Getting A Home Loan
How do you get a home loan? What type of loan should you get? What can you expect when you talk to a lender? What is the difference between lender “prequalification” and lender “preapproval”? What are “points”? Here are the ABCs of getting a home loan…
Ask yourself some personal questions, and be honest and practical with your answers. If more than one person is involved, such as a spouse or partner, each of you needs to answer the questions and then you need to come to an agreement on the answers. This will help you determine what type of loan(s) may work best for you, and will help your lender better advise you on what types of loans would be available to you.
- How long do you intend to live in the home?
- What is your income per year?
- Do you expect your income to go up, go down, or remain steady over time?
- How secure is your job?
- What are your monthly debts (e.g., car payment, credit card payment, child support)
- How much money can, or do you want to, use for the down payment and closing costs? (What can you afford to “bring to the table” at closing?)
- Are you a veteran?
- Are you a first-time home buyer (have not owned a home in the past three years)?
- What is your credit score? (A lender can get this for you if you don’t know it.)
- Do you have anything negative on your credit report, such as a judgment or recent bankruptcy?
- How much do you want to pay each month for a house payment, including property taxes and homeowners insurance (usually included in your monthly payment)? Note that what you are willing to pay may be more or less than what a lender will approve you to pay.
Be Knowledgeable About Common Types Of Loans
There are MANY types of loans out there, but I will only cover the most common ones here. Having a basic understanding of these loan programs will be helpful to you when speaking with lenders. Remember that, based on your personal financial and credit situations, not all loan types may be available to you.
Fixed-rate conventional loans: These loans have an interest rate that does not change over the life of the loan. The principle and interest part of your payment will never change, although the amount of your property tax and homeowners insurance (usually included in your total monthly payment) probably will.
FHA: FHA loans are insured by the Federal government and are great programs for first-time buyers and others because the minimum down payment required is only 3.5% (can be 0% when combined with other programs). Also, lower credit scores and higher debt-to-income ratios are acceptable. FHA charges 1.5% of the loan amount for mortgage insurance. This can be added to the loan and does not have to be paid in cash up front. There is also a small amount added to each month’s payment for mortgage insurance. FHA sets limits on the maximum amount a mortgage can be. These limits vary by area and change over time.
VA: This is a government loan available to veterans who have served in the U.S. Armed Forces and, in some cases, to spouses of deceased veterans. You do not need any down payment for a VA loan.
ARMs: ARMS are Adjustable Rate Mortgages. Your interest rate is set at one value at the beginning, and remains the same for a set period of time, such as for one, three or five years. It will then adjust to a different value based on an index specified in the mortgage. It can go up or down at that point. Some ARMS adjust yearly. One example would be a 3-1 ARM. With this loan, the initial interest rate stays the same for 3 years, and the ARM would then adjust annually thereafter. ARMs generally have periodic and overall interest rate caps. The periodic cap limits the amount your interest can increase from one adjustment period to the next, and the overall cap limits how much the interest rate can increase over the life of the loan. This sounds like a sort of built-in protection, but it can cause a big problem called “negative amortization”. This occurs when, due to a periodic cap, the monthly mortgage payments are not large enough to pay all the interest due on the mortgage. If this happens, the unpaid amount will be added back into the loan amount, continually increasing what you owe on the home. The interest rate for ARMS generally starts out lower than for a fixed-rate loan, but you cannot predict what will happen at the time of the adjustments, meaning that you cannot predict what your monthly payment will be after each adjustment.
Choose A Lender And Get Preapproved For A Loan
The next step is to contact one or more lenders. You should be able to start this process by phone. Options include your bank, credit union or any number of companies that specialize in home lending. These companies will often have the word “mortgage” in their name, such as Superior Mortgage.
Keep in mind that, in helping their clients, real estate brokers have experience with MANY lenders. I know which ones have been problematic in the past and which ones have been a breeze to work with. While I certainly cannot predict future performance, I can certainly advise you on my experiences with past performance with many lenders.
I recommend that you speak with more than one lender and compare their fees and interest rates. While many loan programs are the same across lenders, different lenders charge different fees and different interest rates on some types of loans.
Based on your answers to the personal questions listed above, lenders can recommend different types of loans available to you, and advise you on how much you will be allowed to borrow. This, in combination with how much you can pay for your down payment, will determine the home price range you should look within.
Documentation You Will Need
Once you have selected a lender, they will need documentation from you in order to preapprove you for a loan. The requirements may vary somewhat by lender, but the following list shows examples of copies of documents your lender may request:
- Your last two pay checks
- Your last two years’ W-2s
- Your last two years’ Federal Income tax returns
- Your bank statement(s) for the past one to two months
- Your 401K statement(s) for the past one to two months
- Any other documentation of your financial situation
- Any child support agreement
- Bankruptcy papers if you filed within the past 5 years, or if it still shows on your credit report
Preapproval Vs. Prequalification
It is extremely important that you get preapproved or prequalified by a lender prior to home-hunting and, especially, prior to making an offer on a home. Doing so lets you know what price range you should be looking within, and many sellers will not seriously consider your offer, let alone accept it, without knowing you are qualified to buy the home. A preapproval letter is far more powerful than a prequalification letter, because it demonstrates that the lender has actually verified your credit situation, financial records and income. With a prequalification letter, the lender has used the information you’ve given them to determine your maximum loan amount, but they have not yet verified that information.
What Are “Points”?
Lenders may mention one or two types of “points” to you. Origination Points are fees charged by a lender just to give you a loan. My personal opinion is to avoid lenders who do this—the fee provides no benefit to you, usually results in higher lender fees, and is not tax deductible. Discount points are essentially prepaid interest and, therefore, may be tax deductible (verify this with your financial advisor).
Either way, one point is 1% of the loan amount. For example, for a $100,000 loan, one point would equal $1000. Your interest rate is reduced by paying one or more points (or a fraction thereof) up front. On a 30-year conventional mortgage, one point will typically lower your interest rate by .125%. That means that a 6.125% rate would be reduced to 6% if you purchased one point. In this example, the lower rate would reduce your monthly payment by approximately $8. You paid $1000 to do this, meaning that you would need to remain in the home for 125 months (over 10 years) to break even on buying that point. This really does not make sense for most people unless they purchase several points up front to more significantly reduce their monthly payment.
On the other hand, if the only way to qualify for the loan is by reducing the monthly payment, paying points up front may be the only way to get the loan.
This information is deemed reliable as of the date of this posting, but is not guaranteed.