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A home is among the biggest money moves you’ll ever make—and with 88% of homebuyers financing their purchases, odds are you’ll need a mortgage.
The process of 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 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.
In just the past few months, the way you go about buying a house has changed, as the industry has adjusted to an increasingly remote process. In the middle of a pandemic and recession, it’s even more important to know what you’ll need for a smooth mortgage process.
COVID-19’s Impact on Mortgage Approvals
Lenders have become more strict with whom they are willing to loan money in response to the pandemic and ensuing economic recession. Minimum credit score requirements have increased, and lenders are holding borrowers to higher standards. For example, lenders are now verifying employment just before the loan is finalized, Parker says.
The logistics of getting a mortgage have also changed in the age of social distancing. Many states have fast tracked approval for the use of digital or mobile notaries, and virtual home tours, “drive-by” appraisals, and remote closings are becoming more common.
While many lenders have refined the logistics of approving home loans remotely, you may still experience delays in the process. All-time low mortgage rates have caused a boom in refinancing as existing homeowners look to save. “We have been historically busy lately,” Parker says, noting that Navy Federal closed a record number of loans in June 2020.
Spring is normally a busy time for the real estate market, but with the shutdown, many buyers had to put their house hunting on pause. As these buyers return to the market, loan originators are becoming even busier.
How to Qualify for a Mortgage
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.
1. Get Your Finances in Order
Preparing your finances is increasingly important given how wary lenders have become. Sean Moss, the director of operations for Down Payment Resource, an aggregator of homebuyer assistance programs, 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). So strengthening your credit by paying your bills on time and paying off debt can make a mortgage more affordable.
Two of the best things you can do to get the best mortgage rates: taking the time to build up your credit score and saving for a down payment of at least 20%.
The cost of purchasing a home goes far 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%-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 home ownership 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.
2. 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.
3. Shop for the Right Mortgage and Lender
When looking for a mortgage it’s a good idea to shop around to compare rates and fees for 2-3 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.
It’s also important to understand the different mortgage terms. 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 changes.
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 adjustable rate mortgages, which have an interest rate that changes with market conditions after a set number of years. There are also what are known as government-backed loans and conventional loans.
A government-insured mortgage is less risky for the lender, so it may be easier to qualify for, but comes with extra restrictions. For example, loans backed by the U.S. Department of Agriculture (USDA) are only issued for properties located in a qualifying rural area. Also, the private mortgage insurance requirement is generally dropped from conventional loans when the loan-to-value ratio (LTV) falls to 80%. But for USDA and Federal Housing Administration (FHA) loans, you’ll pay a version of mortgage insurance for the life of the loan.
4. Navigate the Underwriting and Closing Process
Before you get the keys to your new home you’ve got to finish the closing process, which technically starts when your offer is accepted.
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.