If you thought college involved a lot of debt, wait until you get your first mortgage. There’s a reason many of them take 30 or more years to pay off. Fortunately, there are some things to do before applying for a mortgage that can reduce your interest payment and help you get better terms from a financial institution, even if they’ve already written you a pre-approval letter.
#1: Figure Out The Paperwork You Need To Bring
Most financial institutions will look at a lot of financial information before they offer you a mortgage. Here are some of the most likely things you’ll need to bring:
- One Month Of Pay Stubs: These are to demonstrate that you have a job capable of supporting the terms of the loan. Depending on how you get your money, you may need to find other records of payments.
- Two Years Of Tax Filings: This is another verification measure. Banks want to see that you’re financially stable and have been properly paying your taxes. They’ll mainly be paying attention to your total income, but you can expect questions on any unusual sources of money.
- Three Months Of Statements For Your Bank Accounts: These are used to judge how you spend money on a month-to-month basis. If you’re saving a lot of money, banks are more likely to believe you can pay off the mortgage. If you’re going into the red on a frequent basis, they’ll be far more hesitant unless you can explain yourself.
- Explanations For Odd Transactions: If you have any odd activity in your accounts (i.e., large deposits not from a job), you’ll need to have some way of explaining them. It is always better to have documentation explaining what that money is, why you got it, and what it’s for. This usually pops up with inheritance, lottery winnings, and so on.
Collecting documents is easily one of the most important things to do before applying for a mortgage. Just to be sure, talk to your financial institution and ask what you should have. Most of them are quite willing to give you a list that explains everything they want to see.
#2: Know How Much You Can Spend On Your Mortgage
The majority of lenders use the 28/36 rule. This is an industry standard that measures your mortgage and debt in comparison to your monthly income. In short, you shouldn’t be spending more than 28% of your total income on your mortgage payments, and your total debt payments should be limited to 36% of your income.
If you have a lot of other debt – student loan payments, credit cards, car payments, and so on – you may need to pay some of them off before you can get a mortgage.
Note that lenders don’t strictly obey this rule. Some lenders will be a bit stricter, while others are more willing to be flexible, but this is in the range you should expect.
#3: Improve Your Credit Score
This is one of the first things that banks will check when you’re applying for a loan. For starters, you’ll need to get copies of your credit scores from the major bureaus, then address any problems you see. The credit bureaus can and do make mistakes, and clearing those can instantly improve your score and help you get better terms.
Aside from that, there aren’t too many ways to raise your score besides paying off existing debt. You don’t want to do anything that requires a credit check shortly before you apply for a mortgage. Just having your credit score examined on a regular basis can lower it, and while that may seem unfair, it’s how the system works.
Think of your credit score as a measure of reliability. If everything in your life seems stable and predictable, banks are more willing to lend you hundreds of thousands of dollars. That is, after all, quite a lot of money they’re handing over. Anything that suggests you’re risky can cause them to balk, or at least to offer you a worse rate.
#4: Get Your Taxes Filed Early
We touched on this above, but banks will be looking at two years of your taxes. Depending on when you apply for a mortgage, you may need to file early so they can check your latest numbers. Here’s where things get a little trickier.
Most financial institutions will also ask you to sign a waiver. This waiver allows them to go to the IRS and verify the information you gave them, usually by submitting a Form 4506-T and asking the IRS to send it to the lender. This may take a little time, especially around tax season, which is one reason mortgages take so long to get approved. Getting it done early is, therefore, one of the most important things to do before applying for a mortgage.
Your financial institution will compare what’s on the transcript of the information you provided. If there are any discrepancies or irregularities, you’ll need to explain to them before your loan will be approved. In some cases, you may need to amend your tax returns.
To avoid problems with this, make sure your taxes are done by a professional in the years before applying for a mortgage. This drastically reduces the likelihood you’ll make a mistake.
#5: Avoid Other Major Purchases
As you may have noticed, most of the items on this list involve looking like a safe person to lend to, and this one is no different. What many people don’t realize is that financial institutions will keep checking your credit score until the deal is closed and the check is written.
Major purchases – especially those that involve taking on more debt – can sink the whole thing. Don’t buy a bunch of furniture while waiting to get the loan approved, don’t rack up debt to go on vacation, and definitely don’t buy a new car.
Obviously, all of these are easier if you can pay cash. And when we say “cash”, we mean cash, as in physical bills you have on-hand several months before applying for a mortgage. If you prepare early enough, banks won’t be looking too hard at this.
Similarly, if your income is high enough that these purchases won’t push you anywhere near the edge, you may be able to get away with it. It’s best to avoid the risk, though, even if you’re sure you can pay for everything. What matters is how safe the banks think you are, and that generally means being as boring (to them) as possible.
#6: Study Your Market
Here’s another thing that many buyers tend to forget. Each real estate market is different, and the type of home you’re buying can significantly impact your chances of getting a loan. For example, if homes in a neighborhood are constantly being foreclosed, banks may have much stricter standards.
(It’s rare for banks to loosen their regulations, so don’t count on that happening for you.)
The best way to learn about the market is to talk to a realtor who knows the area. You can look for one on your own, but your financial institution may have someone on staff or be able to make a recommendation. Be sure to do this before you apply for your mortgage. There’s no such thing as being over-prepared.
#7: Learn About The Different Types Of Mortgages
There are many types of mortgages, and it’s important to understand the differences before applying for one. Below are some quick explanations – but do further research on any of them that sound like something you could go for.
- Fixed-Rate: Arguably the most basic type of mortgage, fixed-rates have the same payments across the entirety of the loan. They don’t change, even ten or twenty years down the road, making them extremely predictable to work into your budget.
- Adjustable Rate: These mortgages have interest rates that change over time, usually based on factors like the Federal Reserve’s rates. Many of these loans have a fixed rate for a set time (often 5 years), then switch to adjustable rates afterward.
- FHA Loans: The Federal Housing Administration offers loans to all borrowers. These tend to have a low down payment (which is good if you’re making enough to pay off the mortgage but not enough to save a lot beyond that), but also require mortgage insurance, so they’re larger on a per-month basis.
- VA Loans: Veterans Affairs loans are available to members of the military and some parts of their family. VA loans can provide up to 100% financing, which means no down payment at all.
- USDA Loans: The United States Department of Agriculture offers loans through the Rural Housing Service. This is intended for rural (i.e., non-city) owners of generally low income who can’t get housing through normal finances. If you don’t want to live near other people, this may be your best option.
- Conforming Loan: Conforming Loans are smaller loans that can be bought as mortgage-backed securities by Fannie Mae or Freddie Mac (yes, the big institutions from the financial crisis). These are the “common” type of loan.
- Jumbo Loans: These are similar to Conforming Loans, but surpass the normal size limits. Since they’re riskier, you generally need a large down payment and an outstanding credit score before you can get a jumbo loan.
Some banks may offer mortgages that fall outside of these common guidelines. In such cases, talk to a representative for more information and review the terms with a professional (such as a financial or real estate lawyer) before accepting.