What to Know Before You Get a Mortgage
Buying a home can be an intense process. If you go in unprepared, you dramatically increase the likelihood of both stress and bad choices. However, if you see the process through to completion, it can be one of the most rewarding decisions you make in life.
One of the most difficult parts of the home buying process is learning how to get a mortgage loan from a lender. The mortgage you select will make or break your investment in the long run. That being the case, it’s important to do your best to secure a great rate.
Before we explain how to do that, let’s take a step back and get our terms straight.
What is a Mortgage?
A mortgage is a loan that a lender issues to a borrower, allowing them to buy a piece of property if they don’t have the necessary capital to pay the full price outright.
With a mortgage loan, you can pay a house off slowly over a period of time. Most mortgages run either 15 or 30 years.
The important thing to keep in mind about mortgages is that the bank that issues the loan technically owns the house until the loan is paid off in full. As a homeowner, you will legally have the right to sell the house if you choose and to make changes to it as needed. However, the financial element will still be controlled by the bank.
To that point, lenders will often strategically sell mortgages to other financial providers after an acquisition. It’s possible that you will work with several financial providers during the course of your mortgage. Different lenders include Mr. Cooper, Walter Investment Management Corp. and FirstKey Holdings.
The Two Types of Financing
01. Adjustable-Rate Mortgage (ARM)
A variable rate or floating rate mortgage is a type of loan with a fluctuating interest rate. This rate can change at various periods, meaning your mortgage payment will rise or fall accordingly. In other words, you will sometimes have to pay a higher rate.
ARMs can benefit buyers when interest rates plummet over time and when they are in a position to pay off a loan before adjustments take place. However, unexpected circumstances can arise that can cause homeowners to pay much more over the course of a loan.
02. Fixed-Rate Mortgage
A fixed-rate mortgage is a loan that has a set rate, meaning it does not fluctuate over the course of the loan. This is the better option when mortgage interest rates are expected to increase or stay the same. It’s also good for people who prefer having predictable payments.
Is It Always a Good Idea to Get a Mortgage?
Savvy home shoppers sometimes ask whether a mortgage is necessary. For example, suppose you have $500,000 saved in the bank and are eying a $200,000 property. Should you put down a 20% down payment to avoid private mortgage insurance (PMI) and take out a loan for the remaining $160,000 and lock yourself into making monthly payments or pay the house off in full?
As it turns out, mortgages are helpful for investors. As counterintuitive as it may seem, many argue that it’s a good idea to get as big a mortgage as you can comfortably afford and keep it for as long as you can.
The main reason for this is that a mortgage won’t affect a home’s overall value. Home prices will likely fluctuate considerably over the course of a 20- to 30-year period whether or not you have a mortgage. And since equity doesn’t earn interest, it doesn’t make sense to dump a ton of money into a house. By making steady mortgage payments, your equity can increase while your home’s value goes up.
Another reason to get a mortgage is that you may be able to secure very low interest rates — much lower than credit cards or bank loans. Of course, this assumes you have a solid credit score/FICO score and good financials. Plus, if you don’t qualify for the loan that you initially hoped for, you can refinance and secure a better rate after you demonstrate your ability to make consistent payments over time.
In short, borrowers should feel confident about taking on mortgage loans even though they may seem frightening at first. Mortgages empower homebuyers, allowing them to generate equity slowly while putting money into higher-earning investment opportunities like stocks, bonds, exchange-traded funds (ETFs), and mutual funds.
A smart investor will stash some money, secure a great deal on a house with a reasonable mortgage rate, and pay off the money over a 20- or 30-year period while funneling their money into other investments in the meantime.
What Type of Mortgage Should I Get?
Generally speaking, there are two types of mortgage loans to know about, including Federal Housing Administration (FHA) and conventional loans.
FHA loans are insured by the FHA. Because they are easier to qualify for, they are typically used for first-time homebuyers, although this is not always the case.
