Home Loans and Mortgages: The Basics
Your home is quite likely the largest purchase you’ll ever make, and your mortgage the largest debt. Your credit will play a key role in how much your home loan (and by extension, your home) will cost you in the long run. Here is essential information if you hope to get a mortgage to buy a home, or to refinance:
How Much Can I Borrow?
Your lender will compare your gross income (before taxes are withheld) to your debts to calculate your “debt-to-income” ratios.
- Ideally, the monthly payment on your new mortgage loan (principal, interest, taxes and insurance) should total 28% or less of your monthly income, though some lenders will go as high as 40%.
- Your total monthly debt payments, including your mortgage and payments on student loans, credit cards, or auto loans, should total no more than 36% of your monthly income, though some lenders will go higher.
Down Payments and Equity:
To buy a home, you’ll usually need a down payment. If you are refinancing, the lender will typically want to see that you have equity in your home.
- Have limited funds for a down payment? Ask your lender about low or no down payment loans, including FHA or VA loans, that may allow you to buy a home with little money out of pocket.
- Most low or no down payment loans require that you pay mortgage insurance which protects the lender if you default. Mortgage insurance will increase your monthly payments, until you build up enough equity to drop it.
- Want to refinance but have little or no equity? Ask your lender about the Home Affordable Refinance Program.
What you will pay depends on factors like your credit scores, your down payment or equity, the length of the loan, etc.
- When a lender quotes a rate, ask about costs, too. You may be able to get a lower rate if you are willing to pay points (a point is 1% of the loan amount) or conversely, you may be able to pay fewer closing costs if you accept a higher rate.
- The Annual Percentage Rate (APR) can be helpful for comparing rates, as it includes some (though not all) of the costs associated with the loan over the long run.
- Ask your loan officer whether you can “lock” your rate. A lock will guarantee that rate if your loan closes before the lock expires.
These may include fees from the lender and/or mortgage company, third-party fees (real estate attorney, appraisal etc.) and pre-paid items (taxes, insurance, etc.).
- Closing costs vary by region and by lender. Your lender must provide a Good Faith Estimate of closing costs within three days of taking your application. Review it carefully and don’t be afraid to question those costs.
- Title insurance can cost hundreds of dollars depending on the state where the property is located and other factors. In some states, title insurance costs are fixed, but in states where they are not, you may be able to shop for a cheaper policy.
- Short on cash? You may be able to get a credit from your lender toward closing costs by agreeing to a higher interest rate. Ask your loan officer for a compariso
Your Credit Scores:
The mortgage company will check your credit reports and scores – so you should too. Most mortgage lenders use FICO credit scores, which may be different than the credit scores you get through other credit monitoring services.
- Try to check your credit reports at least three months before you plan to get a loan to allow for time to address problems or dispute mistakes.
- Don’t make drastic changes to your credit without talking with your loan officer first. For example, closing credit cards you have paid off or opening new credit accounts to buy furniture or appliances may lower your scores. The lender may check your credit scores again before closing and you don’t want any surprises.
- Worried about hurting your credit scores if you shop for a mortgage? You’ll be relieved to know that mortgage-related credit inquiries in the past 30 days are ignored when calculating FICO scores, and after thirty days multiple mortgage-related inquires in a relatively short period of time count as a single inquiry.