Getting a home loan is a necessary part of the process of buying a home for most people. It can take extra work to get a good loan, but if you're familiar with the process and know what to look for, you can improve your prospects.
The Preapproval Process
The entire home-buying process is typically very stressful, but it gets easier if you are preapproved for a mortgage. You know for sure how much house you can afford and a lot of the paperwork is taken care of. Preapproval differs from prequalification; when you are preapproved, your lender has confirmed that they're willing to loan you a specific amount of money. The interest rate can change from the time that you are preapproved to the time you actually closed. However, you can pay to lock your rate in place if you expect that interest rates will rise during that time.
In order to get approval for a mortgage from your lender, you'll need to submit documentation of your current capital and your income. The paperwork will typically include one month of paycheck stubs, two years of W-2 forms, and three months of bank account statements, although other paperwork may be necessary depending on your own financial situation.
It's also important to have an idea of how much you want to borrow. While a lender can talk to you about how big of a mortgage you can afford, you should have an idea of what kind of house is in your price range, as well as what you want.
If you're a first-time home buyer or a veteran, you may qualify for assistance with financing through the Federal Housing Administration or the Department of Veteran Affairs. However, ask if a prospective lender provides FHA loans before starting the application process, because some — such as credit unions — do not.
Choosing a Mortgage
Where once there was only a standard 30-year mortgage, there are now a variety of different options. While a 30-year fixed rate is the best option for many homebuyers, you may be offered an ARM, an Option ARM, or an Interest Only mortgage. You can also look at a 15-year fixed rate mortgage.
- 30-year fixed rate: While a traditional mortgage typically has a slightly higher interest rate than an ARM to start with, it will not change over the life of the loan.
- 15-year fixed rate: Identical to a 30-year fixed rate mortgage except for length, a 15-year fixed rate mortgage typically has a higher payment than a 30-year loan — but you'll pay less interest in the end.
- ARM: With an ARM, loans start off at a low interest rate which remains stable for a certain period of time and then is regularly adjusted until the mortgage is paid off. A 5/1 loan, for example, has a fixed interest rate for 5 years and a rate that is adjusted every year from then on out.
- Option ARM: Payments on an option ARM can vary by your personal preference. You can pay the full interest and principal due each month, pay just the interest, or pay just a part of the interest. If you opt for the partial payment, the unpaid interest is added to the principal you owe.
- Interest Only: For the first five years of an interest only mortgage, you pay only the interest. Payments are low in the first five years and significantly more in the following 25.
Any option other than a fixed rate mortgage should be considered very carefully. Because your monthly payment can increase almost overnight with ARMs, such a loan can endanger your finances. You should only consider a loan other than a fixed rate mortgage if you're certain you can refinance your home before the end of the fixed rate period.
Due to the recent troubles with the housing market, it's virtually impossible to get a home loan without a down payment. In general, a down payment of 20 percent of the cost of your new house is considered the minimum. However, if you qualify for a FHA loan, help from a state housing agency, or a VA loan, you may be able to put down closer to 10 percent of the house's cost.
Making less than a 20 percent down payment can lead your lender to request private mortgage insurance, known as PMI. The insurance offers protection to your lender in the event of foreclosure. On average, PMI can add $55 to your mortgage payment for every $100,000 you borrow.
Once you've reduced your loan balance to 78 percent of your home's appraised value, your lender must cancel your PMI unless they have reason to consider you a credit risk. If you have good credit, you can often get your lender to drop your PMI when you've reduced the balance of your loan to 80 percent of your house's value.
You can avoid PMI entirely if you put at least 20 percent down. It's also worth considering a larger down payment if you can afford it. The larger the down payment you can make when you purchase your house, the less money you need to borrow and the less interest you'll wind up paying on your mortgage over the years.
Buying Discount Points
Lenders will typically offer you the opportunity to buy discount points, which will decrease your interest rate. However, making the decision to purchase points can be a difficult one. Not only do you have to purchase points upfront, increasing your closing costs, but if you aren't planning to stay in your house for more than a few years, it may not be worthwhile.
Before deciding to purchase discount points, it's important to run the numbers and determine whether you'll be able to recoup the cost of the points and more during the time you plan to live in the house.