August 11, 2020 admin

The Ultimate Guide to Preparing for a Mortgage

Table of Contents


I. Decide whether buying a home is right for you

First thing’s first: You need to decide whether or not you should buy a home at all. The reality is, buying a home isn’t the right choice for everyone. For example, if you tend to move to a new city for work every year or two, it might not make sense to buy a home right now. It might make better sense for you to stick with the flexibility of renting.

No matter your situation, it’s a good idea to weigh the pros and cons of home ownership. So before you save up for that down payment, and spend months of your life browsing home listings on your favorite real estate site, spend some time thinking through the finer points of buying versus renting a home.

Explore the pros and cons of renting versus buying a home

Buying and renting both have distinct pros and cons. Let’s walk through them so you can properly weigh your options:

Pros of buying a home

  • Build equity: When you buy a home, you build equity. Equity is like your “stake” in the home (with your lender being the other stakeholder). The more you pay off your home loan, and the more your home value increases, the more equity you build in your property.
  • Create wealth: Building home equity is one of the top ways to create wealth. Data shows that in most areas, real estate tends to appreciate in value over time. Buying a home can be a smart financial decision that helps set you up for the future. Plus, owning a home gives you the option to rent it out for profit.
  • Take advantage of historically low interest rates: In today’s market, mortgage interest rates are near record lows, making it a great time to save money on your home purchase. Taking advantage of low rates can save you tens of thousands of dollars over the life of a loan. (Check out our Mortgage Rate Trends to learn more)
  • Deduct mortgage interest and property taxes on your taxes: Depending on your tax situation, you may be able to deduct mortgage loan interest and property taxes on your annual taxes. This can add up to a big deduction on your return, and save you a nice chunk of change come tax time.
  • Save money on rent: With rent prices skyrocketing all over the country, you may be able to save money by getting a mortgage, depending on the specifics of your situation. Plus, when you have a mortgage, each payment helps you build more equity in your home.
  • Enjoy security and fixed monthly costs: If you get a fixed-rate mortgage, you’ll know exactly what your housing payments will be each month, and the payment amount won’t change unless you refinance down the road. Plus, you also have the security of knowing you can stay in one place. When you rent, your monthly payment can be increased, or your property can be sold to a new owner and you could be out of a home.
  • You don’t have to pay forever: Eventually, you’ll (hopefully) pay off your mortgage. And then you’re done — you don’t need to pay your mortgage anymore once you own your home outright. At that point, you’ll only be responsible for smaller ticket items (home maintenance, property taxes, homeowners insurance, etc.) if you choose to keep it.
  • Improve your credit score: If you pay your mortgage on time every month, your credit score will improve over time. That’s not typically the case with renting, as rent payments are rarely reported to credit bureaus. However, you may be able to report your rent payments to the credit bureaus to improve your credit score. Although, understand that this method won’t improve your score as much as owning a home and making mortgage payments.
  • It’s all yours: Have an affinity for wacky kitchen fixtures, or always dreamed of painting your walls in technicolor? When you own your home, you can do what you want with it (barring local ordinances or HOA regulations).

Cons of buying a home

  • Your home could lose value: While home values tend to increase over time, there is always a risk that your home could instead lose value. This is what happened during the Great Recession; home values fell, leaving many Americans on the losing end of the American Dream. Depending on how long you plan to stay in your home (longer term ownership is typically a safer investment) you could risk losing equity if your home’s value drops.
  • There are significant upfront costs: When you buy a home, there are some pretty significant upfront expenses to consider, like your down payment, closing costs, moving costs, and anything you need to buy for your new home. The first year of home ownership can be a massive drain on your savings, meaning you’ll need to have far more savings than you would for a security deposit on a rental home.
  • There can also be significant ongoing costs: Unfortunately, your monthly costs for home ownership don’t end with paying your mortgage. You’ll also need to pay property taxes, homeowners insurance, HOA dues (if you have one), and mortgage insurance if you put less than 20% down on your new home.
  • Real estate transaction costs can really add up: Any time you buy or sell a home, you’ll have major costs to consider, like agent and attorney fees, closing costs, inspections, and more. If you need the flexibility to move often, buying a home — with all its associated costs — might not make sense for you. 
  • Maintenance and repairs are all on you: On the plus side, when you own property, you can do whatever you want with it. On the not-so-plus side, it’s all on you to maintain it and fix it when something goes wrong. And maintenance and repairs can really add up, so you’ll need to budget for them while thinking about how much home you can afford.

