What do you think is the most stressful (and confusing) part of buying a house? Would you say it’s trying to find the right real estate agent? Maybe it’s the task of looking at house after house until you find the one. Why, maybe it’s even dealing with the anxiety that comes while you’re waiting for closing day to finally come. All of these things are stressful and confusing, but you’d be surprised by how many people struggle with the mortgage process. And they need answers to their mortgage questions.
Why can’t it be as easy as asking for a certain amount of money, getting approved, and buying a house? Why must there be so many lending companies, all of which have different requirements and terms?
As a first-time homebuyer, you’re likely among the 85% of buyers who will apply for a home mortgage instead of paying cash. To help you understand exactly what you’re getting into, we’ve created a comprehensive guide that answers the most common mortgage questions buyers have for lenders about the mortgage process.
Without further ado, let’s get started.
A: Home affordability is pretty self-explanatory — it’s an expression of how much house you can afford to buy and still live comfortably.
However, the home a person can afford isn’t cut-and-dried; it varies from buyer to buyer. Everyone’s finances and circumstances are different.
To figure out how much house you can afford, you’re going to have to take a close look at a few different variables.
The very first thing you need to consider is your income. First, lenders will look at your annual gross income when they’re deciding how much money you can borrow. Your gross annual income includes money earned from full-time jobs, part-time jobs, and any money earned from self-employment (so long as you’ve been steadily earning this self-employment income for at least two years). It also includes alimony payments, income from rental properties, unemployment earnings, and pension payments.
However, when you are trying to figure out how much house you can afford, you should also look at your monthly net income. This is the amount of money you have after taxes and any deductions come out of your paycheck. You can include alimony, child support, and passive income when calculating your net pay.
Note: If you have a spouse, you will want to include their earnings in these figures.
After looking at how much money is flowing into your household, you’ll want to write down your monthly debts. That’s because lenders will also look at your debt-to-income ratio, or DTI.
“You would add up all of your monthly debt payments, such as auto loans, mortgage payments, minimum payments on credit cards, student loan payments and installment debts,” explains Marcus Rittman from HomeLight Home Loans.
To come up with your debt-to-income ratio, Rittman adds, “You’re going to take your monthly debt and then divide that by your gross monthly income. That number will be your debt-to-income ratio. As a general rule, the maximum debt-to-income ratio buyers should use to calculate how much house they can buy would be 43%.”
As an example, let’s say this is what your monthly debts look like:
- $1,200 for mortgage
- $300 for car payment
- $500 for credit card payments and student loan payments
Add this up and it equals $2,000 in monthly debt.
Then let’s say you gross $8,333 per month.
( 2,000 / 8,333 ) X 100 = 0.36 X 100 = 36%
Your debt-to-income ratio is 36%. If you wanted to upgrade to a more expensive home, and planned to go up to 43% DTI, you could afford $2,783 per month considering your other debt payments.
Typically, the lower your DTI, the more home you’ll be able to afford when you get a mortgage.
If this math is making your head spin, you can use our affordability calculator to figure out your DTI, too.
How much do you have in your savings account right now? In September 2020, the average American had $3,500 in a savings account, although the Federal Reserve released a report that stated only 61% of Americans could cover a $400 emergency in 2018.
If you’re going to buy a home, you’ll need enough savings for a down payment, closing costs, and financial experts advise that you should also have enough money left over in your savings accounts to cover at least three months of expenses in case of an emergency.
Your credit score is another big factor to consider because it helps determine whether you qualify for a mortgage, and the interest rate you’re offered on your loan.
Buyers with excellent credit are offered lower interest rates which translates to lower mortgage payments each month, while buyers with lower credit scores pay higher rates and will pay more for their mortgages.
Q: What credit score do I need to qualify for a mortgage?
A: Your credit score is a reflection of your ability to repay debts on time and in full.
There are three main credit bureaus: Equifax, Experian and Transunion. They collect your credit information and compile it so lenders can determine your creditworthiness.
Lenders will typically look at your FICO score, which takes the credit information from the three credit bureaus, and assigns you a numeric credit score from 300 to 850.
The higher your score, the better chances you’ll have at being approved for a mortgage with lower interest rates. Credit scores typically fall into one of these ratings:
- 580 and below: poor
- 580-669: fair
- 679-739: good
- 740-799: very good
- 800-850: excellent
The minimum credit score you need to be approved for a mortgage will depend on what kind of loan you are applying for. FHA loans allow credit scores as low as 580 (or even 500 if you’re putting down 10% or more), and conventional loans allow credit scores as low as 620.
Los Angeles-based top-selling agent, Alison Van Wig, works with 72% more single-family homes in her area than average agents, and she strongly recommends that clients reach out to an agent up to an entire year before deciding to buy a house.
“Sometimes, the longer you wait to call us, the harder it’s going to be to get you into a home when you are ready.” She advises that the sooner you contact an agent, the sooner they can recommend a qualified loan officer that can advise you on your financial situations and steps you might take to save a downpayment or fix issues with your credit which could take up to a year and a half to repair.
