Homebuying: More about Mortgage Loans

By Stanley Gill on 6/3/2020

Tags: just for fun

Buying a home can be a challenge, especially if you are a first time home-buyer. There are so many different steps, tasks, and requirements, so it's easy to feel anxious and overwhelmed about the whole process. However, homebuyers can demystify the task at hand by breaking it down into steps and learning what to expect from the process.

Buying a Home

Determine if You're Ready to Buy a Home

Buying a house is a huge commitment, and plenty of parts of a house may need attention in the years following the closing. When visiting a lender to determine how much you're qualified to borrow, you'll need to consider the following factors:

Income and Employment Status: Lenders want to see how much money you make as well as several years of work history to ensure that your income source is stable and reliable. You'll need to provide recent pay stubs, W-2s, tax returns, or other documents that a lender may request if you are self-employed.
Debt-to-Income (DTI) Ratio: Your DTI ratio helps a lender understand how much of your monthly income goes to debt so they can evaluate how much mortgage debt you can take on. Your DTI ratio is calculated by dividing your monthly debt by your monthly gross income. Lenders will use the debts shown on your credit report to calculate your DTI ratio. In most cases, you need a DTI ratio of 50% or less to qualify for a mortgage, but this number can vary.
Liquid Assets: You'll also need cash for a down payment and for closing costs. The down payment is the first payment you make on your loan, and the amount you need will depend on your loan type and how much you borrow. You could buy a home with as little as 3% down. Closing costs are fees that go to the lender and other parties for creating your loan. This amount depends on your location and loan type, but prepare for it to be 3% to 6% of the home's value. In some situations, closing costs can be rolled into your mortgage payments or paid by the seller.
Credit Score: Your credit score plays a huge role in the loans and interest rates that you can qualify for. Your credit score is based on your payment history, amount of money owed, length of credit history, types of credit used, and pursuit of new credit, and having a better credit score means you are less of a risk to lenders. Lenders usually require a score of at least 620 to qualify for most loans, but over 720 generally gets the best loan terms.
Willingness to Settle in One Place: Mortgages are a 30-year commitment, so it's important to consider your career goals, family obligations, and interest in your current area. These factors play a major role in the type of home you buy when you set up a primary residence.
Timing: Decide if it's a good time to buy a house. This depends on a variety of personal factors and market conditions and ultimately comes down to your own unique situation. The best course of action is to consult an expert before making any big decisions.

Calculate How Much House You Can Afford

Once you know you're ready for a home, the next step is setting a budget. Start by calculating your DTI ratio and looking at your current debts and income to determine how much you can reasonably afford to spend every month on a mortgage. Keep in mind that owning a home comes with costs that you don't have while renting, such as property taxes and homeowners' insurance, and those expenses should be factored into your budget.

Save for a Down Payment and Closing Costs

There are a variety of ways to save for a home, such as gifts of money from relatives, investments, and savings accounts. Home-buyers often mistakenly believe that they need at least a 20% down payment, but while a large down payment can help mitigate costs down the line, it's unrealistic for many first-time home-buyers. However, there are plenty of options for those who cannot put that much down. For example, conventional loans are available for as little as 3% down, and FHA loans have a minimum down payment of 3.5%. Some VA loans and USDA loans allow qualified borrowers to put no money down at all. Keep in mind, though, that putting less money down means that you may have larger mortgage payments, you may have to pay a higher interest rate, and you may need to pay for private mortgage insurance (PMI).

Closing costs are also important to consider when buying a house. You should prepare to pay 3% to 6% of the home's value, depending on your loan type, your lender, and your location. Before you close, your lender will give you a closing disclosure document that lists all of the closing costs and how much you'll need to pay. Always look it over closely so you know what to expect.

Get Pre-Approved for a Mortgage

Once you're ready to start looking for houses, you need to get pre-approved for a mortgage. When you apply, the lender will give you a letter that states how much you're approved for based on your credit, assets, and income. This letter can be used by a real estate agent to help you find homes within your budget.

Find the Right Real Estate Agent for You

A real estate agent is a representative in the home-buying process who will look out for your best interests and find homes that meet your criteria. They'll arrange showings, help you write up offers, and interact with the selling agent for you. It's possible to buy a house without a real estate agent, but it's not recommended for first-time buyers; the process of buying a home can be complicated, and an agent can help to ensure that all of the steps are followed correctly and that you don't end up overpaying for the house.

Start House-Hunting

A real estate agent will help you find houses that fit your requirements. Before you start, it's always a good idea to make a list of what you want in a house. Some factors you may want to consider in your search for a house are:

Location
Price
Square footage
Proximity to a good school district
Number of bedrooms
Condition of the house vs. the extent of repairs you're willing to take on
Access to public transportation
Yard size and configuration
Property value trends
Property and real estate taxes

Make an Offer

Once you find your dream home, you have to submit an offer letter in writing that includes details about yourself, such as your name and current address, how much you're offering, and a deadline. The seller then has three options to respond: accept the offer and move forward, reject the offer, or make a counteroffer that could change the purchase price or the terms of sale. If you receive a counteroffer, you can either accept or reject it or make your own counteroffer.