Pros of renting a home

  • Flexibility: If you like to move around, the flexibility of renting might be more your speed than owning a home. It’s much cheaper to move from rental to rental than it is to pay for an expensive real estate transaction buying or selling a home.
  • Less upfront costs: When you rent, you pay your security deposit and moving costs, and that’s pretty much it. You don’t have to worry about having a huge amount tucked away in savings for a down payment. It’s a financially leaner way to house yourself if you’re still working on improving your credit.
  • Your wealth isn’t dependent on the housing market: When a large portion of your wealth is tied up in real estate, you run the risk that your equity — and net worth — could take a major hit if the housing market crashes. When you rent, you can invest elsewhere, completely independent of the housing market where you live.
  • No maintenance or repair costs: Another big plus of renting? It’s the landlord’s job to keep the place in good shape. When something breaks, you call the landlord, and it’s their problem. When you own, you also own the problems.
  • Less expenses: Your rent payments are pretty much all-inclusive housing payments, outside of say, utilities. You don’t have to worry about property taxes, homeowner’s insurance, or HOA fees. When you rent, those costs are your landlord’s responsibility, not yours.

Cons of renting a home

  • You won’t build equity: If you’re renting, you’re building your landlord’s equity, not your own.
  • You’re not taking advantage of low mortgage rates: Mortgage rates are extremely low right now, and buyers who don’t take advantage of them could be leaving significant money on the table.
  • Rent payments increase with the market: Rent payments tend to increase as time goes on, bringing your payment up to market value. Compare that to buying a home with a fixed-rate mortgage: you’ll make the same monthly payment for 30 years; a payment that’s based on the price of the home when you bought it. On the flipside, imagine how much you’ll pay in rent after 30 years of incremental increases.
  • Rent payments go on indefinitely: When you’re a renter, there’s never a time when you pay your home off. That expense is with you for as long as you’re renting, and again, that money is going toward building your landlord’s wealth, not yours.
  • Less freedom to do what you want: When you rent, your home technically isn’t your home. It belongs to your landlord, and you’ll have to follow their rules. You may not be able to paint the walls, or upgrade the dishwasher, or change up the flooring without permission from your landlord. Plus, you’ll be spending your money upgrading someone else’s investment.
  • Rentals can lack stability: Unfortunately, rentals aren’t the most stable options. Your landlord could jack up the price, or sell the property to someone else. That means you could suddenly be out of a home, or in a home you can no longer afford.

Use a renting versus buying calculator

Now that you’ve thought through some of the pros and cons of renting versus buying, you need to crunch the numbers and figure out which option makes the most sense for your bottom line. There are tons of rent vs. buy calculators out there to choose from, but we recommend this offering from the New York Times. It’s extremely user-friendly and customizable to any situation.

Important questions to ask yourself before you buy a home

Okay, you’ve crunched the numbers, and you think you can afford this whole home ownership thing. Now what? It’s time to ask yourself some pretty challenging questions, like:

  • What’s my monthly housing budget?
  • What’s the maximum price I’m willing to pay for my new home?
  • How much do I want to save for a down payment?
  • How much should I put aside for closing costs?
  • What do I need to save for moving costs?
  • Will I need to buy furniture and decor for my new home?
  • Where do I want to buy a home?
  • How much space do I need? How many bedrooms? How many bathrooms?
  • Am I looking to buy in an area with a specific school system?
  • How much property do I want to take care of?
  • How much time am I willing to spend on home maintenance?
  • How much money will I need to put away for emergencies?
  • What will my yearly maintenance budget be?
  • What expertise does my real estate agent need to have?
  • What are the most important features my new home needs to have?
  • Do I want a starter home so I can trade up, or a larger home I can grow into?
  • How long do I plan to be in the home?
  • Am I willing to buy and take care of a fixer-upper? Or should I go with something that’s easier to maintain?
  • How much am I willing to spend on remodeling before I move into my new home?
  • Do I want a big yard that needs landscaping?

