Getting a mortgage isn't too difficult, but it will involve some effort on your part. If you're planning on taking out a loan to buy a home sometime in the near future, here are ten things you need to learn about—and do—to make sure that the transaction goes smoothly and that you fully understand what you're getting into.
Your credit score is a numerical calculation that is designed to indicate your creditworthiness. There are different types of credit scores, like FICO and VantageScore. A basic FICO score or VantageScore ranges from 300 to 850. The closer your score is to 850, the better you'll look in the eyes of the lender. These companies offer a variety of scoring formulas that emphasize different aspects of your credit, so you'll likely have more than one score.
For around 20 years, Fannie Mae and Freddie Mac required lenders to use the "Classic FICO" credit score to evaluate borrowers' credit. On October 24, 2022, the Federal Housing Finance Agency (FHFA) announced that it would eventually require lenders to deliver both FICO 10T and VantageScore 4.0 credit scores with each loan sold to Fannie Mae and Freddie Mac. (The FHFA is the government agency that oversees Fannie Mae and Freddie Mac.) FICO 10T and VantageScore 4.0 consider different types of payment histories for borrowers than Classic FICO. For instance, when available, they include rent, utilities, and telecom payments when calculating scores.
You can pay to find out your scores, including the scores most widely used in mortgage, auto, and credit card lending. But your lender might use a different score than the versions you receive from a credit scoring company's website (remember, there are lots of different types of scores), or another type of credit score altogether. You can also contact the three major credit reporting agencies—Experian, Equifax, and TransUnion—but these companies might not give you the actual credit score that creditors will use to evaluate you. Still, you'll get an idea of where you fall in terms of credit risk if you get your scores from a credit scoring company or the credit reporting agencies.
It's also a good idea to review your credit reports. Fortunately, under federal law, the credit reporting agencies have to give you a free copy of your credit report once every 12 months if you ask for it. To get your free report from any (or all three) of the major credit reporting agencies—again, Experian, Equifax, and TransUnion—go to AnnualCreditReport.com. You can also get weekly free online reports during the COVID-19 national emergency.
After you get the report, review it for errors and then take steps to correct any mistakes or outdated information and add positive information. Your credit score is based on what's in your credit reports. Incorrect information can hurt your score. Remember, this isn't just a case of wanting a lender to approve or disapprove you for a loan—lenders use your credit history to determine whether you should be charged a higher interest rate, too.
It's worth getting educated about the different types of mortgages—like conventional, FHA, VA, and others—that are available before you start shopping for a loan.
If you select a fixed-rate mortgage, the amount you'll pay in total for principal and interest remains the same over the entire mortgage term because the interest rate stays the same. Although you slowly pay off the principal, your monthly payment will normally be set at the same amount each month, based on a mathematical process called "amortization." This payment could go up, though, if there's an increase in your property taxes or homeowners' insurance, and those items are escrowed and paid as part of your mortgage payment.
With an adjustable rate mortgage (ARM), the rate will change from time to time based on the economy's interest rates. Your monthly payment will increase if rates go up and go down if rates fall.
Another option is a hybrid ARM, which has a fixed rate for a certain amount of time, like three, five, seven, or ten years. After the fixed-rate period ends, the interest rate switches to an adjustable one and remains variable for the loan term's remainder.
A mortgage term (that is, how long it takes to pay off the loan) is typically 15 or 30 years, though it could vary. If you take out a 15-year mortgage, you'll pay off the loan much quicker (half the time) than with a 30-year loan, but the monthly payment is higher. The advantage to choosing a 15-year mortgage is that you will save thousands of dollars in interest, but the higher monthly payment isn't affordable for many borrowers.
Lenders will ordinarily recommend that you look at homes that cost no more than around three times your annual household income, assuming you expect to make a 20% down payment and don't have too much other debt.
Another basic rule for determining how much home you can afford is that your monthly mortgage payment shouldn't be more than around 28% of your gross (pre-tax) monthly income. These figures, though, might not accurately reflect your own financial and personal situation.
To get a rough idea of how much home you can afford, use Nolo's calculator.
Even if you think you can afford a specific loan amount, that doesn't mean that a lender will agree with you. One way to get an idea of how much a lender will actually lend to you is to get prequalified for a mortgage.
To do this, you'll have to provide your prospective lender with some information about your income, assets, and debts. The lender will then tell you how much it might lend to you based on this information. The lender won't guarantee that you'll be approved for this amount, but you'll get a ballpark idea of how much you can qualify for when shopping for a new home.
Before you apply for a mortgage, it's a good idea to shop around for the best home loan deal available. You'll need to figure out where you want to get your loan—through a broker or by going directly to the bank, for example—as well as keep your eyes open for the best interest rate and lowest closing costs. Always talk to several sources to find the best mortgage deal that you can get.
Once you're ready to finalize the mortgage deal, you'll have to fill out an application. The application will ask for information about you, your finances, and the details of your potential mortgage.
Be sure to take your time and be honest when you fill out the application. You'll seriously jeopardize your chances of getting the mortgage if you include inaccurate or false information in the application.
If you apply for a mortgage on or after October 3, 2015, the lender must deliver or mail to you a form called a "Loan Estimate" no later than the third business day after receiving your mortgage loan application. You'll also get a user-friendly "Closing Disclosure" three business days before you close on the mortgage loan. Be sure to review these forms carefully and ask your lender any questions before you go to the closing table.
For a guide that will help you select the right house, mortgage, agent, inspections, and much more, get Nolo's Essential Guide to Buying Your First Home, by Ilona Bray and Marcia Stewart (Nolo).