What First Time Home Buyers Need to Know for Mortgage Preapproval
Posted by: Mike Dulla, President, United Home Loans
What’s in this article?
- Know your credit scores
- Plan for a down payment and closing costs
- Understand mortgage insurance (PMI)
- Set a monthly budget
- Organize financial documents
- Get pre-approved
- Start your home search
[Next article will review contract, mortgage application and closing process]
Know Your Credit Scores
Like or not, so much is riding on your credit scores. To begin with, most lenders require a minimum credit score of 620 to even issue an approval. And beyond that, your credit score will have a direct impact on the amount of your monthly payment. A higher credit score will typically mean a lower interest rate and mortgage insurance premium (if required) and of course a lower credit score will have the opposite effect. So, it pays to check your credit score well before you think about buying a home.
Also, it is important to understand that many of the free credit score providers, such as Credit Karma or Experian, may use a different scoring model than mortgage lenders use and the difference in scores can be dramatic. Fannie Mae and Freddie Mac, the mortgage giants that control the industry, still require the use of an older FICO classic credit scoring model where many large credit score providers use a newer model. That is why it pays to have your credit checked by a mortgage lender so you know the scores you see are the scores that will be used for your loan approval.
Plan for a Down Payment and Closing Costs
Prior to buying, you will need to have some money saved for your down payment and closing costs. Most buyers will need a down payment of at least 5%, but some programs allow for down payments as low as 3.5% or even 3%. Underwriting requirements do permit gifts from family members so if you have a rich uncle, give him a call.
Closing costs will typically run approximately 2% to 3% of the sales price. But, there are many ways to lower that amount through a seller credit or a lender credit. Make sure you discuss this with your lender up front so a credit can be negotiated as part of the loan terms, sales price or both.
Understanding Mortgage Insurance or PMI
If you put down less than 20% on your home purchase. Your lender will require that you have mortgage insurance as part of the loan transaction. Mortgage insurance (PMI) protects the lender up to a certain dollar amount if you default on your loan payments. PMI protects the lender, not the borrower. Even though PMI gets a bad rap, it allows lenders to provide loans with less than 20% down so in the end, it is good for consumers. There are also ways to buy out your mortgage insurance; discuss those options with your mortgage lender.
Set a Monthly Budget
We always tell clients there is a big difference between what a lender says you can afford and what you truly feel like you can afford. Only you will know your personal spending habits on items like food, entertainment and other miscellaneous expenses. Those costs do not show up as part of your loan application but can obviously have a big impact on the affordability of a new housing payment. Set a monthly budget with your net monthly income, fixed and variable expenses. There are several great templates on line that will do the trick. Just make sure you actually complete the budget before you really think about buying.
Organize Your Financial Documents
Most mortgage lenders will require the “2s” – two paystubs, two years of W2 forms, two years of tax returns and two months of statements on your bank and investment accounts. Be prepared to document large deposits into your bank accounts to prove where that money came from. Just about every lender now operates on a paperless loan file so save these documents as PDFs in a secure location on your computer. Also, make sure your lender provides you a secure way to transmit these documents; do not just email them unless they are password protected and secure.
Your pre-approval will most likely consist of a fairly quick on-line application, providing the above referenced documents, a credit check and most importantly, a phone conversation and consultation. There are many factors to consider when selecting a mortgage program and this conversation should help guide you and the mortgage lender to the perfect loan structure for you. Pre-approvals are typically valid for 120 days so if you buy within that time frame, you should be all set. If not, you will need to update your credit report and some of your financial documents. The lender should provide you with a copy of this pre-approval letter which you will definitely want to share with your real estate agent, assuming you are working with one at that time.
Start Your Home Search
Now the fun begins. With your pre-approval in hand, you have a great idea of how much home you can afford. The home search process is quite involved but if you are like 90% of the rest of the country, you will most likely begin looking at homes on line. But once you get serious, make sure you engage a top notch real estate agent who really knows the market where you want to buy. Some homes never even make it to the Multiple Listing Service (MLS) so you want to work with an agent who is in the know. Every good mortgage lender should know a good agent in your desired market.
The home purchase and home financing processes are still very complicated, involved and labor intensive. While you can find a lot of information online, you should always pick up the phone and talk to an expert. Sometimes a 10-minute call can be worth hours of online research. Contact United Home Loans at 708-531-8388 for expert advice specific to your situation.