Let’s take a closer look at a home loan and how its application process works.
What is a home loan?
A home loan, or a mortgage, enables you to purchase a home without having to foot all the cash out of pocket. You will, however, need to make a down payment, which is typically between 3.5-20% of the home’s appraised value, closing costs, and some other fees. The lender then finances the rest of the purchase. You’ll repay the loan, along with interest, over the course of (generally) 15 to 30 years.
Are all home loans alike?
Before you get started, you’ll need to choose a mortgage type. A conventional loan will necessitate a 5-20% down payment on the home. There’s also an FHA loan, which only requires a down payment of 3.5%, but necessitates mortgage insurance. If you’re a military veteran, consider obtaining a VA loan, which lets you buy a home with zero down payments.
Once you’ve chosen the kind of loan that is best for your scenario, you may select repayment arrangements for that loan. Here are the three common types of mortgages:
- 30-year fixed-rate mortgage. The interest rate on this 30-year mortgage will remain fixed, no matter the national rate changes.
- 15-year fixed-rate mortgage. This mortgage will also have a fixed interest rate, but the term lasts just 15 years. The monthly payments will be higher, but the overall interest paid throughout the loan will be significantly lower.
- Adjustable-rate mortgage (ARM). An ARM gives the borrower a lower interest rate in the early years of the loan, and then a gradual increase (adjustment) in rate over the rest of the life of the mortgage.
What do I need to know before applying for a home loan?
A home is likely to be the largest purchase you will ever make. To qualify for one, you will need to prove that you live a financially responsible life and can afford the monthly payments.
The primary way lenders gauge your financial responsibility is through your credit score. This number is like a grade that tells lenders how you’ve handled your past credit card accounts and other debts. It will include the length of time you’ve had your credit cards and loans open, the timeliness with which you’ve made your payments, the trajectory of your debt, and the amount of available credit you might use. Most lenders will only grant a home loan to borrowers with a credit score of 650 or higher. You can check your score for free on Credit Karma. You might also consider ordering a free credit report from all three major credit bureaus at AnnualCreditReport.com.
When leading up to your mortgage application, make sure to pay all your bills on time, don’t open new credit cards, and work on paying down the overall debt. A higher credit score will help you get approved quicker, and it will get you a lower interest rate on your loan.
Another crucial factor in determining your eligibility for a mortgage is your debt-to-income ratio or your DTI. Lenders want to know how significant your outstanding collective debt will be to your income if you receive the home loan. Most lenders will only allow a maximum DTI of 36%. Here at Magnolia FCU, we enable our members to take out a home loan with a DTI of [XX%].
When should I apply for a home loan?
While you won’t need the loan until you are ready to close on a house, it’s good to start the process before you begin house-hunting. Your lender will let you know whether you can expect to be approved for a loan and provide you with an estimate of how much house you can afford so you don’t face disappointment later.
When initially applying for a home loan, ask your lender for a letter of pre-approval. This letter confirms you are pre-approved for a home loan up to a specific amount. Having this letter in hand shows real estate agents and sellers that you are serious about buying. Most pre-approvals are only good for 60-90 days, so make sure you’re ready to start house hunting before you get yours.
How do I apply for a home loan?
To apply for a home loan at Magnolia FCU, stop by and ask a representative or email terry@magfedcu.org. Ensure all of your financial paperwork is in order and hold on to all critical financial documents in the months leading up to your application.
To make it easier, we’ve created a list of the information you’ll need to prepare for:
- Verifying your income and employment
- Reviewing your credit report in detail
- Analyzing your assets
- Calculating your debt-to-income ratio
- Performing a credit score check.
To become approved for a mortgage, and one with a favorable rate, you’ll have to prove you’re in good financial standing. You’ll have to stay that way between you filling out the application and the finalization of all your documents.
As you begin the mortgage application process, you’ll want to do your best to avoid anything that could interfere with that consistency or substantially change the condition of your finances. You will also need to explain any blemishes on your financial record, including bankruptcies, collections, foreclosures, and delinquencies.
Here are several tips to help maintain a smooth mortgage process:
- Don’t Apply for New Credit Cards
Each time you apply for credit, it temporarily dings your credit score. Not to mention, taking on any new debt could impact your approval for a mortgage.
It’s a sensitive set of equations that dictates how much you can afford to borrow. Your credit score is a big part of that equation, which could be impacted negatively by new credit applications. Each credit application could take several points off your credit score, and this can add up if you apply for several credit cards.
- Don’t Make Large Purchases
It’s understandable — You’ve been pre-approved for a new home mortgage, and you’re excited. In the midst of anticipation of moving in, you start buying new appliances and furniture that you plan on filling up your new home.
Don’t be tempted to do this. Making any major purchases during this time takes credit or money. Your mortgage approval is based on specific criteria, like cash reserves, debt-to-income ratio, and assets. Changing any of these could put the funding and closing of your new home in jeopardy. You’ll need available funds for your down payment and closing costs anyway, so you’ll want to avoid making any significant expenses until you close your loan.
- Avoid Changing Jobs
If you plan on a job change, you might want to do it either a couple of months before applying for a mortgage or after you’ve closed on your home. Switching employment can negatively impact the mortgage approval process. Lenders want to see consistency in your income, and a job change can disrupt income. Some types of job changes can also increase your lending risk because it makes your income less predictable.
For instance, two scenarios that could affect the approval of your mortgage loan are:
- Becoming self-employed or a contract employee: If you’re considering going from a W-2 employee to starting your own business or becoming an independent contractor, the best advice is to hold off until after you’ve closed on your home. While some loan programs approve loans after a year of self-employment, most prefer seeing at least a two-year self-employed history.
- Moving to a commission-based position from a salaried job: Commissioned income is typically going to be averaged over the last year. You could potentially derail your mortgage approval by changing to this type of pay structure.
If you’re ready to apply for a home loan, stop by Magnolia FCU or email terry@magfedcu.org. We’re committed to helping you navigate the process with ease.
Your Turn: How did you prepare for a home loan application? Please share your tips with us in the comments.