How to Get a Mortgage
If you stop to think about it, most statements of homeownership are misnomers. The majority of Americans do not own homes outright, but have a mortgage loan, or lien, where a lender has conditional ownership of the property and can exercise that right if the borrower doesn’t make the monthly mortgage payments.
For the past decade, about 65 percent of homeowners had a mortgage. This percentage shoots up to 80 percent and higher for people 54-years-old and younger and drops as people get older. The reason is simple: Houses are very expensive and take a long time to pay off. As of the third quarter of 2019, the median sale price of a house in the United States was $310,900. And in the most expensive cities, real estate prices are more than triple that amount.
These homeowners with mortgages are not all bastions of financial perfection. Some have high student loan payments. Others have credit card debt. And there are likely a few who have been through short sales or even foreclosures in the past. They got mortgages by assessing their financial situation, targeting houses they could afford, choosing lenders that fit for their financial scenario, pulling together the appropriate paperwork and using the available resources.
Like their financial situations, the loans these homeowners’ have are not homogenous. The guide below outlines five common scenarios and the distinct path to homeownership for each of them.
- Family A: First-time home buyers, steady W2 incomes, low savings, higher debt, FICO scores below 670
- Family B: First-time home buyers, steady W2 incomes, low savings, manageable debt, FICO scores above 670
- Family C: First-time home buyers, mix of steady W2 income and 1090s, healthy saving account and low debt, FICO credit score above 670
- Family D: Single wage earner household, steady W2 income, good savings and low debt, FICO score above 740, job involving possible relocation
- Family E: Self-employed couple, 1099 income with ups and downs, good savings and low debt, FICO score above 740
Your Financial Checkup
A mortgage is a home loan based on your financial condition and the house or condo you are buying. Your personal financial condition includes your income, savings and most importantly, your credit score.
Once you know your financial vital statistics, you can place yourself in the right family group and determine what kind of mortgage would suit you best. To keep it simple, we are using the median home cost of $310,900 (third quarter of 2019) and the median household income for homebuyers of $91,600 (as of 2017).
Credit score: Your credit report shows lenders your ability to repay debt. The higher your credit score, the lower risk you represent to a lender, and the lower the interest risk (generally speaking) you can command from a lender. This is critical because just a 0.5 percent increase in the mortgage interest rate will cost you tens of thousands of dollars over the life of the loan.
A credit score below 620 will typically make obtaining a mortgage at lower interest rates extremely difficult.
Savings: Financial experts suggest that people have three to six months of living expenses saved to cover housing, food, transportation, health care, utilities, personal expenses, and any debt payments. For homeowners, they also suggest putting aside 1% of the home’s value to cover maintenance and repairs.
Debt to Income Ratio (DTI): This formula helps lenders determine if you have the capacity to meet your monthly debt obligations. Lenders prefer to see a debt-to-income ratio below 43 percent. Your DTI= Total monthly debt/gross monthly income.
Upfront housing costs: Conventional mortgages require a 20 percent down payment and incur closing costs equal to about 2 percent of the home’s purchase price. On a $310,900 house, that equals $68,398.
Ongoing monthly costs: Your monthly payments depend on your mortgage and property taxes. Lenders like to see borrowers spend no more than 28 percent of their gross monthly income on a mortgage and associated housing costs. Gross monthly income includes child support, pension income, alimony, Social Security income and bonuses or commissions. For our $310,900 house, assuming 20 percent down, a 3.68% interest rate for a 30-year fixed rate loan, and including both property taxes and homeowners’ insurance, the total is about $1,500
The first step in house hunting is getting a mortgage pre-approval letter. It tells you how much you can afford, which informs your initial housing search. It also lets real estate agents know you are serious about buying a home. A pre-approval letter is not a guarantee you will be approved for a loan, it just means that as of the time the letter was issued, the lender does not see any impediments to approving you for a loan for a stated amount.
When you are attending open houses and putting in bids, sellers who have multiple offers are more likely to choose bids from people with pre-approval letters as those letters are proof the potential buyers have the needed money.
At a minimum, you should expect to provide two recent paystubs, your two most recent W2s, two months of bank statements, your most recent tax return and copies of any existing mortgage statements and property tax bills. You know your financial situation best. While some people may want a pre-approval letter allowing a higher purchase price so that they have more options, other buyers would rather keep that number lower. If a potential seller sees you were approved for a higher number, they may be more tempted to counter your offer. At Own Up, we decide how much you can afford, but we let your letter reflect the amount you want up to that maximum.
Shopping for a Mortgage
Shopping for a mortgage should be approached the same way as shopping for a car or large appliance. Research your potential options and get multiple price quotes. More than 75 percent of homebuyers do not shop around as part of the mortgage process, this despite the opportunity to save tens of thousands of dollars.
