- Most people need a mortgage, or a loan, to buy a home.
- While the mortgage process can seem daunting, it’s totally manageable if you break it into small steps.
- You don’t always need a down payment of 20% of the price of the home; some mortgages require just 3%.
- There are a number of types of mortgages available, and you can find one that fits your financial situation.
Homeownership is the pinnacle of the American dream for many people. Unfortunately, most Americans can’t afford to buy a home outright. Instead, they need a mortgage to help achieve that dream.
A mortgage is a type of loan specifically designed for the purchase of a home or another property. It’s a major commitment, and lenders often have strict requirements for whom they’ll lend money to.
In this guide, we’ll break down the mortgage process so you know exactly how to prepare to apply for a mortgage.
Inside this article
How do mortgages work?
A mortgage is a type of loan designed for the purchase of real estate. It’s a secured loan, meaning that for as long as you owe the bank money, there’s a lien on your home that allows the bank to seize the property if you stop making mortgage payments.
When you apply for a mortgage, a lender will consider your credit score, credit history, income and other factors to determine if you’re a good candidate for a loan. The more creditworthy the bank believes you to be, the lower the interest rate you’ll get on your loan. But the lender usually won’t lend you the full value of the home. Instead, the average down payment is closer to 6%, according to Rocket Mortgage.
A mortgage can have a down payment as low as 3%, depending on the type of loan. However, if you borrow a conventional mortgage—meaning one that isn’t backed by a government entity—and put less than 20% down, you’ll have to pay private mortgage insurance (PMI) until you reach 20% equity in your home.
Most mortgages have terms of 30 years, according to Rocket Mortgage, and the majority of them have fixed rates. During the loan term, you’ll make monthly payments to your lender to cover both the principal and interest of the loan. Your lender may also require you to pay your property taxes and homeowners insurance to them, which they will in turn pay out to the companies.
Getting a mortgage may seem overwhelming, but it doesn’t have to be. Below are the six steps you’ll need to follow to get a mortgage. Focus on just one step at a time, and you’ll find it’s a lot easier to start making progress toward your homeownership dream.
Step 1: Review your finances
Before taking any steps toward buying your home, it’s important to take an in-depth look at your finances. For most people, a home is the most expensive purchase they’ll ever make so it’s critical to make sure your finances are in good shape.
First, check your credit score and credit report to see if there’s anything that might hold you back from qualifying for a mortgage. Large debts compared to your income or missed payments will stand out to mortgage lenders, and most lenders require a certain credit score to get a loan. The last thing you want is to apply for a mortgage and find you don’t qualify. You can run your credit report with any of the three credit bureaus, Equifax, Experian or TransUnion. You can also visit AnnualCreditReport.com to see all three credit reports at once.
Not only does your credit score affect whether you can get a mortgage but it also affects what interest rate you can get. According to Experian, the best interest rates are generally available to borrowers with credit scores of 760 or higher.
Additionally, take a look at your debt situation. Is there debt you could pay off before buying a home? While many people with student loan debt buy homes, you may want to get rid of credit card debt before starting the home-buying process. Your debt-to-income ratio (DTI), meaning the percentage of your monthly income that goes toward debt, is an important financial indicator that mortgage lenders consider. And credit card debt especially has high interest rates that can make it more difficult to pay off.
Finally, consider your current income and budget and how much additional room you have for spending. Homeownership is expensive—the monthly payment won’t be your only new cost. Other new costs in your budget could include homeowners insurance, property taxes, homeowners association fees and home maintenance. You’ll want to make sure you have plenty of wiggle room in your budget rather than buying at the top of your budget and living paycheck to paycheck.
Step 2: Research mortgage lenders
Once you feel comfortable that you’re ready to buy a home, you can start researching mortgage lenders to find the best one for you. There are so many lenders to choose from, especially with the increase in online lending institutions.
Some questions to ask yourself as you’re researching mortgage lenders are:
Do I want to work with a bank or credit union?
Each serves basically the same purpose, but banks are for-profit companies, while credit unions are nonprofit organizations owned by their members.
Would I feel comfortable working with an online lender, or do I want one I can speak to face-to-face?
There’s an increasing number of online lenders available, but not everyone is comfortable with taking out a large loan without meeting in person.
Do I want to work with a regional or local lender?
A local lender may provide more personalized service, but a national company may offer better rates, more advanced technology and other attractive features.
What type of mortgage does each lender offer?
While most lenders offer 30-year conventional mortgages, some may also offer adjustable-rate mortgages, jumbo loans and government-backed loans (more on these below).
How does each lender’s interest rate compare with others?
You may find the rate you’re quoted is different from one lender to the next.
