Taking out a mortgage to buy a home is the largest financial decision most people will ever undertake, so it’s wise to spend some time fully understanding how your current financial situation may impact your future mortgage options. The more time you give yourself to prepare before you’re ready to apply, the better off you’ll be when the time comes.
- Understanding what lenders look for will show you how to strengthen your application before you apply.
- Checking your credit report for errors now can save you a lot of frustration down the road.
- Set aside needed documents as you find them so you don’t have to search for them later.
Check your credit report
Go to annualcreditreport.com to make sure the information that’s been reported to the major credit bureaus is all correct. Not only can fixing errors take some time, but you don’t want to first find out about a problem after you’ve applied. Be cautious of any other website offering a free credit report, as annualcreditreport.com is the only federally mandated site to offer a free annual copy of your report. Obtaining a report from another provider isn’t necessarily bad, but most of the time you’ll be required to sign-up for a special service they’re selling. Just be sure you understand what you might be obligated to pay and how long you’ll be required to pay for it if you use one of these other sites.
Understand your mortgage options
Before diving into the specifics of various mortgage products, it may help to familiarize yourself with some common mortgage terms and phrases. Once you have an understanding of the lingo, the differences between various loan programs will start to make sense. The Consumer Financial Protection Bureau is a great third-party resource for anyone looking to understand how various mortgage programs work. Use our mortgage payment calculator on the right side of this page to see what your monthly mortgage payment would be using current rates for the most common mortgage products.
Credit unions operate under the philosophy that what is best for their members is automatically best for them. In general, we believe credit unions offer a better experience and more overall value than you’ll find elsewhere, but it’s still a good idea to research your options. Look for information on rates, mortgage terms, product offerings, and estimates on closing costs. Just like choosing a doctor, cheaper often isn’t better when it comes to choosing someone to help you with a mortgage. Look for someone who will take the time to educate you and clearly explain things to you. It’s also important to understand what a lender plans to do with your loan once they’ve issued it to you. Some lenders will sell your loan to another lender after closing and you may find yourself making payments to several different lenders throughout the life of your loan. Each time that happens you’ll have to update who you make payments to, and you’ll need to ensure that the new lender sets you up correctly since it’s common for small issues to occur in the transfer process. The bottom line is that you’re entering into a long-term relationship when you get a mortgage, so upfront cost is just one of the factors you should consider. Avoiding hassle and frustration down the road is also key.
Save for a down payment
Not having enough money for a down payment may limit your options when it comes time to apply for a mortgage. While the task may seem daunting, there are many effective ways to save for a down payment.
Compile a list of assets
Assets are anything you own that has a monetary value. Examples include any cash you have in or outside your checking and savings accounts, physical assets like cars, boats, and jewelry, and also liquid assets like stocks and bonds. Aside from verifying that you have enough cash to cover the down payment, closing costs and other upfront expenses to get the loan, lenders also want to know that you have enough assets to fall back on if you run into an unexpected economic hardship down the road. In terms of showing you have enough cash to cover upfront costs for the loan, remember to keep records that trace where the money comes from for any large deposits that will appear on your bank statements.. For example, if you sell an expensive piece of jewelry, make sure you have receipts to show the amount you received matches the amount you deposited. Otherwise your lender won’t be able to tell if the money was truly yours or if it was a loan you’re required to repay.
Lower your debt-to-income ratio (DTI)
Your debt-to-income ratio is your total monthly debt payments divided by your total monthly gross income (then multiplied by 100 to end up with a percentage). Lenders typically want your DTI ratio to be less than 49%. Anything higher could indicate you rely too heavily on credit, and could potentially be unable to make your mortgage payments later on. You can lower your DTI by either reducing your debt, or increasing your income. Paying down credit cards, making payments twice a month, taking a part-time job, or freelancing for additional income are all ways to improve your DTI ratio.
A pre-approval consists of a thorough inspection of your finances, where documents like tax returns and W2s are submitted, and a credit check is performed so a lender can determine how much they can safely loan you. A pre-approval letter from a lender will help you know where you stand, and also show sellers that you’re a serious buyer. Read more about pre-approvals here.
Thanks to modern technology, documentation requirements have made the process easier for many people. Provided you give the needed authorizations during the application process, your lender may be able to obtain your personal tax returns directly from the IRS, obtain income information from your employer, and collect bank statements directly from your bank or credit union. If you’re self-employed you’ll most likely have to provide some additional documentation on your business though. No matter what, it’s still wise to keep the following list of documents at the ready just in case they’re needed during the process:
- 2 years of personal tax returns and W-2’s
- Most recent 30 days of pay stubs, or other proof of income
- Most recent 2 months of bank statements showing the funds for the down payment and closing costs
- Most recent retirement account statement
- Photo ID
- Rental payment history showing you’ve paid on-time (usually 12 months worth)
Note: the full list of documents you’ll need will vary depending on the type of loan you’re applying for.
Get expert advice
Contact a mortgage loan officer for specific guidance on what you should do before applying for a mortgage.