Negotiations may take some time. It is a real estate agent's job to help you manage negotiations, but even so, don't be afraid to walk away if an agreement can't be reached. Once a seller accepts an offer, you can move on to the next step.

Get a Home Inspection

Lenders don't usually require a home inspection to get a loan, but you should always get an inspection anyway before you buy property to ensure that you are buying a home that is safe and that the seller isn't trying to hide major issues. An inspector will go through the home specifically looking for problems and will test electrical systems, make sure appliances are working, and check the roof. After the inspection, the inspector will give you a list of problems found in the home, and you should go through them line by line to look for major issues. If the home has serious hazards, such as lead paint or mold, it isn't unreasonable to ask the seller to correct the problems before the closing. If you and the seller cannot reach an agreement, you may want to back out of the deal.

Keep in mind that after closing on the house, you'll be liable for any major repairs. If your home inspection reveals a major problem, like issues with the foundation, a leaking roof, or poorly installed windows, then you may want to reconsider your purchase.

Get a Home Appraisal

An appraisal is required by lenders because they will not lend more than a home is worth; if the appraised value comes back lower than your offer, you could have trouble financing the house. However, you can consider contesting the results of the appraisal if you believe it's too low.

Ask for Repairs or Credits

After you review your inspection report, you can ask the seller to correct the problems the inspector found in one of three ways:

Ask the seller for a discounted purchase price
Request that the seller give you credits to cover some of your closing costs
Ask the seller to fix the problems before you close

Do a Final Walkthrough

Always do one more walkthrough before you close on the property, even if you know that the home is exactly the one you want. This walkthrough allows you to check that the seller has made any necessary repairs, that the seller has completely cleared out their property, and that everything is in working order. If everything looks good, you can confidently move on to the closing.

Close on Your New Home

Your lender is required to give you a closing disclosure, which details everything that needs to be paid when you close on your house. Always read through the closing disclosure to make sure the numbers don't vary too much from the loan estimate.

At your closing, bring your ID, a copy of the disclosure, and any required payment for the closing. You'll have to sign a settlement statement that lists all of the costs related to the sale, and this is when you pay both the down payment and closing costs. You will also have to sign a mortgage note that states that you promise to repay the loan and a mortgage or deed of trust to secure the mortgage note. After you do that, you are officially a homeowner!

Types of Mortgages

While you're looking to take out a mortgage, keep in mind that there are plenty of different kinds of mortgages out there that offer different benefits and drawbacks for every potential home-buyer.

Conventional Mortgages

Most loans in the U.S. are conventional loans backed by Fannie Mae or Freddie Mac. They are popular options for home-buyers, and you can get one for as low as 3% down.

Jumbo Mortgages

A jumbo mortgage is a type of loan that exceeds the limit originally set by the Federal Housing Finance Agency. Unlike conventional mortgages, these loans are not eligible to be purchased by Fannie Mae or Freddie Mac and are designed to finance homes in high-priced markets and luxury properties. Jumbo mortgages have unique underwriting requirements and have gained traction after the housing market began to recover following the Great Recession.

Government-Insured Mortgages

Government-insured mortgages are popular with lenders because if the person who took out the loan defaults, the lenders are not on the hook for the money. Here are some of the most popular types of mortgages that are insured by the government:

FHA Loans: Since these loans are backed by the Federal Housing Administration, they are less of a risk for lenders. Because of that, FHA loans have less strict credit score requirements and are available with a down payment as low as 3.5%.
VA Loans: These are mortgages for veterans, active-duty members of any branch of the armed forces, and surviving spouses. VA loans are insured by the Department of Veterans Affairs and are popular with home-buyers because there's no down payment required.
USDA Loans: These are government-backed loans that help people in rural and suburban areas buy homes. You can get a USDA loan without any down payment, but the home must be in a rural area that is acceptable to the terms of the loan and you must meet all income eligibility rules.
VA Home Loans
FHA Loan Requirements
USDA Eligibility
Basic FHA-Insured Home Mortgage Guide

Fixed-Rate Mortgages

A fixed-rate mortgage has an interest rate that doesn't change during the period the loan is active, so your monthly payment of principal and interest will remain the same over time. These mortgages are popular because they offer predictability and stability.

Adjustable-Rate Mortgages

Unlike a fixed-rate mortgage, an adjustable-rate mortgage has an interest rate that varies throughout the life of the loan. There are limits set on how much the interest rates and payments can rise over the life of the loan, and this option can be a smart financial choice for home-buyers who plan to pay off the loan within a specific amount of time and will not be financially hurt if the rate rises.