Really take time to think through what you want out of home ownership, and how you can afford it. That way, you’ll go into the process prepared and ready for anything.

II. Set a new home budget

Buying a home doesn’t come cheap, so you’ll need to set a budget, also known as a home price you’re comfortable with.

When you buy a home, you’re responsible for the purchasing costs (like down payment and closing costs), plus you’re also responsible for the ongoing costs of home ownership, like mortgage payments.

Consider the costs of purchasing a home

  • Earnest money deposit: An earnest money deposit (EMD) is a deposit you put down with your offer to show the seller you’re serious about buying their home. EMDs are typically between 1-3% of the home’s purchase price, though they can be up to 10% in highly competitive housing markets. Your EMD is placed in an escrow account until closing, and then it’s usually applied toward your down payment.
  • Down payment: Your down payment is a chunk of money you put down upfront and out-of-pocket for your new home. Many experts suggest putting down 20% or more on a home, but that simply isn’t realistic for many buyers. It also isn’t necessary. Many buyers put far less than 20% down, though a lower down payment will likely require you to pay extra for mortgage insurance. Depending on your situation, you may be able to purchase a home with as little as 3% down—or in some cases, zero down. To learn about the different types of mortgage loans, and their down payment requirements, check out our simple comparison chart.
  • Closing costs: Closing costs are fees you pay when you close on a home. They tend to add up to between 2-5% of a home’s purchase price. They include things like lender fees, prepaid property taxes, appraisal fees, and more.
  • Moving costs: Remember that buying a new home also comes with moving expenses, and they can really add up. Whether you hire a moving company or DIY your move, you should budget for what it will cost to actually get into your new home.
  • Repairs and remodeling costs: Your new home may need some repairs before it’s livable. Or, perhaps you’re just looking to make some updates. You’ll need to consider the costs of repairs and remodeling when setting your home budget.

Don’t forget to factor in the costs of homeownership

  • Mortgage payments: You’ll need to make your mortgage payment each month, so this is probably the biggest and most important cost you should consider when setting your budget.
  • Property taxes: Property taxes are typically rolled into your monthly mortgage payment, but it depends on your lender. Property taxes can vary significantly from one town to the next, so make sure to understand your monthly tax commitment before purchasing a home.
  • Homeowner’s insurance: Again, homeowner’s insurance is often rolled in to your mortgage payment, but it depends on your lender. Costs for homeowner’s insurance vary depending on the location, the type and size of the property, and more, but the average U.S. homeowner pays around $1,192 per year for homeowner’s insurance.
  • HOA fees: Not everyone has a Homeowners Association, so not everyone will pay this fee. Plus, these fees tend to vary widely, from a couple hundred dollars a year, to hundreds per month. One upside to these fees? HOA fees also tend to come with amenities. Think about whether HOA fees fit into your budget before you start homeshopping, so you can stay within a comfortable price range.
  • Title insurance: Title insurance protects your title to the home. That way some long lost relative of a previous owner can’t turn up to announce that they have ownership of your brand new home. The cost for title insurance typically averages to about $1,000 per policy.
  • Flood insurance (where relevant): In some areas, flood insurance is necessary when you purchase a home. The costs for this can vary, but on average, U.S. homeowners pay $708 per year for flood insurance.
  • Maintenance and repairs: Again, you need to budget for maintenance and repairs on your home. Many experts suggest setting aside 1-3% for home maintenance and repair costs.
  • Utilities: Your utility bills will depend on where you live and how you use your home, but homeowners are typically advised to set aside around $400 per month on average for utilities.
  • Mortgage insurance (where relevant): If you put down less than 20% on your new home, you’ll likely have to pay mortgage insurance until you reach 20% equity. This protects your lender, in case you default on your loan. Mortgage insurance usually costs between 0.5-1% of the entire loan amount each year.

