even small choices in how you prepare for homeownership, or what type of mortgage you get, can have big consequences for your bank account.
It’s all about working with a lender you feel comfortable with and you trust to understand your situation, says Kevin Parker, vice president of field mortgage originations at Navy Federal Credit Union. No two loans are exactly the same, he says, so getting guidance on what makes sense for your situation in the short term and the long term is key.
Here’s what you need to know about how to get a mortgage and how to choose the right mortgage and lender for you.
Getting a Mortgage, Step by Step
Buying a home, especially if it’s your first time, can be a complicated and stressful process. But it can be easier if you give yourself enough time to prepare and put together a team of professionals who are familiar with the area you want to live in. Working with an experienced real estate agent and lender or mortgage broker can help you navigate the process.
Here are the steps to getting a mortgage, from preparation to closing:
- Get Your Finances in Order
- Know How Much Mortgage You Can Afford
- Get Preapproved for a Mortgage
- Choose the Right Mortgage and Lender for You
- Figure Out If You Need to Get Private Mortgage Insurance (PMI)
- Submit Your Application
- Navigate the Underwriting Process
- Close on the Home
- Frequently Asked Questions (FAQ)
1. Get Your Finances in Order
Preparing your finances is increasingly important right now, as higher mortgage rates and housing prices have made homeownership increasingly expensive, especially for first-time homebuyers. Sean Moss, the executive vice president of product and operations at Down Payment Resource, recommends you start the process by talking with a loan officer. Even if you think homeownership is beyond your reach, there could be a 6-12 month plan you can start working on now before your next lease renewal, he says.
You should focus on two things: Building your credit and saving your cash. Having more cash on hand and a stronger credit score will help you be able to afford a wider range of homes, making the time it takes to shore up both well worth it.
Your approval odds and mortgage options will be better the higher your credit score. And while it may be possible to get a mortgage with bad credit, it’ll come with extra costs you’ll want to avoid, if at all possible. The lower your credit score, the higher your mortgage interest rate (and thus financing costs) will be. So, strengthening your credit by paying your bills on time and paying off debt can make a mortgage more affordable.
Is there a minimum credit score?
The minimum credit score required to get a mortgage depends on the type of mortgage you get and the lender you use.
Conventional mortgages backed by Fannie Mae or Freddie Mac have a minimum credit score requirement of 620, although individual lenders may set their own, higher credit score requirements on top of that.
FHA loans typically require a minimum credit score of 580. However, you can get an FHA loan with a lower credit score if you have a higher down payment — if you put down 10% (as opposed to the usual 3.5% down), you can get a loan with a credit score as low as 500.
USDA loans and VA loans don’t list official credit score requirements. Instead, lenders will look at your application as a whole when deciding whether to approve you for a mortgage. However, your credit score is still a major factor in that decision.
Keep in mind that even if you qualify for a mortgage with a low credit score, your interest rate will likely be higher, increasing your total cost of borrowing in the long run.
2. Know How Much Mortgage Can You Afford
To get a good idea of what your monthly mortgage payment will look like, you can use NextAdvisor’s mortgage calculator to estimate your monthly payments. But keep in mind that how much you feel you can comfortably fit into your budget may be more or less than what a bank is willing to lend to you.
One of the ways your mortgage lender determines how much you can borrow is by looking at your debt-to-income ratio (DTI). The maximum DTI you can have varies depending on the type of mortgage, but typically it’s in the 45% range. So if you make $6,000 a month, you may be able to secure a mortgage with a payment of up to $2,700 a month, if you have no other debt.
But just because you can borrow that much doesn’t mean you should. A good rule of thumb is to have a DTI that’s no higher than 36%. That includes not just your mortgage payment, but all of your other monthly debt payments. To keep a DTI of 36% or less on that same $6,000 a month income, you could have up to $2,160 combined monthly debt and mortgage payments.
Be aware of other housing costs
How much house you can afford goes beyond just the monthly mortgage payment. You’ll need a big chunk of cash to pay upfront closing costs and a down payment. Closing costs include all fees associated with processing the mortgage and average 3% to 6% of the purchase price. A healthy down payment will be 20% of the home’s value, though it is possible to buy a home with a smaller down payment, especially for certain types of loans. Add it all up and you’re looking at bringing tens of thousands of dollars to the table when you buy a home.
But don’t let that number deter you from making homeownership a reality. There are ways to bring it down. There are local and regional programs that offer closing cost and down payment assistance for qualified buyers, usually first-time homeowners or buyers with low-to-moderate income.
