Getting approved for a mortgage loan can seem confusing, especially to first-time homebuyers. But with the right preparation and planning, the mortgage application process can get easier, setting potential borrowers up for quicker approval. Here’s Five Steps to Mortgage Approval.
Step 1: Know and Improve Your Credit Score
Your FICO credit score is a critical factor that affects the mortgage application and approval process. Get a free annual credit report if you have not already done so and understand what your credit score is. For a government backed FHA loan, you will need at least a score of 580 (and up to a 620) to be eligible, and for conventional loans, most lenders will require a 620 or above. Those with credit scores at or above the 760 mark will be eligible for the most attractive loans with the lowest interest rates.
If your credit is below these levels, you will need to work to improve your credit score. Review your free credit report and dispute any errors or inconsistencies contained within it. Anything from clerical errors to former spousal debt can appear mistakenly on credit reports and 1 in 4 Americans report having spotted at least one error on their credit record. Fixing credit record errors can help boost your score and get you those extra points needed.
Another tip to improve credit scores is to lower debt utilization ratios on outstanding credit cards or equity lines. This means keeping the total debt on these credit lines under 20% to 25% of the total credit limits for the lines. So, if you have a credit card with a $5,000 credit limit, work to keep your balance on that line under $1,000. The debt utilization ratios are a critical factor for credit scores, accounting for as much as 30% of the score.
Step 2: Know Your Budget
Be reasonable and honest with yourself about the terms and amounts of the loan you’ll be eligible for. Review your assets and savings, along with current debt and monthly bills, to determine how much of a loan you can afford. For an FHA loan, you will typically need 3.5% or more of the total loan amount as a down payment. For conventional private loans, the down payment will be higher, anywhere between 5% and 20% of the loan amount.
If you don’t have more than a 20% down payment, you will also need private mortgage insurance (PMI), which will increase your monthly costs to repay the loan. However, with an HRCCU mortgage, no matter the down payment, you won’t be required to pay PMI on your home loan. This will result in lower mortgage payments as the average PMI rate ranges between 0.3% and 1.2% of the loan amount on an annual basis.
Finally, closing costs are another upfront sum of money needed, typically between 2% and 5% of the total loan amount. Be sure to account for the full costs of the mortgage when planning and budgeting, as the loan amount itself is not the entirety of the associated costs.
Step 3: Know and Manage Your Debt to Income Ratio
Besides your credit history and total assets, lenders will also look closely at your debt to income (DTI) ratio. This is the percentage of your monthly income that goes toward paying off different types of debt, such as student loans, auto loans, credit cards, etc.
As a general rule, you should keep all debt payments, including the monthly mortgage payments, below 35% of your monthly income. So, if you make $5,000 a month, the total debt (including mortgage) shouldn’t be more than $1,750. If your credit to income ratios are higher than 35%, work to pay off existing debt and loans, starting with those that have the highest monthly costs. This will free up some needed percentage points that improve your DTI ratio.
Step Four: Gather Needed Paperwork and Documentation
Before you apply for a mortgage, you will need to gather a range of paperwork and documentation to provide to the lender. Typical materials you will need to gather include:
- Proof of assets: Lenders will look at bank account statements to verify you have the savings needed for a down payment in addition to the PMI and closing costs for the loan amount. Savings accounts and other financial assets such as bonds, stocks, annuities, etc. can all count toward your total assets.
- Proof of income: Lenders will also need to verify current income to fully gauge your ability to continue repaying the loan. Gather recent paycheck stubs that show your income levels going back 3-6 months. Similarly, gather your annual W2 statements and tax returns for the last 2-3 years.
- Employment Verification: Besides proof of income, lenders will want to verify borrowers are still currently employed. Lenders often require a statement of confirmation of employment by your employer(s) as part of the mortgage application process.
- Other Identification: Thorough documentation of identification is needed to protect lenders and borrowers alike. Typical instruments of identification needed during a mortgage application include a state issued Driver’s License. The credit check that lenders will run on borrowers requires a Social Security Number (SSN) as well. Having these documents in hand is critical to prove identification.
Step Five: Compare Loan Types and Offers
While lenders will be reviewing and scrutinizing the financial details of the borrower, the borrower can equally scrutinize lenders. Become familiar with the different types of mortgage loans, from FHA to Conventional to Conventional 97 loans.
Each comes with different home loan lengths, terms and requirements, from the minimum down payment, length of repayment schedule, PMI requirements and loan closing costs. Different banks and lenders will vary slightly in these details, and borrowers who are educated are more likely to find the best overall loan and lender for their situation and needs.
By following the five steps above, homebuyers can be confident that they’ve put in the necessary planning and budgeting to apply for a mortgage loan. That peace of mind goes a long way during what can often be a stressful multi-month process. If you have any questions or concerns about a home mortgage application, be sure to contact one of our mortgage specialists today!