Can you afford to buy a home? Crunch the numbers with our calculator

You know the major costs, so now you need to think about what you can actually afford. This is going to take some serious number-crunching, so grab your budget, and let’s get started.

What’s home affordability and why does it matter?

Home affordability basically asks the question: can you really afford your home? And the question goes beyond whether you can make your mortgage payments each month (although that’s important, too!). You should also think about whether you can comfortably afford your home.

Home affordability factors every buyer should know

Before you calculate how much home you can afford, there are a few factors to understand:

  • Annual income: Your annual income is how much you and your co-borrower make before taxes. This number includes your base salary, tips, commissions, bonuses, rental and investment income, overtime, alimony, child support, and any other income you bring in.
  • Monthly debts: Your monthly debts include you and your co-borrower’s recurring monthly debt payments like your car, student loans, credit cards, personal loans, and anything else that shows up on your credit report. This number does not include any rent payments you make.
  • Savings: How much money do you have saved for your home purchase? Remember, this money will need to cover your down payment, closing costs, and moving costs.
  • Down payment amount: This is how much money you plan to put down on your home, AKA how much equity you’re buying right away. Do you plan to put down 20%, or start with a more modest deposit? Now is the time to think about how much you’re comfortable putting down on your new home.
  • Credit score: Your credit score is important for determining your mortgage rate, and how much you’ll pay for your mortgage over time. The higher your score, the lower your rate and the less money you’ll pay over time.
  • Loan term & Interest Rate Type: This is the time period over which you’ll pay back your mortgage. Are you planning to get a 30-year mortgage and pay less each month, or a 15-year mortgage with higher monthly payments? And will you take out a fixed rate loan, or an adjustable rate mortgage (ARM)? There are pros and cons to each interest rate option, so it’s important to think carefully through the best loan for you.

DTI and how it can help you determine how much home you can afford

Your debt-to-income ratio or DTI, helps lenders determine how much home you can afford to buy. Your DTI looks at — you guessed it — how much debt you have comparable to your income. It’s calculated by dividing your debt by your income.

So let’s say you make $5,000 per month, and your currently monthly debts add up to $500.

$500 ÷ $5,000 = 10% DTI

Typically, lenders don’t like to see your DTI go above 43% when giving you a mortgage loan. And for many buyers, 43% may still be too high. So think of 43% DTI as your upper limit, rather than the guideline to strive for.

Let’s go back to our example of making $5,000 per month. At 43% DTI, your monthly debt shouldn’t exceed $2,150 per month. That means if you already carry that $500 of debt each month, your mortgage payment shouldn’t exceed $1650 per month. If you plan to keep a lower DTI, say around 36%, your mortgage payment can’t exceed $1,300 per month.

DTI is a good way to think about home affordability, because it’s exactly how your lender will think about what you can afford when the time comes to apply for a mortgage.

Set a budget with our home affordability calculator

Ready to take a hard look at the numbers? Head on over to our Home Affordability Calculator, and give it a whirl. Make sure to have your monthly income, debts, and down payment amount handy.

III. Get your finances in order

Another big step toward home ownership? Getting your finances in order to save up for your upfront costs like the down payment and closing costs. Let’s dive into how it’s done.

Save up for your down payment and closing costs

You know you need money for your down payment and closing costs. Now it’s time to get to the hard work of saving for the big purchase.

Assess your spending and create a budget to save money

If it wasn’t clear already, you’re going to need a personal budget if you want to save money to buy a home. Basically, that means taking a hard look at your current spending and finances, and figuring out what you can afford to spend each month for housing, utilities, maintenance and repairs, plus all your other debts and living expenses (including entertainment).

Get out your bank and credit card statements over the past six months, and go through them with a fine toothed comb. How much did you save, and how much did you spend? What did you spend your money on? Could you cut some expenses and save more? Are there any holes in your spending? Get everything on paper, and figure out your homeownership goals.