This assistance usually is in the form of a grant, low or no-interest loan, or a forgivable loan. Down payment assistance programs are great for preventing a buyer from having to use all of their cash to get into a home, Moss says. This helps the borrower keep money in savings so they’re better prepared for emergencies and the extra expenses of homeownership.
Aside from the upfront costs, ongoing costs can also eat into your budget. Property taxes will vary depending on your location and your home’s value, but can add up to several thousand dollars per year. Mortgage insurance — a requirement if you have an FHA loan or if you have a conventional loan with less than 20% down payment — can also add $100 to $200 to your monthly mortgage payment. Finally, there may be additional expenses associated with maintaining your house or surprise repairs you need to pay for out of pocket.
3. Get Preapproved for a Mortgage
Getting preapproved for a mortgage gives you a good idea of how much you can borrow and shows sellers you are a qualified buyer. To get a preapproval, a lender will check your credit score and proof of your income, assets, and employment. Even though a preapproval letter doesn’t guarantee you’ll qualify for financing, it shows the seller you have your finances in a place to pass an initial cursory examination from a lender.
Most preapproval letters are valid for 60-90 days, and when it comes time to apply for a mortgage all of your information will need to be reverified. Also, don’t confuse preapproval with prequalification. A prequalification is a quick estimate of what you can borrow based on the numbers you share and doesn’t require any documentation. So it’s less rigorous than a preapproval and carries less weight.
4. Choose the Right Mortgage and Lender for You
When looking for a mortgage it’s a good idea to shop around to compare rates and fees for several lenders. When you submit a mortgage application, the lender is required to give you what is known as a loan estimate within three business days. Every loan estimate contains the same information, so it’s easy to compare not only interest rates, but also the upfront fees you’ll need to pay. Once you have several loan estimates in hand, you can compare and even use the different offers to negotiate with the lenders for better rates or fees.
You should also understand how different types of mortgages affect your situation. Depending on what kind of mortgage you choose, you can have a different down payment requirement. And different mortgages have different repayment terms, which impact the size of your monthly payment and how much interest you’ll pay over the life of the loan.
It’s also important to understand the different mortgage terms when you’re shopping for a mortgage lender. The term is the amount of time the loan is repaid over typical mortgage terms are 10, 15, and 30 years. This has a big impact on your monthly payment and how much interest you pay over the life of the loan. A longer loan will have smaller monthly payments, because the purchase amount is spread out over a longer period of time. A shorter-term loan will save you money on interest. This is because shorter loans usually have lower interest rates, and you’re paying the loan off in a shorter amount of time.
To understand how different terms impact your bottom line, use our mortgage calculator to see how the monthly payment and the total interest you’ll pay change.
Adjustable rate vs. fixed rate
Mortgages also come with a variety of other things to consider. There are fixed-rate loans, which have the same interest for the duration of the mortgage. And then there are adjustable-rate mortgages, which have an interest rate that changes with market conditions after a set number of years.
Most homeowners opt for a fixed-rate mortgage for the peace of mind knowing that their mortgage rate — and monthly payment — can’t unexpectedly change in the future. But if you know you’ll be selling your home or refinancing before your rate resets, an adjustable rate may make sense. This is because adjustable-rate mortgages typically have lower interest rates during the initial introductory period before the rate adjusts.
Each type of mortgage has different minimum down payment requirements.
Some conventional loans require as little as 3% for a down payment. But most have down payment requirements of 10% to 20%. If you can’t afford a big down payment, then you might want to consider a government-secured mortgage.
A government-insured mortgage is less risky for the lender, so it may be easier to qualify for, and have a smaller down payment. For example, you can put 0% down on loans backed by the U.S. Department of Agriculture (USDA) and VA loans, backed by the Department of Veterans Affairs. But both of these loans have strict limitations. USDA loans are limited to qualifying rural areas, and VA loans are for eligible military veterans. However, mortgages backed by the Federal Housing Administration are open to all eligible borrowers. FHA loans require as little as 3.5% down, and are easier to qualify for than conventional loans.
Other types of loans to consider
While conventional loans are the most popular option in the mortgage industry, sometimes government-backed loans can offer unique benefits that conventional loans don’t. Here are the most common types of government-backed loans that are worth considering if you can qualify for them:
FHA loans are offered by the Federal Housing Administration (FHA) and are meant to make homeownership more accessible.
These loans are easier to qualify for than conventional mortgages, requiring a down payment as low as 3.5% and a minimum credit score of 580 in most cases (though you can get an FHA loan with a credit score as low as 500 if you put down 10%).
