It’s an exciting moment when you decide to charge ahead and purchase your first home. You look forward to finding the right house in a neighborhood you like and settling in to become part of the community. Plus in terms of personal finance, homeownership is a major accomplishment.
But there are a host of obstacles and setbacks you may encounter along the path to becoming a first-time homebuyer. Clearing your way to get approved for a home loan will ensure that you are ready to act when that dream home appears on the housing market. Follow these ten steps for how to get a home loan and put a plan in place to finance what will most likely be the biggest purchase of your life.
The most critical step? Start early. You may find that you need to improve your general financial health, reduce your debt, or commit to putting money away into savings that will put you in a better position to buy a house. Most mortgage lenders advise starting the pre-approval process for a home loan 6 to 8 months ahead of when you expect to begin looking for a house.
Step 1: Know your credit score
Your credit score is a significant factor in determining the type of loan and rates you’ll receive for your home loan. It’s important to note that your credit score from a free credit report website is not the same score that banks and mortgage companies use to determine your loan approval. A free credit report will give you a baseline, but you need to speak directly with the bank or mortgage company to know what factors go into how they score you. Ask the bank or mortgage broker to pull the credit report they use for loan pre-approval. The loan officer can then advise you about any changes you need to make to qualify for a loan. (See more about what credit score is needed to buy a house.)
And don’t worry if you decide to change lenders. There is no requirement to work with the lender that pre-approves a loan for you. In a best-case scenario, there could be more than one lender competing for your business and you simply choose the best option for you.
Step 2: Know your budget to buy a home
Because of how your credit score affects your loan’s interest rate which will affect how much your monthly loan payment will be, it’s difficult to know the exact price range you can afford until you go through the pre-approval process. However, with your credit score in hand and some other personal finances recorded, your lender can pre-qualify you for a home loan, which will give you an estimated range of what you can borrow and at what interest rate.
Though you should be aware that this interest rate and the quoted loan amount are not yet locked in or guaranteed until you go through the pre-approval process, however, it is a great starting point to understanding how much house you can afford. You can now use an online mortgage payment calculator to help you account for other costs such as property taxes, HOA fees, PMI, and homeowner’s insurance to help project more clearly what your monthly mortgage payments will be. This will also help you determine a good price range for a home.
You can then start looking at homes. However, don’t tempt yourself by looking at houses priced at the highest end of your pre-qualified amount. According to the bank, you may be able to “afford” that amount, but in homeownership, things happen. You will have repairs, possibly even major ones. You will likely want to make at least a few changes or improvements to the house, and you won’t be able to do those things if you spend too much money on your mortgage payment.
Step 3: Start saving for a down payment on a house
Your down payment can make or break the home loan process. A lender needs you to have “skin in the game.” They don’t want to issue a loan and have you not tied to it in some way. Your down payment represents your first investment in the house, making it hard to walk away and providing an incentive to make the payments.
The down payment amount can vary depending on the type of loan for which you qualify. There are down payment assistance programs as well, and your lender can help you research your options. In the best-case scenario, the amount of your down payment may be enough to eliminate Private Mortgage Insurance (PMI). PMI is an extra amount added to your home loan payment if your down payment is less than 20% of the home’s purchase price. This insurance protects the lender in case you default on your mortgage payments. Learn more about how to save for a downpayment so you can start your homebuying journey today.
Step 4: Get pre-approved for a mortgage loan
This is not the same as step 2. Being pre-qualified and pre-approved for a loan are two different things. Pre-qualification offers a quick overview of your income, credit score, and expenses to determine the range for a loan amount.
The home loan pre-approval process is more in-depth and takes more time. The lender will ask for specific documentation and do a deep dive into your financial life. They will look at your most recent W-2, the last two pay stubs, current bank and brokerage account statements, and your tax returns from the last two years. Based on this information, the lender will determine your loan’s actual approval amount when you find a house.
Step 5: Compare at least a few offers from different lenders
You can be pre-approved by many different lenders. Homebuyers should try to visit with at least three lenders to evaluate their options. It’s important to understand what each lender’s terms mean for your loan payment, rate of interest, and the total cost over your home loan’s lifetime. There is also a range of standard fees that most lenders charge – it’s essential to know how these fees affect your home loan.
At the risk of stating the obvious, a higher interest rate means a higher payment and a larger amount that you will pay over time. Other fees include:
- Loan origination fee: Your lender charges this fee to administer the loan, and to cover all of their work in the pre-approval and approval process.
- Discount points: This is an up-front fee that you can choose to pay to reduce your loan interest rate. If you plan to live in this home for a long time, buying discount points makes sense.
- Various other fees: Lenders can and do charge additional fees – for processing the loan application, document preparation, for underwriting the loan, and other miscellaneous processing fees.
These fees all vary per lender, so be sure to take a close look at your lenders’ offers and how they affect your bottom line.
Step 6: Find your ideal real estate agent and start home shopping
If you haven’t been poking around at open houses already, this is the point where you can start to look in earnest for your dream home. You are now armed with all the information you need about getting a home loan, what those payments will be, and what that means for your future. Now all you need to do is find the house.
This is also the time to choose a real estate agent to work with. It’s always a good idea to interview three or four real estate agents until you find one you think understands your requirements and is willing to work hard for you. You should also make sure this person is a good fit for your personality. You could potentially be spending a lot of time with your real estate agent and if your personalities clash, it could ruin the home buying experience. Learn more about how to choose a real estate agent.
Step 7: Maintain your credit status
Unless you have been advised by your lender to pay off a credit card, old debt, or a student loan, continue to make timely payments as usual. Do not make any large purchases, such as buying a car or a boat. You should also hold off purchases for your potential new home, such as furniture or a new TV. The lender will check your credit right before the loan’s final pre-approval, and large purchases or large payoffs matter. Listen to your loan officer and stick to their advice.
Step 8: Do not change jobs
Your pre-qualification and pre-approval are based on your current employment and your financial lifestyle over the past two years. Making any sudden changes in employment can affect whether or not you qualify for a loan. In some cases, a job change is not in your control. If that’s the case, speak with your lender about it to determine the next steps.
Step 9: Make an offer
You’ve found the perfect home and now it’s time to make the offer. Your real estate agent can help you arrive at a purchase price offer that makes sense for your budget but is also one the seller is likely to accept. Again, try to stay well within your pre-approval amount. You don’t want to get overcommitted and not have any wiggle room for unexpected expenses. Also, in case of a competing offer, think about writing a letter to the home seller to help make your offer stand out.
Step 10: Get the final home loan approval
Your lender will be as excited as you are that you found the home of your dreams. During the final home loan approval process, your lender will double-check that nothing in your financial picture has changed between your pre-approval and the accepted offer date. And make no mistake – the lender has access to information about any purchases made on credit or even job changes in the interim. If you have ignored their suggestions, you may get turned down for the loan. If you have followed their advice, you are only a few signatures away from being a homeowner.
Following the right steps to secure a home loan may be just as important as the home search itself. You don’t want to get your heart set on a house only to find out you don’t qualify for the mortgage loan you need.
Take the time to prepare everything you need to get a home loan at least six months before you begin your home search. Not only will you be confident that you can close the purchase when you find that dream house, but you’ll also know that you got the best loan for your income and lifestyle.