How to Get Approved for a Home Loan
If you want to buy a new home, you’re most likely going to need to work with a mortgage lender to secure a home loan for your new property. Understanding the entire process before you begin can save you substantial amounts of time and money.
Keep reading to learn about what a home loan is and how to go about getting one.
What is a Home Loan?
As you probably know by now, homes are very expensive. The U.S. median home price is now hovering just over $320,000 — well beyond what most people can or should buy outright.
Instead, most homeowners choose to take out a home loan on their property. In short, a home loan, which is often called a mortgage loan, is a loan given to a borrower to assist in buying a piece of property.
Types of Home Loans
Home loans can have either adjustable or fixed rates, and there are many different types of home loans to consider.
The FHA loan program is backed by the Federal Government and is intended to make it easier for first-time homebuyers to qualify for a mortgage loan. FHA stands for Federal Housing Administration.
If you qualify for an FHA loan, you may be able to access lower interest rates, and you may be able to put down a lower downpayment amount.
A conventional loan is a standard loan that is not insured by the government. Instead, conventional loans are backed by private lenders and mortgage brokers. As such, the cost of insurance on the loan is typically passed down to the borrower (since the government isn’t backing it). Conventional loans are the most common form of loan.
Conforming loans “conform” to the standards set forth by Fannie Mae and Freddie Mac, which are federally backed mortgage lenders. The most significant feature of a conforming loan is that the loan amount cannot exceed a certain amount. For example, in 2019, the max loan amount for a single-family residence was around $484,000. Each year, the Federal Housing Finance Agency (FHFA) sets the max loan amount.
A non-conforming loan is one that does not meet the standard requirements for a traditional loan. Therefore, the loan is not government-backed, and it cannot be resold to agencies like Freddie Mac or Fannie Mae.
Is a Home Loan a Mortgage?
A mortgage is a type of secured home loan that is used for buying property. It’s considered a secure loan because the borrower offers collateral (usually, the buyer’s home) in exchange for financial backing to buy the home. This collateral protects the lender in the case that the homeowner defaults on the loan, or stops making monthly payments for an extended period of time. In most cases, until the borrower pays off a mortgage loan, the lender technically owns it.
The Benefits of a Home Loan
Taking out a home loan with a mortgage may seem very intimidating if you’ve never done it before. But when you think about it, a home loan can be very advantageous to a borrower.
Here are some of the top benefits that you can expect to see by securing a home loan.
Affordable Monthly Mortgage Payments
Banks typically give you 15 or 30 years to pay off a loan, which works out in the borrower’s favor. Longer mortgages cost less per month because the payments are spread out over a longer time frame. As a result, you can keep more cash on hand to make other investments and pay for your daily living expenses.
Low Interest Rates
Interest rates for home loans are usually much lower than other forms of loans.
Mortgage rates tend to vary from 2% to 5%. By comparison, credit cards typically have APRs of 15% to 20%, and auto loans typically range from 3% to 20% APR.
A home loan can allow you to secure a piece of property that increases in value over time. When it’s time to sell your home, you may be able to earn a profit, if your home’s value increased while you lived there. Owning a home also adds to your overall net worth.
How to Get Approved for a Home Loan
Now that you have a basic understanding of how home loans work and why they’re beneficial for borrowers, let’s take a look at how to get one.
Have Your Paperwork in Order
The first thing you’ll want to do before you even start looking at houses is to get your paperwork in order. The last thing you want is to find your dream home, only to find out that you aren’t able to get a loan on it due to administrative issues.
Here are a few of the items that you’ll need to secure a home loan.
Proof of Income and Employment
When you apply for a loan, the lender is going to want to see that you are currently employed, and have been steadily employed for the last few years. And if you have other sources of income (like rental properties or a business), the lender is going to want to know about those as well.
So, round up your recent pay stubs, tax returns, and proof of income and assets to present to the lender. If you are self-employed, be prepared to submit more financial paperwork about your business.
The lender is also going to want to see your FICO score. Your credit score and credit history play a huge factor in terms of the type of loan that you are eligible for and how much money you can borrow.
Best practices call for running a credit report and reviewing your credit score before you move forward with the buying process. This way, you have a chance to put yourself in a better situation to secure a loan. By paying off credit cards or other debt, you might be able to boost your credit score, which can lead to a lower interest rate on your loan, and thousands of dollars in interest fees saved over time.
This part often catches borrowers off guard. You may have to show your banking transaction history going back several years. The bank is going to want to take a look at your transactions to see where you’re allocating money on a monthly basis.
This part feels creepy and invasive, but look at it from the point of view of the lender: They’re about to issue you a massive loan and give you years to pay it off. So it’s within their right to gain some visibility into your spending habits to make sure you consistently have money in your bank account.
Now that your paperwork is in order, let’s take a look at the next steps that you need to take.
Find a Real Estate Agent
Your real estate agent likely has a preferred financial partner they’ll recommend who can help you secure a home loan. That doesn’t necessarily mean you have to use their financial partner, but if they have a trusted relationship, it could help you secure the loan faster.
Make sure to thoroughly vet the real estate agent. The best in the business can help you find the best homes at the best prices.
Before you can put an offer down on a house, first you’ll have to go through the prequalification and preapproval process. The goal is to get a preapproval letter indicating you are a worthy borrower.
Prequalification is a preliminary assessment from a mortgage lender that you are most likely qualified for a mortgage. You can even get prequalified over the phone by providing some basic information about your income, savings, and the loan amount you want to apply for.
Some realtors require prospective buyers to have a prequalification letter prior to showing a property, or prior to taking you on as their client.
Mortgage pre-approval is a more stringent review of your financial history. To get pre-approved, lenders take a closer look at your credit score, credit history, and employment, among other things.
Pre-approval is required to proceed with an official mortgage loan application.
Frequently Asked Questions
What is the debt-to-income (DTI) ratio?
Debt-to-income ratio is the total percentage of your gross monthly income that you allocate toward paying monthly debt payments.
How much should you put on a down payment?
If you can afford to put down 20%, then do it. These days, most first time homebuyers put less than 10% down on a house.
The reason I recommend a 20% down payment is so that you can avoid private mortgage insurance (PMI), which is usually tacked onto loans that have less than 20% down. Also, putting down more on a home gives you more equity, and lower monthly payments.
Should I buy a foreclosure?
Foreclosures are typically higher risk for a buyer, but they can also come at a value price. If your real estate agent suggests you look at a foreclosure, make sure to do your homework so you understand exactly what you are getting into.
What are mortgage rates?
A mortgage rate is a rate of interest that is applied to a mortgage. Mortgage rates are set by lenders, and they can either be fixed or adjustable.
What is the purchase price?
The purchase price is the amount that a home buyer or investor agrees to pay for a property. For example, if the price of a house is $200,000, this is the amount you can expect to pay for the purchase. However, the purchase price does not necessarily indicate the overall value of the property.
The Bottom Line
The bottom line is that while home-buying can be a lengthy and arduous process, it’s most likely in your best financial interest to go through it. Not only does a home loan enable you to secure a house for you and your family, but it also can add to your overall net worth.
Homeownership isn’t for everyone, though. You need to have money saved up, and you also need to be in a position to reliably pay your mortgage off for up to thirty years. Also, if you tend to move a lot, or spend extended periods of time away from home, it might not make sense to own a home.
At the end of the day, only you can decide if homeownership will help achieve your financial goals. For me, it was one of the best financial decisions I ever made.