FHA loans can be a good option for first-time homebuyers who can’t afford a large down payment, or those with lower credit scores. However, there are some strings attached: you can only get an FHA loan on a primary residence (not investment properties or vacation houses) and the value of the property can’t exceed the FHA loan limits in your area. In addition, you’ll need to pay FHA mortgage insurance for the life of the loan, and you can’t get rid of it without refinancing into a private loan.
VA loans are backed by the U.S. Department of Veterans Affairs (VA) and are available exclusively to service members, veterans, and qualifying surviving spouses. There are two types of VA loans: VA direct home loans and VA-backed home loans. With VA direct home loans, which are only available through the Native American Direct Loan (NADL) program, VA acts directly as your mortgage lender. For VA-backed loans, VA guarantees a portion of the loan you get from a private lender, meaning that VA will reimburse the lender a portion of the unpaid balance if you default.
For those who qualify, a VA loan can provide a lot of benefits. You can buy a house without a down payment, and you won’t need to pay private mortgage insurance either (which is usually required if you get a conventional loan with a down payment of less than 20%). VA loan interest rates can also be lower than conventional loan rates, although it’s still important to shop around with multiple lenders to make sure you’re getting the best rate.
VA loans do come with a one-time funding fee, which is charged based on a percentage of the total loan amount. The funding fee may be waived in certain circumstances.
The USDA Rural Development program, offered by the U.S. Department of Agriculture (USDA), provides home loans to middle- and low-income families purchasing homes in qualifying rural and suburban areas. USDA loans offer lower interest rates than conventional mortgages, more lenient credit requirements, and require no down payment.
There are two types of USDA loans. Guaranteed loans, which are more common, are offered by USDA-approved private lenders and available to middle- and low-income households on eligible homes. Direct loans, offered directly through the USDA, are available to low- or very low-income households who lack “decent, safe and sanitary housing” and fall below a certain income threshold. Direct loans also have more restrictions on what types of property can be purchased.
To get a USDA loan, your income must fall within the USDA loan income limits of your area. In addition to borrower requirements, USDA loans also have requirements for the property itself. The property must be located in an eligible rural area and must be a primary residence, not a vacation home or investment property.
Best mortgage lenders
A home is likely the biggest purchase you will make in your life, so it’s important to choose the right lender to work with. Here are NextAdvisor’s top picks for the best mortgage lenders of 2022, chosen based on factors including transparency, accessibility, online convenience, loan product variety, and customer satisfaction:
- Guaranteed Rate: Best With Fast Preapprovals and Closings
- Navy Federal Credit Union: Best for Military Families
- Rocket Mortgage: Top Lender for Customer Satisfaction
- Veterans United Home Loans: Top Lender Among Military Families
- North American Savings Bank: Best for the Non-Traditional Borrower
- Truist Bank: Best for Full Service Banking
- Sebonic Financial: Best Online Application Process
- Pennymac Loan Services: Best Online Experience
- Watermark Home Loans: Best for the Self-Employed Borrower
- LenderFi: Best Pricing Transparency
- Honorable Mention: Costco Mortgage Program
Be sure to compare rates from multiple lenders before signing with any particular one, in order to get the best deal. Especially in today’s rising rate environment, even a small difference in your interest rate could save — or cost — you thousands of dollars over the life of your loan.
5. Figure Out If You Need to Get Private Mortgage Insurance (PMI)
Private mortgage insurance (PMI) protects a lender in case the borrower defaults on their loan, so it’s your lender’s call whether they want to require PMI on your loan. Generally, lenders will require private mortgage insurance on loans with a down payment of less than 20%. PMI may be tax-deductible in certain situations.
However, there are a few exceptions. You don’t need PMI on VA loans no matter how much you put down, even if it’s 0%. USDA guaranteed loans don’t require PMI, but borrowers are instead charged an annual guarantee fee that serves the same purpose. FHA loans require a one-time Up Front Mortgage Insurance Premium and annual mortgage insurance premium (MIP) instead of PMI.
PMI can add hundreds of dollars to your monthly mortgage payments, but it doesn’t have to last forever. If you have a conventional loan, you can file a request with your lender to cancel your PMI once you’ve reached a loan-to-value ratio (LTV) of 80%, meaning you have at least 20% equity in your house. If you don’t request a cancellation, your lender must automatically cancel PMI on the date your LTV reaches 78% based on the original payment schedule, per the Homeowners Protection Act.
If you have a USDA or FHA loan, the only way to get rid of mortgage insurance is to refinance to a conventional mortgage. If your LTV when you refinance is less than 80%, you won’t need PMI on your new loan.
