8 Frequently Asked Mortgage Questions
Maybe you’ve heard some horror stories about homebuying: rising prices, housing shortages and tightened lending requirements. But searching for your dream home doesn’t have to be nightmarish when armed with knowledge to face today’s market.
We’ll answer potential buyers’ most common questions. But first, some good and bad news: Yes, creeping home prices put September’s median price of an existing home at about $258,100, 4.2% higher than the same time last year, according to the National Association of Realtors. And yes, while lending requirements were tighter earlier this year, there are signs that’s changing. The upside of rising home prices and a general housing shortage is that more people are sitting it out, which means lenders need a way to bring business back. In June, mortgage credit availability increased, with just one catch — it was offset by a decline in credit for government loans.
Whether you’re shopping for a government-backed mortgage or a conventional one, our experts tell you what you need to know.
Do I need a great credit score?
In general, the best interest rates goes to those with good credit. You may qualify for a Federal Housing Administration loan with a credit score of 580 but conventional loans typically require a score of at least 620. You may qualify for an FHA loan with a score as low as 500, but your down payment will be higher, 10% versus 3.5%.
Other types of loans have different requirements. A Veterans Affairs loan technically has no minimum credit score — instead it requires that lenders look at a potential borrower’s entire profile. U.S. Department of Agriculture loans, primarily designed for those in rural areas, typically require a credit score of at least 640.
Does my spouse’s credit score matter?
Yes. If your spouse submits their name as a co-applicant, the lender will consider their credit score and credit history, according to Todd Hatfield, loan department manager at Granite Credit Union. “Credit approval is based on the lowest two middle scores of both borrowers. We take the lowest middle score from all three reporting agencies, and use that as a baseline,” he said.
Checking your credit report with each of the bureaus before you apply for a home loan will give you time to fix any errors or take care of any items that could be affecting your credit score.
Do I need a large down payment?
The not-so-short answer: It depends. Traditionally, a borrower is expected to bring about 20% to the table. However, according to Freddie Mac, it’s not a hard-and-fast rule. In fact, buyers may be able to get away with down payments as low as 3% through special programs. One benefit of providing at least 20% at closing is the absence of private mortgage insurance (PMI).
Buyers who put down less may have an additional fee added to their monthly mortgage payment to cover the PMI until they’ve built 20% equity in their home. Learn more about ways to avoid PMI.
How do I get approved for a mortgage?
The approval process can be a bit long and tedious. After filling out an application with the lender, you’ll have to provide a lot of information, including:
- Pay stubs (last 30 days)
- Two years of W-2s
- Two years of tax returns
- Bank statements from the last two months
- Investment statements
- Proof of where you got money for a down payment, such as bank statements or a statement from someone saying it was a gift
- Proof of identity
- Social Security number
Once you provide the necessary documents, the lender will review your information and pull your credit report and score. If you meet their requirements — usually a minimum credit score, cash for a down payment and low debt-to-income ratio — you may be approved. There are a number of things that can derail your home purchase (even after a preapproval), so don’t open any new lines of credit or spend a ton of money until after your loan is finalized.
What’s a good debt-to-income ratio?
Aim for 43% or lower. Fannie Mae will insure loans for borrowers with a DTI ratio as high as 50%, but in general, lenders prefer to see lower levels, which indicate the ease with which you can repay the house loan. Freddie Mac recommends a mortgage payment that’s less than 28% of your monthly income. There are some indications that lenders weigh DTI more heavily than credit score.
Do I need a preapproval?
Preapproval or prequalification might be some of the first terms you hear in any house hunt — many real estate agents will be reluctant to show you any properties without a preapproval letter. A preapproval letter is typically good for 60 to 90 days. You’ll want to apply for a preapproval once you are serious about your home search, as you may have to reapply if you don’t find a home within the designated time frame.
What’s the difference between preapproval and prequalification? A prequalification requires less paperwork and verbal confirmation of credit scores. A prequalification does not mean you will be preapproved, it just means you are likely to qualify. A preapproval requires more documentation, including tax returns and bank statements. The lender pulls your credit report and offers a conditional loan. This number should help narrow your search to homes you can afford. If you are preapproved for a loan, you still have to wait for the bank to offer a commitment. This step entails a home appraisal, and the bank may ask for more information from you or the seller if they feel it’s necessary.
What is the biggest mistake people make during the mortgage process?
One of the biggest mistakes you can make while in the process of purchasing a home is opening a new line of credit. “The biggest detriment to buying is to get new credit. You get people that are excited and run down to buy new furniture or a new car,” Hatfield said. “That has to be factored into their debt ratio. If it puts them over, they can lose out on the home.”
Once you’ve submitted your paperwork for preapproval, stop spending money on any of your credit cards. Don’t make any large purchases until after you have the keys to the home. Even if the expense doesn’t push you over the debt range, it could delay the approval process, which could cost you your dream home, especially in a competitive market.
Can I get a mortgage loan if I’m self-employed?
A common misconception is that individuals who are self-employed cannot get a home loan or that it’s more difficult. But, this isn’t true, Hatfield said. “Being self-employed doesn’t create problems. It just changes the documentation needed.”
He did note that one common issue is when self-employed buyers write off expenses to reduce their taxes. “If you write it off, it’s not income and it can affect your ability to qualify.”
Tip: Plan ahead. Consider cutting back on your write-offs or saving more money for the down payment to offset the lower income number.
What type of mortgage is right for me?
There is no one right answer for this. The type of mortgage loan that works for you may not work for your neighbor. And the type of loan that works for your co-worker may not work for you.There are several loan types available but here are a few terms to keep in mind:
- Conventional and government-backed loans
- Adjustable versus fixed-rate loans
- Conforming, or jumbo, loans
Government-insured or conventional?
The big difference is that a conventional mortgage is a loan from a private institution. The loan is not insured by the government. A government-insured loan (like the FHA, VA, USDA loans we mentioned earlier) also originates from a private lender, but the government insures the loan so that the lender doesn’t lose money if the borrower defaults. While an FHA loan does require a two-step approval process (the lender and the government), it’s actually easier to qualify for than a conventional loan. Because a conventional loan isn’t insured by the government, lenders often have stricter requirements.
Adjustable or fixed rate?
An adjustable rate means your interest rate and your monthly payment may vary. The payoff is that you can take advantage of lower interest rates. The risk: Your mortgage payment won’t be the same every single month. A fixed rate loan means the interest rate (and your payment) stay the same for the life of your loan.
Conforming or nonconforming?
A conforming loan simply means that the loan meets standards set by Fannie Mae and Freddie Mac, including loan limits. A nonconforming loan is one that exceeds those limits, which is why it’s often referred to as a “jumbo” mortgage. Most lenders opt for a conforming loan as it’s easier to insure and/or sell.
What is the most difficult part of the mortgage process?
Hatfield says the most difficult part for buyers is stepping back and looking at the house with a clear perspective. “Buying a home is an investment. You need to treat it that way. Don’t rely on emotions. When you purchase a home it’s for a long time, it’s not that easy to get out of a home after your purchase. If a home needs major repairs, for example, you should consider if those problems are things you can or want to invest in fixing.”
Buying a home is an exciting time, but applying for and choosing the right loan can be overwhelming. Reviewing these frequently asked questions will help clarify the loan process so you can spend more time enjoying your house hunt and less time stressing about the paperwork.