Step 3: Decide on the right type of mortgage for you
Before getting preapproved for a mortgage, it’s important to decide what type of mortgage you want. There are several to choose from, each suited for certain borrowers and situations. Here are some of the decisions you’ll run into when choosing what type of mortgage you want:
Conventional vs. government-backed loan: A conventional loan is one that isn’t backed by a government agency. This type of mortgage is the most common. A conventional loan requires a credit score of at least 620, a down payment of at least 3% and a debt-to-income ratio of no more than 45%. A government-backed loan, on the other hand, is one that a certain government agency backs to make homeownership more achievable. The most common government loan programs are:
FHA loan: Backed by the Federal Housing Administration, these loans help borrowers with low credit buy homes. You’ll need a down payment of either 3.5% if your credit score is 580 or higher or 10% if your credit score is 500 to 570. As with a conventional mortgage, you’ll pay mortgage insurance because you are putting down less than 20% of the price of your home, but it’s known as a mortgage insurance premium (MIP).
VA loan: Backed by the Department of Veterans Affairs, these loans are available to military veterans and service members. They don’t require a down payment or PMI, and there is no minimum credit score.
USDA loan: Backed by the U.S. Department of Agriculture, these loans help low-to-moderate-income borrowers in rural areas to buy homes with no down payment.
Fixed vs. adjustable-rate loan: When you take out a mortgage, you can choose between a fixed or adjustable-rate loan. A fixed-rate loan has a fixed interest rate for the entire loan term, while the rate on an adjustable-rate loan fluctuates with the market. For example, a 5/1 adjustable-rate mortgage (ARM) has a rate that’s fixed for the first five years, but then adjusts once every year after that.
30-year vs. 15-year loan: The two most common mortgage terms are 30 years and 15 years. While 30-year loans generally allow for lower monthly payments, 15-year loans offer lower interest rates and a shorter payment term.
Conforming vs. jumbo loan: Each year, the Federal Housing Finance Agency sets what are known as conforming loan limits. In 2022, the limit is $647,200 for most of the country. Any loan that exceeds that conforming loan limit is known as a jumbo loan.
If you aren’t sure what type of loan is most appropriate for your situation, your lender can review your situation and advise you.
Step 4: Get preapproved
Before you start shopping for a home, it’s best to get preapproved for a mortgage. Preapproval is a letter from a mortgage lender that confirms you qualify for a mortgage, as well as the loan amount you qualify for. The preapproval letter also tells you what interest rate you may qualify for, and allows you to compare offers across different lenders.
The benefit of obtaining preapproval before shopping for a home is that it shows the seller you’re serious. You could make a $300,000 offer on a home, but unless you’re able to get the necessary financing, you can’t actually buy the home. A preapproval letter gives sellers the peace of mind to know that a lender has already agreed to give you a loan.
When you make an offer on a home, especially in a seller’s market like we’ve had the past year and a half, you may be more likely to have your offer accepted if you are preapproved for a mortgage.
The preapproval process isn’t difficult and, in some cases, can be completed in as little as a few minutes, though it can take as long as 10 days.
When you apply for mortgage preapproval, a lender will ask you for proof of income to determine what size monthly payments you can afford. They will also review your credit report and credit score to determine your creditworthiness and what interest rate you qualify for.
Once you’ve received your preapproval letter, it’s usually only good for a certain amount of time, ranging from 30 to 90 days. If your preapproval expires, you’ll have to apply for a new one, either with the same lender or with a different lender.
Step 5: Get your final approval
Once you have an offer accepted on a home, you’ll have to be officially approved for a mortgage by your lender. This process requires far more paperwork than the preapproval. First, you’ll have to provide paperwork that includes:
Pay stubs or W-2 forms
Information on assets and debts
Gift letters for any funds received for your down payment
This step is known as underwriting. How long the process takes depends on a variety of factors, including your employment situation, credit report and more. Once your lender has verified that you meet all the necessary requirements for the mortgage, your application will be approved.
In some cases, the lender may suspend your application if they don’t have all the information they need. A suspension could occur if they can’t verify your income or employment, or if the home didn’t appraise as expected. It doesn’t mean your application has been denied—it simply means more information is needed for a final decision.
Step 6: Close on your home
Once your mortgage has been approved and your documents have been finalized, you can finally close on your home.
In preparation for the closing, you’ll have to do a few things like purchasing homeowners insurance, reviewing your final loan documents and securing the funds for your cash to close, which includes your down payment and closing costs.
At the actual closing, you’ll meet with your real estate agent, the seller, the seller’s agent and a title company to complete the final paperwork and officially take ownership of your new home.