FHA loans come with a minimum down payment of 3.5% on a piece of property and require a credit score of at least 580. If you have a poor credit score, you can still qualify. But you will most likely be required to pay a higher down payment.
Conventional loans often don’t come with the same perks that government-insured loans provide like low credit score requirements. Conventional loans typically have higher credit minimums of at least 620.
The main difference between a conventional and FHA loan is that a conventional loan is not backed by a government agency.
Conventional loans can be broken down into conforming and non-conforming loans. A conforming loan adheres to the rules of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) while a non-conforming loan does not.
Getting Pre-Approved by a Mortgage Lender
Rather than stress about the type of loan that’s right for you, your best bet is to either consult your real estate agent for advice or go through the pre-approval process with a lender. They will walk you through this and explain which types of loans you are eligible for based on your financial situation.
An initial consultation will usually be enough information to let you know whether you’re in a good position to go through the official pre-approval process or whether it makes sense to improve your financial situation before buying a home.
During the mortgage pre-approval process, you will need to produce the following information upfront to a lender.
Proof of Identification
Come to the table with proof of identification. Make sure to check with the lender to determine what types of identification are required. Some may require you to bring a license or ID and secondary proof, like a piece of mail or a passport.
Consider running a credit report at least a few months to a year before going through the pre-approval process. That way, if your score is low or average, you could look for ways of boosting your credit before going to a lender. They’ll still be able to see your credit history over time. But you may be able to secure a lower rate if you can get your score up to a higher level.
Remember: You can still secure a home with poor credit. But you’ll wind up having to put more down on your payment and you’ll get a worse loan to start with. As such, it’s in your best interest to maintain a strong credit score by paying down and avoiding bad debt wherever possible.
Tax Returns and Recent Transactions
You’ll also need to be prepared to provide several years’ worth of tax returns and even recent transactions stretching back at least a few months. In addition, you’ll also need to provide proof of employment for the last few years.
Investors can get spooked about providing personal information during a pre-approval process. But rest assured this is a standard operating procedure when asking for a mortgage loan.
Put yourself in the bank’s shoes. They’re considering giving you a massive loan at a reasonable interest rate and giving you decades to pay it back. So, the bank will want to make sure that you’re a responsible and law-abiding citizen who earns an honest living and can reasonably be counted on to repay the loan. Be patient, procure the documents they ask for, and you’ll be fine.
Also, keep in mind that much of this process is for regulatory and compliance purposes. Banks typically want to issue mortgages because they can be bundled into bonds and sold to investors. Banks profit from high mortgage rates and low bond interest.
Finding the Best Mortgage Rates
Once you get pre-approved for a loan, don’t be afraid about shopping around for a better rate. Going to another bank with a pre-approval letter and asking them to beat it is certainly within your right. You should never feel constrained by a loan.
To that end, here are some things that you should do to secure the best possible rate from a lender.
Negotiate with Lenders
Lenders are obligated to provide written loan estimates detailing the total cost of their mortgage. This estimate must be provided within three days after receiving a mortgage application. However, borrowers do not have to accept the loan terms. Borrowers can negotiate for better terms. This process is similar to buying a car. Ask to reduce fees and interest rates in hopes of getting the lender to agree to better rates.
Request Rate Locks in Writing
Once you’re happy with the proposal, ask the lender for a rate lock and get it in writing. This will basically lock in the agreed rate and payback period.
In all likelihood, the lender will charge you for a lock-in which is often worth paying for. The next step is to secure a pre-approval letter, which will give you the ability to go to another lender and ask them to beat it or to put an offer down on a house.
A pre-approval letter or lock-in aren’t required for putting an offer down on a house. However, doing so will increase your chances of the offer being taken seriously by the bank.
Try a Mortgage Broker
If you’re short on time and don’t want to go through the process of meeting individually with lenders — or you’re afraid that you may get taken advantage of — then consider working with a mortgage broker who will act on your behalf. They’ll line up lenders and help negotiate for better rates.
