Even before you start looking for your new home — whether buying your first or your forever home — you need to know what you can afford. Further, it really helps your negotiating position as a buyer if you already have your mortgage lender and pre-approval locked in place. You know what you can spend and the seller knows that you’ve got ready financing when you make your offer. So, begin your home search by considering the types of mortgages and mortgage lenders that might be right for you.
Consult Mortgage Lenders for Pre-Approval
There are two sorts of “pre-approval” for a mortgage. The first is pre-qualification. Although people often use this term interchangeably with pre-approval, the two are not the same. When you pre-qualify, your financial institution looks at an overview of your finances, including your income and debts. The mortgage lender then gives you an estimated loan amount that it would likely approve. This process provides you with a fairly solid idea of what you can spend, but it offers nothing to a seller when you make an offer.
On the other hand, a pre-approval requires you to complete a mortgage application, provide your Social Security number (and your spouse’s if it will be a joint mortgage), and submit a full, complete credit report. This process means that the lender pulls a credit report and score. You will also have to provide a list of your assets and debts on the application. Armed with all this information, your credit union or other mortgage lenders will give you a pre-approval letter, usually good for 60 to 90 days. You can share this document in the negotiating process to demonstrate to a seller that you are good to go.
The great thing about the pre-approval process is that you can identify any potential problems in your financial situation. With this knowledge, you can address issues before you are in the high-pressure period of actually negotiating a purchase. In the current housing market, competition is fierce. The advantage of seeking pre-approval is that you will stand out in the already competitive market. Some sellers may not let you put down an offer, let alone view the house if you are not pre-approved, so you’ll want to get the process started as soon as you decide you want to buy.
Different Mortgage Types and Mortgage Lenders
Okay, you have your pre-approval from your credit union or mortgage lender. Now it’s time to look at various mortgages to see which might be the best choice for you. There are several primary mortgage types.
Conventional Loan
There are two types of loans:
- Conforming Loan: A conforming loan matches up with a set of standards issued by the Federal Housing Finance Agency (FHFA). The most important standard is the loan size limit, but there are other issues relating to your credit and debt. For example, the conforming loan limits for 2022 are $647,200 generally and $970,800 in certain high-priced housing markets.
- Non-Conforming Loan: Non-conforming loans do not meet the FHFA standards. These loans might exceed the limits or go to borrowers with subpar credit or a bankruptcy in their history.
If you have a good credit score (at least 620) and the cash for a large down payment, a conventional mortgage is likely your best option. Most buyers using a conventional mortgage take a 30-year, fixed-rate mortgage.
Jumbo Loan
A jumbo loan is one where the amount exceeds the FHFA limits. These usually appear in higher-cost housing markets like Los Angeles, New York City, and Hawaii. Because they present more risk to mortgage lenders, the application process is more stringent, but you can access a lot more money. Usually, jumbo loans require a credit score of at least 700 and a debt-to-income ratio of no more than 45%.
Government-Insured Loan
The government will not lend you money, but it does have three agencies that back individual mortgages. These loans are:
- FHA Loan: Backed by the Federal Housing Administration, these loans help borrowers who need assistance with a down payment or credit score. You will need a credit score of at least 580 to obtain approval for a loan with a 3.5% down payment. You must also purchase private mortgage insurance (PMI), partly paid at closing, with the remainder paid during the life of the loan as part of your monthly payment.
- USDA Loan: These loans help less well-to-do buyers get a home in a USDA-eligible rural area. USDA loans impose some extra fees, but for some buyers may not require a down payment.
- VA Loans: The Veterans Administration (VA) backs flexible low-interest mortgages for active and former members of the U.S. military. These loans generally do not require a down payment or the purchasing of mortgage insurance. Closing costs are limited and may be paid by the seller. The lender will impose a funding fee, but its cost can be rolled into the mortgage loan. These loans usually have low interest rates and sometimes accept lower credit scores.
Interest Rate Options
Mortgage lenders offer two primary ways of calculating your interest.
- Fixed-Rate Mortgage: A fixed-rate mortgage has the same interest rate for its entire life, meaning that your mortgage payment will always remain the same. They are usually for 15 or 30 years.
- Adjustable-Rate Mortgage (ARM): An ARM usually starts with a low interest rate for the first few years before a new rate is imposed for the remainder of the mortgage term. You may, for example, get a five-year initial rate with an adjustment every five years thereafter. Be sure to read your contract carefully to understand the highest amounts that you can end up owing. ARMs benefit those who only plan to own the home for a few years. These buyers don’t need to worry about the adjustment period.
Get Ready to Buy Your New Home
Your new home almost undoubtedly represents the biggest single purchase you will ever make. It will probably be the most valuable asset you ever own. So preparing to make that purchase wisely and well is vital. Understanding the types of mortgages and mortgage lenders available, the interest options you can choose from, and what it takes to qualify for them is a wonderful start. Another excellent starting point is to consider using a financial institution you can be confident in. Most credit unions and banks offer mortgages, and the application and approval process is usually straightforward. Moreover, financial institutions really appreciate customers who have several products with them. Adding a mortgage to a broader product mix may provide you with additional benefits like a reduced rate or a free safe deposit box.
Remember that your mortgage and its payment history will be a critical component of your credit score. That’s why you want a good fit with which you can comfortably comply. To achieve this goal, carefully examine the types of mortgages and mortgage lenders to find the best fit for you.
Disclaimer: This content does not necessarily represent the views of IWB.