6. Submit Your Application
Once you’re ready to submit your application, you’ll need to gather all of the necessary documentation. The lender needs to be able to verify every part of your finances. So, depending on your situation, the list of what you need to submit along with your application can get long.
You’ll need to submit documentation such as:
- Tax returns
- Pay stubs, 1099 forms, W-2 forms
- Bank or investment account statements
- Government ID
- Authorization to pull credit reports
- Documentation of your debts
- Employment history
- Housing history
If you are self-employed or are a freelancer whose income is not recorded on a W-2 form, then you’re likely to need to provide even more information. You’ll usually need extra documentation such as:
- Two years of tax returns and business tax returns
- Business bank account statements
- Copies of your business licenses
7. Navigate the Underwriting Process
The mortgage underwriting process is when the lender will verify that you are a qualified borrower and give you final approval for the home loan.
Your financial health will be closely scrutinized during the underwriting process and before the mortgage is issued or your application is rejected. You’ll need to provide recent documentation to verify your employment, income, assets, and debts. You may also be required to submit letters to explain things like employment gaps or to document gifts you receive to help with the down payment or closing costs.
The underwriting process is meant to answer one question – is the borrower likely to repay this loan? So during this time, lenders are sensitive to any change in your credit profile. Avoid any big purchases, closing or opening new accounts, and making unusually large withdrawals or deposits.
As part of closing, the lender will require an appraisal to be completed on the home to verify its value. You’ll also need to have a title search done on the property and secure lender’s title insurance and homeowner’s insurance. It can take anywhere from a few weeks to a few months before you wrap it up with a final walkthrough of the property and sign the dotted line at the closing appointment.
8. Close on the Home
Before you get the keys to your new home, you need to finish the closing process, which technically starts when your offer is accepted.
As part of closing, the lender will require an appraisal to be completed on the home to verify its value. You’ll also need to have a title search done on the property and secure lender’s title insurance and homeowner’s insurance. Your lender will also verify that you are still employed during the closing process. They may even require employment verification up to the day of closing.
It can take anywhere from a few weeks to a few months (in a worst-case scenario) before you wrap it up with a final walkthrough of the property and sign the dotted line at the closing appointment.
Frequently Asked Questions (FAQ)
How can I increase my approval odds?
The best way to increase your chances of getting approved for a mortgage is to review your credit history and finances ahead of time. This gives you the opportunity to address errors or blemishes on your credit report, and potentially increase your credit score.
If you have the money, making a larger down payment or having more money set aside in savings can increase your chances of being approved. Lenders are trying to evaluate how likely you are to repay the loan, and having more skin in the game, or a cushion for unexpected emergencies, will work in your favor.
What can I do to get the best mortgage rate?
Mortgage rates vary a lot between lenders. So the most important action to take to ensure you’re getting the best mortgage rate is to shop around.
Two of the biggest factors for mortgage rates are your credit score and your loan-to-value ratio (LTV). To get the lowest rate, you’ll want to improve your credit score to at least 740. For LTV, aim to put 20% down when you purchase or to have an LTV of 80% or less.
The length of your home loan also plays an important role in determining your rate. Shorter-term loans typically have lower interest rates. So a 15-year loan will have a lower rate than a 30-year loan, all else being equal.
Does getting preapproved hurt my credit score?
When you’re preapproved for a mortgage, the lender will complete what’s known as a hard credit pull or hard credit inquiry. When there’s a hard inquiry on your credit report, it usually temporarily lowers your score by a small amount. Hence the idea that getting preapproved can hurt your credit score.
But getting preapproved for a mortgage does not necessarily negatively impact your chances of getting approved for a mortgage. Lenders understand that preapproval is part of the process of purchasing a home. And if you get a number of preapprovals within a short enough time frame, those inquiries may end up getting merged together into a single hard pull.
Can I get a mortgage if I have bad credit?
Getting a mortgage if you have poor credit can be difficult, but it’s not impossible. It just depends on a lot of factors. Also, if you have a lower credit score, you’ll typically end up with a higher mortgage rate and may need a bigger down payment.
So, having a bad credit score means borrowing money becomes more expensive for you. And having a higher rate increases your monthly payment, which reduces the amount you’ll be eligible to borrow. That means you’ll have to reduce your home buying budget.
Conventional loans are difficult to qualify for with bad credit. So you’ll most likely need to apply for a government-secured loan. FHA loans can be a great option as the FHA only requires a credit score of 500+ if you have a 10% down payment and a credit score of 580+ with a 3.5% down payment. However, lenders have additional requirements above and beyond the FHA guidelines, and many won’t issue FHA loans if your credit score is under 620.