Just remember that brokers aren’t free. You’ll wind up paying for their services. But you could wind up getting a much better rate in the long term if you go through a savvy firm.
Unexpected Mortgage Fees to Consider
Buying a home is expensive, especially when securing a mortgage. Homebuyers are often shocked at how much they have to give up during the process. This can amount to thousands of dollars.
Part of the reason there are so many fees during the homebuying process is because it’s meant to serve as a financial gut check for what you’re about to get involved with. If you have trouble paying fees during the buying process, you may not be in a strong position to own a home — and you could wind up in an unenviable financial situation in the process.
That said, here are some of the top hidden mortgage fees to consider.
In addition to buying homeowner’s insurance, you’ll also need to buy private mortgage insurance if you put down a small down payment. This basically makes it less risky for the lender to issue your money. If you default, the insurance company picks up your slack.
Most of the time, mortgage insurance is required if you put down less than 20% of the purchase price of the home.
Closing costs can be as much as 5% of a home’s total purchase price. For example, if you buy a house for $160,000 then you may have to part with $8,000 in addition to your down payment.
However, there are usually some options when it comes to covering closing costs. Sometimes, you can negotiate to have the seller cover the costs. Or, you may be able to wrap closing costs into the overall price and pay it off over the life of the loan. Certain organizations like unions and military groups can also cover closing costs, so make sure to check if you are eligible for any third-party benefits.
Lender and Broker Fees
You can also expect to pay hefty fees throughout the mortgage approval process — for loan applications, loan origination, and mortgage broker services. Costs can add up, especially if you shop around for multiple lenders. Unfortunately, this is just part of the process and something that you’ll have to get comfortable with when purchasing real estate and dealing with mortgage companies.
Beyond these fees, you may also have to pay for inspections, an assessment, and more.
What is an origination fee?
An origination fee is an upfront fee that a loan officer charges to process a new loan application. So, if you shop around for multiple lenders, you will have to pay multiple origination fees. Origination fees can be as high as 8% of a loan amount (though you should be able to find lower). Sometimes you can negotiate origination fees, but this is not always possible.
Is refinancing your mortgage a good idea?
Refinancing a mortgage can lower the interest rate on your existing loan, potentially shaving off years of payments. However, it can also cost more over time due to extra fees and closing costs. Think twice before refinancing a mortgage, and make sure it’s in your best interest before you go through the process.
Can you get a mortgage without a credit score?
It’s still possible to secure a mortgage without a credit score. To do so, you’ll need to go through a manual underwriting process where you’ll need to provide additional documents for the underwriter to make a decision. The process may take a bit longer, but it’s not impossible.
Is pre-approval the same as pre-qualification?
Becoming pre-qualified is the first step to getting approved. The prequalification process involves collecting data and determining your overall financial position. The last step is to get pre-approved, which requires further verification and underwriting.
The Bottom Line
Mortgage shopping can be a daunting and expensive experience. But exploring various loan options and getting approved is something that everyone should experience.
Think of the mortgage process as a financial gut check. If you don’t like what you see during the process and you get poor results, then consider walking away and taking active steps to improve your financial situation. Walking away from the process and rebuilding for a period of time can yield much better results in the long run.
On the flip side, you may find that you’re in a great position to move forward with the process and secure your dream home. Either way, you’ll walk out a winner.
The bottom line is to know what you’re getting involved with in advance so that you can be prepared to go through the financial gauntlet that is securing a mortgage and emerge victorious with a low rate.
Also, I’d recommend thinking twice about buying a house unless you’ve got 20% to put down. There’s no sense in spending a couple hundred bucks a month on mortgage insurance if you can avoid it.
Buying a house is an exhilarating experience. Take a deep breath, don’t make any rash decisions, trust the process, and you’ll do just fine.