Along with setting a budget, you need to figure out how much you want to put down on a home, and how to save it.

Do you plan to be in your new home in one year? If you want to save $10,000 over a one-year period for a down payment, that means you need to save roughly $833 per month to meet your goal. If you can only save $500 per month, you’ll need 20 months.

What changes will you need to make to save that much money? And consider, too, whether it’s worth it to wait that long to buy a home. What if the home prices outpace what you’re able to save? You could find yourself in an uphill battle.

Make sure to consult with a trusted financial advisor while you figure out the best savings path to get you to home ownership.

Build a spending plan to reach your home ownership goals

Once you’ve determined how much you want to save, it’s time to make a plan and put it into action. Let’s say your goal is to save $1,000 a month. How will you get there? Perhaps you could take lunch to work every day instead of ordering from your favorite salad place. Or you could automatically divert some money from each paycheck into a savings account dedicated to your home purchase. Another idea might be to get some side hustle work.

Whatever you decide to do to save money, make a plan, and put it on paper. Buying a home is all about delayed gratification and taking small, daily steps to reach your goal. But it’s not all hard work and sacrifice — think of how proud you’ll feel on closing day!

If you need help setting up a budget, many financial experts recommend You Need a Budget. Although the app comes with a modest cost ($84 per year), they claim new budgeters save an average of $6,000 using it.

7 top tips to build your savings and buy a home

Need some tips to get started on saving for your dream home? Here are a few ideas that almost anyone can implement:

  1. Set up a down payment fund: If you’re serious about saving for a new home, a great place to start is setting up a down payment fund. Basically, that means opening a savings account where you’ll squirrel away money for your down payment over time. To make your money go even further, you can try a high yield savings account. These accounts pay higher-than-average interest, so they’re good for anyone saving up for a large purchase.
  2. Pick up some side income: Another way to boost your savings for your new home is to pick up some side income. It’s never been easier to get gigs, or take advantage of remote opportunities. Whether you decide to take on a couple weekly shifts for a ride sharing app, or pick up some freelance work in your area of expertise, making a little extra side income is a great way to amass cash for your down payment — especially if you don’t have much wiggle room in your current budget.
  3. Cook for yourself: We know, we know. Who’s got the time to cook all their meals these days? But it’s important to make the time to cook for yourself if you’re trying to save up for a home. Here’s why: According to recent research by Wellio, eating out costs a whopping 5x more (on average) than cooking for yourself. Depending on your dining out habits, you could potentially save thousands in a year just by cutting back on takeout and preparing a few extra meals per week. That money could be funneled directly into your high-yield account, instead.
  4. Automatically set aside the money: One favorite tip of financial experts is to “pay yourself first.” This means each time you get a paycheck, you immediately divert some of the money directly into your savings or investments. So, let’s say when you set your budget, you decide to put 10% of each paycheck into your down payment fund. Instead of transferring the money manually each month, set it up so that 10% of your paycheck is automatically diverted into your down payment fund right when it hits your account. That way, you can’t accidentally spend the money, and it’s already stocked away in savings before you even need to think about it.
  5. Cut back your expenses: Are there expenses you could cut back, like your daily Starbucks routine, or that gym membership you haven’t used in 8 months? The reality is, most of us have some unnecessary bloat in our budgets. Saving for your new home is the perfect opportunity to take stock of what’s really important to you, and what expenses could go. Like, maybe now is the time to cut the cord on cable, and go full streaming. Or perhaps instead of trading your car in for a newer model, you could stick with the older model for another year or two.
  6. Cancel subscriptions: Speaking of expenses that can go, it’s probably a good time to review your subscriptions and make sure you really need them. This isn’t to say you should get rid of stuff you’re using. Instead, think of it like you’re trimming the fat. Anything you can cut will get you into your dream home faster.
  7. Skip vacations: According to CreditDonkey, the average vacation costs $1,145 per person. While taking time off work to relax and regroup is important, think long and hard about whether you want to travel while saving for a home. That $1,145 per person could be a big boost to your down payment.

