How Applying for a Mortgage Works

How Applying for a Mortgage Works

Applying for a mortgage can seem like a daunting, maybe insurmountable challenge. Maybe this is because purchasing a new home is quite possibly one of the biggest, most important investments you will make in your life. Or maybe it’s because of the high level of scrutiny you will be under during the process. However, by getting a better understanding of the process and properly organizing your documents, you can go forward into the mortgage process with confidence. 

Really, there is no better time to apply for a mortgage. Interest rates are at historic lows and real estate has returned to being one of the few investments that consistently gains value over time. This means that it is more than worth your while to learn about the mortgage application process and then take action. 

Gathering Personal Income Documents

With all loans, lenders want to know that you will pay back the money they lend to you. With home loans stretching between 15 and 30 years, lenders need to know you can maintain your payments for the long-term. They do this partly by verifying your income.

To help them do this, make sure you have your pay stubs from the past two years on hand. This should demonstrate to lenders that you can generate a consistent income that enables you to pay your bills. You can also count other assets, such as financial dividends, as income, the goal being to make your income look as big as possible without fudging the numbers.

Showing a Solid Employment History

Your employment history is just as critical as your income. It verifies to lenders just how dependable—or not—you will be in supplying the income that will ensure that you can pay them back. Steady employment eases their feelings of risk and gives an overall impression that you are a responsible, reliable person, while a patchy employment history makes them nervous. Two years of pay stubs from one employer is going to work in your favor; two years of pay stubs from four different employers will not. If you do have a sporadic employment history, try to supply documentation that gives good reason for this, such as a medical problem. 

If you're applying with a co-signer, you’ll want to approach his or her employment history with the same scrutiny. Rather than co-signing with someone who has a questionable employment history, you might want to seek out someone whose employment history will put lenders’ fears to rest.

Checking That Credit Score

As soon as you apply for a home loan, the first thing a lender does is pull your credit scores and history. These documents and information speak volumes about your ability to make your payments on time and handle debt responsibly. 

To avoid any surprises, check your credit profile yourself before you apply for a loan. This will allow you to spot and resolve any questionable issues—such as old information, small unpaid debts, identity fraud, or even incorrect entries—early on. You might even be able to raise your credit scores before they get in front of your lender. After all, even small improvements in your credit score can equal better interest rates and save you thousands in the long run.

For those credit issues that you cannot resolve immediately, be ready to provide written explanations as to why they happened and what you are doing to rectify the situation. If applicable, note any extenuating circumstance, like unemployment or sickness, that caused any credit problems. Best of all is if you can establish with underwriters that these problems will not repeat themselves. 

Matching Loan Amounts to Property Value

Once you’ve found your home, had your offer accepted by the buyer, and applied for a loan, the next big step is the property appraisal. The lender will arrange for a professional appraiser to visit and inspect the property to determine if the property is actually worth the amount you offered to pay for it. 

As inconvenient as the appraisal might feel in the moment, it really does benefit and provide protection to both you and the lender. You get notified of any potentially expensive or hazardous conditions on the property and the bank gets a detailed report of how the property will or won’t be a good investment for them.

Knowing Your Down Payment Options

Lenders want to see that you’re putting some skin the game, so to speak, that you are willing to assume some of the risks of your home right alongside them. The down payment is one of the key ways that you, as the borrower, can do this. But providing a large enough down payment to satisfy the lender can be a difficult task. 

For homebuyers coming from a previous home that they’ve owned, whatever profit they make on selling that home can and usually does become their down payment on the new property. But what about first-time homebuyers who may not have that equity or cash to draw from for a down payment?

This is where an FHA loan’s low down payment requirements come in handy. An FHA loan typically requires a minimum down payment of 3.5% of the loan amount, which is small compared to the 15-20% required on many conventional loans. In addition, the FHA allows you to use gift funds from family members or grants from government programs.

Weighing Your Financial Obligations

Can you afford it? It doesn’t help you or your lender to get you into a loan that you can’t pay back in the long term. To spot this problem before they’ve even approved the loan, lenders look at two different versions of your debt-to-income (DTI) ratio. 

The first is your front-end DTI ratio, which is your new house payment as a percentage of your monthly income. The second is your back-end DTI ratio, which is all your monthly debt obligations combined as a percentage of your monthly income. If either of these numbers is too high, lenders could decline to approve your loan. 

By liquidating old debts and avoiding taking on new debt before applying for a mortgage, you can improve your back-end ratio and improve your chances.

Locking in the Rate

Once you have an offer with a low interest rate, you might want to lock in that rate with the lender now. Locking in a rate commits the lender to a specific rate package for a specific period of time, whether that term is 10, 60, or even 90 days.

A rate lock makes sense if the market rates are expected to rise. It might not make sense if rates are falling. For the lender, longer terms could mean a loss if interest rates go up in the meantime. To offset this, lenders will often give you a higher rate or points that you pay upfront. 

Of course, the key here is timing. With interest rates changing every day, you’ll want to discuss the market conditions with your loan specialist and get his or her advice you on the right time to lock in your rate.

Securing Final Loan Approval

Thanks to new technology, loan approvals that used to take weeks can now be finalized and funded in just a few days. 

The best thing you can do at this stage is to eliminate any surprise that could derail the process last-minute. For instance, as the lender runs one last credit check, you don’t want them to find a bunch of credit purchases you made or payments you missed during the loan application process. This could hurt your scores and jeopardize your entire transaction. Rule of thumb here: until your loan is approved, don't do anything that could have an adverse impact on your credit.

Signing the Loan

Until you sign the loan papers, nothing is final. Up until the signing takes place, you can decline the offer and walk away. However, once all the signatures are on paper, loan funds are transferred, and the property title can be transferred, you now have all pride and anxiety that comes with owning your own home.

Do It When You're Ready

Taking out a home loan is no small commitment. Naturally, from the time you first meet with the lender to the moment you sign the papers and even afterward, you will feel a great deal of trepidation and anxiety about this heavy responsibility you’ve just assumed. And ultimately, it’s up to you to decide when the timing is right for you. A good loan specialist will patiently walk you through the process, tell you the best ways to prepare, and make sure that you are making a choice you can live with.

To learn how to successfully apply for an FHA mortgage loan, contact a Mortgage Advisor today.