You’ll want to use the official site for requesting your credit reports from the bureaus, “and look for anything that looks suspicious or fraudulent. If you catch it early, it can be cleaned up quickly. Sometimes you can negotiate your debt and offer to pay a portion of it in exchange for a letter stating the debt has been paid in full.”
Note: Don’t worry, we’ll explain the different mortgages and their requirements later in this guide.
Q: How much should I save for a down payment?
A: A common myth people believe is that you absolutely have to have a 20% down payment when buying a house. That’s a huge chunk of change, and for most people, it would take ages to save that much money.!
Fortunately, you don’t have to put down 20%. The National Association of Realtors reviewed homes that were purchased between July 2019 and June 2020 in its annual Profile of Home Buyers and Sellers, and it found that within that time frame, the average first-time homebuyer put down 7% and financed the remaining 93%.
Repeat buyers typically have a larger down payment — around 16%.
If you’re having a difficult time saving for a down payment, there are quite a few down payment assistance programs worth looking into. Some down payment grants are matching programs, which means the grant will match the down payment amount you’ve already got saved, or possibly pay as much as four times your savings!
If you want more information regarding these down payment programs, we wrote an extensive article about them here.
Q: What type of mortgage should I apply for?
A: Whether you’re a first-time homebuyer or you’ve bought a house before, a common mortgage question folks have surrounds the kind of mortgage they should apply for. The truth is, it really depends on what you qualify for and what terms best suit your needs.
Let’s take a look at your options.
To get a conventional loan, you’ll need to go to a private financial institution, which include banks, credit unions, and mortgage companies. The loans offered by these institutions aren’t backed by a government agency, like an FHA loan or a VA loan would be.
To qualify for a conventional loan, borrowers need to have a minimum credit score in the 620 to 640 range.
A conforming loan is a loan that cannot exceed a certain dollar limit, which is set by the Federal Housing Finance Agency (FHFA). This dollar limit is based on the FHFA’s house price index and will vary from county to county; you can figure out what that limit is in your county by using the FHFA’s interactive map. Most counties in the U.S. have a conforming lending limit of $548,250, though it can be higher in some of the priciest housing markets. The upper limit is $822,375 for these more expensive markets.
To qualify for a conforming loan, the loan must be under the dollar limit set by the FHFA, but you will also need at least a 620 credit score, a debt-to-income ratio below 50%, and at least a 3% down payment (for qualifying first-time buyers).
A government-backed USDA (United States Department of Agriculture) loan is specifically geared toward those interested in buying property in an eligible rural area.
One of the largest draws about this type of loan is that qualifying buyers do not need a down payment.
To qualify for a USDA loan, lenders typically require borrowers to have a 640 credit score, but the USDA itself doesn’t designate a minimum credit score. Borrowers must show they’ve been with the same employer or in the same industry for two years and they cannot earn more than the income threshold for their region.
A borrower going for a USDA loan must follow the USDA’s housing-to-income and debt-to-income ratios to the T. Mortgage payments (this includes homeowner’s insurance, taxes, loan interest, and loan principal) cannot exceed 29% of the household’s monthly income, and their total debt (car payments, credit card debt, student loans, medical debt, and so on) cannot exceed 41% of the household’s monthly income.
Also, it’s important to know that although you may not need to put any money down for a USDA loan, you are expected to be able to pay closing costs.
A FHA (Federal Housing Administration) loan is another government-backed loan that can offer access to more borrowers.
To qualify for a FHA loan, you’ll need a 580 credit score and a down payment of at least 3.5%. However, if you have a credit score lower than 580, lenders will still consider lending to you if you have at least a 10% down payment.
Note: In 2020, some lenders increased the minimum FHA loan credit score to 680 for certain borrowers due to the pandemic.
A VA (Veteran Affairs) loan is a loan specifically for veterans that is guaranteed by the VA. The VA doesn’t have a designated minimum credit score but the average lender will require, at minimum, 620 credit score. Borrowers aren’t required to have a down payment, nor will they be required to have mortgage insurance on the loan.
Note: Some lenders are increasing the minimum credit score to 700 for certain borrowers due to the pandemic.
Q: What’s included in my monthly mortgage payment?
A: Your monthly mortgage payment isn’t just paying back the money that you borrowed. It’s made up of several different components.
The principal refers to the original amount of money that you borrowed from the lender.
The mortgage interest is also known as your mortgage rate, and it’s expressed as a percentage of your loan amount.
Being a homeowner means you’ll have to pay property taxes, which are based on the assessed value of your home, not how much you paid to buy it.
Mortgage insurance is typically required if you put down less than 20% on your new home (unless you get a VA loan — they forgo mortgage insurance entirely, but do charge a funding fee). It usually costs between 0.5% to 1% of the loan amount annually.
Homeowner’s insurance isn’t just a good thing to have; it’s a necessity! This insurance takes the burden for paying for repairs or rebuilding your home should you have a fire, theft, or experience damage from a covered natural disaster.