Improve your credit score and lower your debt

Another big financial goal you’ll need to tackle while preparing to buy a home is improving your credit score. Your credit score is important, because it’s one way lenders determine your mortgage rate. The rule goes: The better your credit score, the better mortgage rate you’ll score.

Why your credit score is important for buying a home

Your credit score is one of the main factors your mortgage lender will use to determine your mortgage rate. Further, if your credit score is too low, you may not qualify for a loan at all. Improving your credit score is one of the single most important things you can do to ensure you get the best deal on your new home, and that it remains affordable for years to come.

What your credit score means

A credit score is a three digit number that assesses your creditworthiness. Basically, when you take on debts like credit cards, personal loans, and car loans, lenders need to think about the risks of lending you that money. Will you make payments consistently and on time? If you have a long history of doing so, a lender is going to be a lot more likely to give you that loan. Hence, the existence of credit scores — they give lenders an easy way to assess how likely you are to pay back your debt on time.

Credit scores can range anywhere from 300 (poor) to 850 (excellent), but mortgage lenders typically like to see strong credit scores of 690 and above. However, there are government programs that allow you to buy a home with a lower credit score, though most have a minimum score of 580.

For more details on what your credit score means, check out our Prepare page.

How to pull and review your credit reports

Credit scores are reported by three main agencies: Experian, Equifax and TransUnion. Each agency calculates credit scores a little differently. Your mortgage lender will probably look at all three.

So how do you know what you’re up against? You’ve got to pull your credit reports, and do some digging into your score, so you’ll be ready when it’s mortgage time.

By law, you’re entitled to a free annual credit report from each of the three major credit agencies. To get your free reports, visit the Federal government’s free credit report site.

The five main components that make up your credit score (and how to improve them!)

Your credit score is made up of five main components: payment history, amount you owe, new credit opened, length of credit history, and types of credit. Let’s walk through the basics of each component, and what you can do to improve your score.

  1. Payment history: 35% of your credit score
  • How it’s calculated: Your payment history looks at your track record of making complete, on-time payments each month. Late payments can hurt your credit score, and a long history of paying on time will boost your score.
  • How to improve your score:
    • Pay off any outstanding debt.
    • Make all payments in-full and on time.
    • If you’ve had a single late payment with one of your creditors, call them and ask if they’ll remove it from your credit reports.
  1. Amount you owe/utilization: 30% of your credit score
    • How it’s calculated: This looks at how much of your credit you’re currently using compared to how much you could be using. For example, if you have a credit card with a $10,000 limit, but you’ve only spent $100 on it, you have low utilization. Low utilization improves your credit score. If you have that same $10,000 credit limit, but you’ve spent $9,500 on it, you have high utilization, which can lower your credit score.
    • How to improve your score:
      • Pay down any credit cards with high balances.
      • Pay your credit card off in full each month.
  • **Important: If you’re able to, pay your credit card off a few days before your statement closes each month. Credit score utilization is based on the numbers from your monthly statement, so if you pay off your card before the statement, your utilization comes in at 0%. Some people claim a 20 to 30 point score increase using this method for a few months. 
  1. New credit opened: 10% of credit score
  • How it’s calculated: Each time you take out a new line of credit (say, getting a car loan), your credit score takes a temporary hit. The good news is, this doesn’t hurt your credit forever — just 6 to 12 months — so with a little patience, your score will recover. Plus, over time, having a few different lines of credit can help your score, provided you’re paying everything off on time every month.
  • How to improve your score:
    • Refrain from taking out any new credit in the year leading up to getting a mortgage.
    • Limit any “hard credit pulls” in the months leading up to your mortgage.
  1. Length of credit history: 15% of credit score
  • How it’s calculated: The longer your history of credit, the safer lenders see you as a borrower. So the longer you’ve held your accounts, and hopefully been in good standing with them, the more this part of your score improves. If you’re brand new to credit, then lenders don’t have much to judge you on, and they may see you as riskier when it comes to issuing a loan.
  • How to improve your score:
    • Don’t close unused accounts, as they can actually help with your length of credit history score.
    • If you’re new to credit, be patient and diligent with your payments. It takes time to build credit, but it will be worth it when you’re finally in your dream home.
  1. Types of credit: 10% of credit score
  • How it’s calculated: This component of your credit score looks at the variety of credit you have, whether through credit cards, student loans, auto loans, personal loans, or a mortgage. Having a few different types of debt that you pay each month shows mortgage lenders you’re likely to pay them, too.
  • How to improve your score:
    • Remember, now is not the time to be taking on new lines of credit, unless you have absolutely no credit and need to establish some. If that’s the case, it’s a good idea to consult with a trusted financial adviser who can help get you set up for your financial future.
    • This is the smallest portion of your credit score, so don’t worry too much about it.

