How to Get a Home Loan in 5 Easy Steps
While it’s tempting to start shopping for homes as soon as you decide it’s time to buy one, doing some financial legwork in advance can save you money and reduce anxiety in what can be a difficult process. Understanding the home loan process and applying for a loan that fits your budget will help you focus your search on houses that you can afford.
Here are five easy steps to getting a home loan.
Step 1: Polish your credit
Generally, when you apply for a home loan, a lender will look at your credit score to determine your interest rate and other loan terms. Credit scores reflect your credit history, including whether you’ve paid bills on time or defaulted on other loans, and lenders use the score to determine how risky it is to lend to you. People with lower credit scores may be charged higher interest rates and be required to make larger down payments because lenders believe they are high-risk.
Potential homebuyers should know their credit scores before they apply for a home loan. The minimum credit score for a conventional loan is 620. The minimum is 500 for a Federal Housing Administration (FHA) loan, but individual lenders may require higher scores. According to the Consumer Financial Protection Bureau, borrowers with credit scores ranging from the mid- to high 700s usually receive the lowest rates, and borrowers with credit scores ranging from the high 600s to the low 700s usually receive slightly higher interest rates.
LendingTree offers an easy tool to check your credit score for free, and the CFPB recommends consulting a homeownership adviser approved by the U.S. Department of Housing and Urban Development to help you understand your credit report. If your credit score is lower than you’d like, take some time to improve it. Milan Griffin, vice president of marketing and outreach for HUD-approved agency HomeFree-USA, suggested potential homebuyers start working on their finances up to 12 months before shopping for a home.
Here are some ways to improve your credit score:
- Check for errors. Sometimes your credit history contains incorrect information that can significantly reduce your credit score. If you see an error on your report, file a dispute with the credit reporting company. A correction can raise your credit score.
- Pay your bills: It’s important for a lender to see that you can pay your bills in full and on time. Even if you’ve had trouble in the past, getting in the habit now of making on-time payments will help you build a good payment history going forward. Setting up automatic payments or monthly reminders may help.
- Manage your credit cards: Credit card debt, especially high balances, can negatively impact your credit score. Through disciplined spending and saving, try to pay down your credit card debt as quickly as possible, and don’t open any new credit card accounts you don’t need.
Griffin also advises building up your savings so that lenders will see that you are financially solvent. “Savings can be just as important when qualifying for a standard loan,” Griffin said. “It’s important to focus on your full money profile and getting financially prepared.”
Step 2. Know how much home you can afford
It’s easy to become emotionally attached to a house that you’ve looked at, and learning that you can’t afford it can be crushing. To avoid that situation, it’s important to figure out the maximum amount you can pay for a house before you start shopping. According to the CFPB, the amount you can pay generally is determined by how much you can pay each month, the size of your down payment, the length of the loan’s terms (such as a 30-year fixed rate vs. a 15-year adjustable rate mortgage) and the interest rate on the loan.
When calculating how much you can afford, keep in mind that the amount of money a lender is willing to lend you does not always equate to how much you should actually spend on a house. You may need to consider impending life changes, such as upcoming college tuition bills, plans to start a family or cash you will need to start a new business, that will impact how much you can afford each month for a mortgage payment.
A HUD-approved homeownership adviser can look at your financial situation and help you determine the maximum home loan that’s appropriate for your financial situation. A home affordability calculator can also be helpful. Our calculator multiplies the borrower’s before-tax income by a preset DTI (debt-to-income ratio), then subtracts other monthly bills such as payments on auto loans, student loans and credit cards. The remaining amount is the most a borrower should pay for a house, including interest, taxes, insurance and principal. You can adjust the estimate based on a conservative, moderate or aggressive approach to home affordability and your debt-to-income ratio.
Step 3: Get pre-qualified
After you’ve estimated how much you can pay for a house, it’s time to start talking to lenders. Lenders will offer you pre-qualification, a process that doesn’t require a credit check and allows you to see what kinds of terms each lender could offer.
Pre-qualification is the equivalent of a rough estimate of the type of loan you could get. Lenders will ask for information about your debts, income, assets and investments. “Pre-qualification is not based on any verification,” Griffin said. “They are throwing out numbers based on what you say.”
This step in the process is valuable, as it allows you to see the loan terms that different lenders would offer. You also can begin to get a feel for what it would be like to work with each lender.
Step 4: Compare options
Once you’ve looked at potential lenders, apply to several for preapproval so that you can get a better idea of the actual loan terms they can offer you. Applying to multiple lenders within a short period (generally within 14 days) counts only as one hard inquiry on your credit report, which minimizes the potentially negative effect on your credit score. At this stage, the lenders will require documentation of your assets, debts and income, as well as run a formal credit check.
Once you’ve received preapproval, you can start making offers on homes and comparing loan terms. You can save thousands of dollars on a home loan by shopping around, and don’t stop at interest rates, down payment requirements and monthly payments. You’ll also want to consider:
- APR: Ask if the rate is fixed or adjustable and what that rate includes. A lender’s annual percentage rate (APR) will include broker fees, points and other loan charges, along with the interest rate.
- Points: These are extra fees you can pay the lender upfront to lower your interest rate. Ask the lender the cost in dollars for each point so that you can calculate them into potential closing costs.
- Fees: Many loans require fees that you pay either with the loan application or when the loan closes. These fees can total several thousand dollars and can vary by lender. Ask the lender for details about loan origination and underwriting fees, settlement fees, transaction costs, closing costs and broker fees.
Griffin advised that homebuyers also look into loan programs they may qualify for that require lower down payments or reduce closing costs, such as FHA loans and U.S. Department of Veteran Affairs (VA) loans. With an FHA loan, for example, you may qualify with a down payment as low as 3.5 percent or a credit score lower than a conventional mortgage requires.
Home loans are a competitive market, and you often have room to negotiate with lenders. Let mortgage brokers know that you are comparing your options, and don’t be afraid to ask for better terms.
Step 5: Choose your lender
Once you’ve thoroughly researched your loan options, it’s time to choose your lender. First, review the details of the loan estimate with the lender to make sure that you are both clear on the details. Between this point and the loan’s closing, your lender will ask you to provide the documentation necessary to complete loan underwriting, so be prepared to respond promptly with this information. While every mortgage situation is different, it’s always a good idea to have your documents ready far in advance of the loan process.