Different institutions offer mortgage loans. These include local banks, credit unions, and large banks. You can also choose to go through a mortgage broker. Own Up is a technology company, not a bank. We provide borrowers with multiple offers from our network of top-rated lenders. Our service is free, as we get paid a commission (which is smaller than that of other brokers and lenders) when you pick a lender from our network. Our commission is the same flat rate across every lender and every type of mortgage offered on our network, so we can act as unbiased advisors to the borrower.
There are two main types of mortgages:
- Fixed-rate mortgages, where the rate remains the same for the life of the mortgage
- Adjustable-rate mortgages where the initial interest rate is lower for a period of time, and then increases.
In either case, mortgage loans are generally for 30-year or 15-year terms and the mortgage application sent to underwriters is extensive. Conventional loans must meet strict financing rules and are backed by Freddie Mac and Freddie Mae, two quasi-governmental organizations. Conventional loans require a 20 percent down payment (also known as 80 percent loan-to-value ratio) or private mortgage interest (PMI) to insure the added risk of the lower down payment.
Beyond these general parameters, there are different ways to make the home buying more affordable. They include paying points to lower your mortgage interest rate, or getting a lender credit to lower your closing costs. Many states offer first-time homebuyer programs and programs for specific groups of people. These include three mortgage options:
- FHA : The Federal Housing Administration offers loans with down payments as low as 3.5% for first-time buyers and those with lower incomes. These loans have low closing costs.
- VA: The U.S. Department of Veterans Affairs offers low or no down payments loans to current and former members of the military.
- USDA Home Loans: These loans are for people buying homes in rural areas. Terms include lower down payments.
Your Path To A Mortgage
Given these many different options, it is not surprising that people find getting a mortgage stressful and will go with the first bank or mortgage broker offer they receive. To make it easier, we have determined potentially good options for people based on their financial situation:
Family A: Because this family will likely not make enough money for a 20 percent down payment and their credit history is not optimal, a conventional loan would come with a higher interest rate and PMI. Being a first-time buyer, this family should consider a FHA loan. If they are veterans or live in a rural area, a VA or USDA loan might also be advisable.
Should they consider a conventional loan, they might consider buying points if they can afford the slightly increased upfront costs. Points cost 1 percent of the total loan and reduce the mortgage interest rate about 0.25 percentage points, though the exact amount varies by lender.
Family B: While this family also has low savings, making a 20 percent down payment unlikely, their high FICO score offers opportunities to balance costs. With a conventional loan, they would have PMI, but their good credit would lead to a lower interest rate. Being a first-time buyer, this family should look into government-backed loan programs available to them.
Should they choose a conventional loan, they might consider using lender credits to reduce their upfront costs. Lender credits are like buying points in reverse. The mortgage lender gives you extra money upfront for closing costs, in exchange for a slightly higher mortgage interest rate. Since this family would potentially be offered a lower rate due to their good credit, using lender credits to reduce the down payment might open the door to homeownership.
Family C: This family likely makes the median family income for homebuyers, and possibly more. Their savings account and good credit allows them to apply for a conventional loan and eliminate the added expenses of PMI and interest rate adjustments for bad credit. For this family, all options are on the table (including a VA loan if either buyer is in the military or a veteran) but conventional lenders will likely provide good options.
Family D: Because this family has a primary breadwinner whose job could involve relocation, they should consider an adjustable-rate mortgage (ARM), especially if they plan to spend less than six years in one house. With ARM mortgages, borrowers pay more in principle during the initial years of the loan and the interest rate is lower. Once the rate goes up, this family would likely have moved on.
Family E: This family is part of the growing gig economy, with both family members self-employed. The freedom of the gig economy comes with hurdles. The lack of regular W2 income worries lenders, despite high credit and good savings. To counter the risk of income evaporating, lenders are likely to offer a mortgage with a higher interest rate. This family has two options: Apply for an ARM mortgage if there is a possibility self-employment for one or both couples could end in future years, at which point they could refinance. This family could use their savings to buy points to lower the mortgage interest rate.
Sealing the Deal
Mortgages involve a lot of paperwork, regardless of the family path you choose. Once you are ready to apply, make sure you have all the proper documentation needed for a mortgage application including income verification, credit reports, tax returns, bank statement and outstanding debt. See a complete list here.
Remember, interest rates are constantly changing and a mortgage is not set in stone forever. You can refinance your mortgage when either interest rates go down significantly and/or to shrink the term of the loan. Refinancing can lower your monthly payments and total costs. Some people also choose to prepay their mortgage, and in some situations this is advisable.
First, we securely collect your information through a secure questionnaire. Then, we anonymously shop your profile to our exclusive network of lenders and present you with your best options via a simple dashboard. We never sell your information so you don't have to worry about spam calls or emails. Lastly, we take a flat commission from the lender (our service is entirely free to use for the borrower) across every mortgage type, rate, and lender so we can truly offer unbiased advice to our customers. Our helpful expert advisors are with you every step of the way, if you'd like to get started, just click the link below.