A home loan is one of the biggest financial transactions you'll ever make, so if you’re thinking about buying a home, here are some basics about the types of mortgages available and how the application process works.
What is a Mortgage?
A home loan, or mortgage, is a loan given by a financial institution or mortgage company to purchase a home without you having to foot all the cash out of your pocket for the purchase.
You will, however, need to make a down payment, which is typically between 3.5-20% of the home’s appraised value – and pay for closing costs and some other fees. The lender then finances the rest of the purchase. You’ll repay the loan, along with interest, typically over 15, 20 or 30 years.
Types of Home Loans
Before applying for a home loan, research different lenders for the best interest rates and terms. Closing costs are typically 2-5% of the home’s purchase price and can vary depending on loan type and mortgage lender. The most common types of mortgages are:
- Conventional loans. Typically has a fixed payment and interest rate for the life of the loan – and requires a 5-20% down payment. For down payments less than 20%, mortgage insurance will be required.
- FHA loans. Only requires a down payment of 3.5% plus requires mortgage insurance.
- VA loans. If you’re a military veteran, consider obtaining a VA loan, which lets you buy a home with zero down payment.
Payment Terms Options
Once you’ve chosen the kind of loan which is best for your scenario, you may be given a choice of repayment arrangements for that loan. The most common include:
- 30-year fixed-rate mortgage. The interest rate on this 30-year mortgage will remain fixed for the life of the loan regardless of changes to the national rate.
- 15-year fixed-rate mortgage. This mortgage will also have a fixed interest rate, but the term lasts just 15 years. The monthly payments will be higher, but the overall interest paid over the course of the loan will be significantly lower.
- Adjustable-rate mortgage (ARM). An ARM gives the borrower a lower interest rate in the early years of the loan, and then a gradual increase (adjustment) in rate over the rest of the life of the mortgage.
To qualify for a home loan, you will need to prove that you are living a within your financial means and you can afford the monthly payments.
The primary way lenders gauge your financial responsibility is through your credit score. This number is like a grade that tells lenders how you’ve handled your past credit card accounts and other debts. It will include the length of time you’ve had your credit cards and loans open, the timeliness with which you’ve made your payments, the trajectory of your debt, and the amount of available credit you might use.
Most lenders will only grant a home loan to borrowers with a credit score of 650 or higher. You can check your score for free on Credit Karma. You might also consider ordering a free credit report from all three major credit bureaus once a year at AnnualCreditReport.com.
During the time leading to your mortgage applications, make sure to pay all your bills on time, don’t open new credit cards, and work on paying down overall debt. A higher credit score will help you get approved quicker and get a lower interest rate on your loan.
Another crucial factor in determining your eligibility for a mortgage is your debt-to-income ratio, or your DTI. Lenders want to know how big your collective outstanding debt will be in relation to your income if you receive the home loan. Most lenders will only allow a maximum DTI of 36%.
While you won’t need the loan until you are ready to close on a house, it’s a good idea to start the process before you begin house-hunting. Your lender will let you know whether you can expect to be approved for a loan and will provide you with an estimate of how much house you can afford so you don’t face disappointment later.
When initially applying for a home loan, ask your lender for a letter of preapproval. This letter confirms you are preapproved for a home loan up to a specific amount. Having this letter in hand shows real estate agents and sellers that you are serious about buying. Most preapprovals are only good for 60-90 days, so make sure you’re ready to start house hunting before you get yours.
Home Loan Application Process
Home loans are available at most financial institutions and mortgage companies. When you apply, you’ll need to make sure all of your financial paperwork is in order and hold onto all important financial documents in the months leading up to your application.
As part of the application process, you may also be asked to provide a written explanation for any blemishes on your financial record including bankruptcies, collections, foreclosures and delinquencies.
If you’re ready to apply for a home loan, stop by Arizona Financial Credit Union today. We’re committed to your financial success.
Your Turn: How did you prepare for a home loan application? Share your tips with us in the comments.