Miscellaneous fees typically include homeowner’s association fees, but other fees may exist as well.
Q: Will I need mortgage insurance?
A: If you have a conventional loan, lenders typically require borrowers to get mortgage insurance when they do not put 20% down on the house. You can avoid this by comparing lenders, as some may not require you to pay for mortgage insurance even if you don’t have a 20% down payment by offering lender-paid mortgage insurance, a piggy-back second mortgage, or by taking advantage of various down payment assistance programs if you qualify.
Fortunately, even if the best loan for you includes MI, you can remove the mortgage insurance from a conventional loan once you’ve accrued 20% equity in your house (meaning you have an 80% loan-to-value ratio).
Q: What is a mortgage rate, and how does it affect my loan?
A: Your mortgage rate (also known as your interest rate) is the interest that your lender charges you for extending you the loan, and you will have to pay it back in addition to the loan principal.
Q: Should I get a fixed-rate or adjustable-rate mortgage?
A: When mortgage rates are low, your best bet is to get a fixed-rate mortgage over an adjustable-rate mortgage.
Fixed-rate mortgages means that your mortgage rate never changes, which means your mortgage payment will stay the same throughout the life of the mortgage (note: your taxes and homeowner’s insurance — which are usually included in your mortgage payment — may rise over time).
An adjustable-rate mortgage means that for the first few years (or however long is specified in your mortgage agreement), you’ll have a lower introductory mortgage rate.
However, once that time frame is over, your interest rate will adjust to reflect the market interest rates. That could be good or bad, depending on what rates have done since you bought your house.
Q: Should I lock in my rate (if so, when)?
A: Short answer: Yes, and as soon as possible.
“If you have a good rate, don’t gamble,” Allison advises.
When interest rates are low, why would you wait to lock in your mortgage rate? Holding out for lower rates might seem like a good tactic, but there’s no guarantee that rates will fall before you buy. If you’re concerned you might miss out, you can talk to your lender about a float-down option, which will let you change your rate once if rates fall again after you lock in your rate but before you close (float-downs are not always offered for free, though).
Q: When is the best time to get preapproved?
A: The best time to get preapproved for a mortgage is before you begin the house hunt. When you have that preapproval letter, you know what your budget is so you aren’t falling in love with houses that you cannot afford.
Q: Should I consider getting points on my loan?
A: When a loan originator talks about “points on your loan,” they’re referring to discount points, which can reduce your loan interest rate. One discount point usually costs roughly 1% of the loan amount (the total amount of money you’re borrowing) and decreases your interest rate by about 0.25%.
“What this does is, you pay extra in closing costs to get a lower rate, which gives you a lower monthly payment,” Rittman explains.
“The average homeowner keeps their mortgage for about seven years. So if they pay $10,000 in points, their monthly savings might be $100. They will have to be in the house for 100 months to recoup that difference.”
Q: What will I pay in closing costs?
A: Closing costs are inevitable. These are the fees that will be paid at closing, and they can range between 2% to 5% of the loan amount. As a buyer, you’ll be expected to pay:
- Lender and broker fees, which covers credit report fees, application fees, and loan origination fees. They’ll typically add up to no more than 3% of the loan amount.
- Third-party fees, which cover tax transfers, title, escrow, recording fees, and homeowners insurance.
You can estimate how much you may have to pay in closing costs by using our closing cost calculator.
Q: How long will it take to close on a home?
A: From the time your offer is accepted, closing typically takes four weeks. During this time, there will be a number of tasks to complete, such as the home inspection, home appraisal, negotiations, and the final walkthrough.
Possible reasons closing may be delayed
As much as we’d love to say that closing always goes smoothly, that’s not always the case. There are quite a few reasons closing could be delayed, but the most common reasons are issues with the mortgage loan, appraisal issues, and inspection problems.
For a full breakdown, check out this blog post where we go over the 17 reasons (yes, 17!) why closing could be delayed.
Q: Can I pay my mortgage off early?
A: Yes, you can and usually without any penalties — depending on your loan.
Rittman explains under what circumstances there would be prepayment penalties: “A non-QM (qualified mortgage) loan is a little different because they are offered by private groups and investors who have different underwriting criteria.”
For example, he says, if someone is self-employed but doesn’t want to provide the lender with all of their earnings documentation, a lender may still work with them if the borrower has great credit and a healthy savings account.
Q: When can I consider refinancing my mortgage?
A: If you’ve made six months’ worth of mortgage payments, you can start looking into refinancing; however, there are some lenders who will want you to pay your mortgage for a year or more before they’ll consider refinancing your loan.
Ideally, you’ll want to refinance when interest rates are significantly lower than when you purchased your home.
Let’s say you bought a house years ago with a 6% interest rate. However, if interest rates fall below 3%, that would be a great time to refinance!
You could also refinance if you need to access the equity in your home and use that money to pay for home improvements, pay off debt, or even expand your real estate empire with rental properties.
Navigating the real estate world can be intimidating, especially when it comes to getting a loan, but we hope this in-depth guide answered all of your mortgage questions!
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