For more tips on how to optimize your credit score, head to our Prepare page.

Get your documentation together to apply for a mortgage

Getting a mortgage means navigating mountains of paperwork. One thing you can do to get ahead of the game is to get your paperwork in order before you’re ready to apply for a mortgage. Here’s what you’ll need.

List of documents you need to get a mortgage

  • 2 years of income verification (W2s, 1099s, pay stubs, etc.)
  • 2 months of bank statements showing proof of the cash you have on hand for the down payment, closing costs, and reserves.
  • Gift letters for any money you’ve been gifted from family members
  • 2 years of your address and rent or mortgage history
  • 2 years of your employment history
  • Proof of any child support or alimony payments you make
  • Proof of any other income you’ll use to qualify for a mortgage, like disability, bonuses, stock dividends, social security, or pension.
  • Information on all debts, including credit cards, auto loans, student loans, personal loans, and mortgages if you have any.
  • Proof of non-liquid assets like debts, bonds, stocks, insurance policies, etc.


IV. Research your housing market and find an agent

Get the pulse on your local real estate market

One of the best things you can do to prepare for buying a home is to study your local real estate market. What are the neighborhoods that would work best for your family? Are school systems important to you? What are the price points in different neighborhoods?

Another good reason to do your research is to make a good investment. For example, on one street, homes may appreciate an average of 3% each year, while the prices of homes a few streets over remain stagnant. If you do the research, you’re going into the biggest financial decision of your life with eyes wide open.

You can research local market data on big real estate sites like Zillow, and get local information like demographics, walkability, and schools on NeighborhoodScout. Another way to get a feel for a market is to check out local publications and media.

But the absolute best way to learn the ins and outs of the local market is through your real estate agent.

Find a qualified real estate agent

Finding a quality real estate agent is crucial if you want to have a smooth home purchase. A great real estate agent is an expert in their local market. They know the ins and outs of prices, neighborhood features, property taxes, and how to make a winning-offer. Plus, they have access to all the listings, including those that aren’t included on the big real estate sites.

And the best part? Buyers typically don’t need to pay their agent — in most cases, the sellers pay the buyer’s agent through closing costs. To find a top agent, check out our Find page.

When should you hire a real estate agent?

So, when’s the right time to engage a real estate agent? That depends on your situation. For some buyers, it makes sense to find someone early on in the process, before they’ve even started thinking about lenders. For others, it makes sense to get an agent after they’ve gotten pre-approved.

If you’re feeling overwhelmed or confused by the whole homebuying process, it might make sense to hire an agent early. If you’re ready to get pre-approved, you could wait until you’re ready to put together your offer.

There’s no wrong answer, and agents are there to help you through your home purchase, so don’t be afraid to find one and tap into their expertise. A quality agent will be happy to help walk you through the process, from home search to close.

Where to find a great real estate agent

If you’re ready to find a great agent, make sure to hire someone who specializes in your needs. For example, if you’re a first-time homebuyer, you’ll want to work with an agent who specializes in helping first-time buyers.

But how do you find an agent who fits your needs when there are 400,000 of them in the country? Check out our Find page. We’ve partnered with HomeLight, a site that analyzes millions of real estate transactions to find you the best agent for your unique needs.

V. Learn the basics about mortgages

Three words that are commonly used to describe the process of getting a mortgage: Confusing, frustrating, and overwhelming. But that doesn’t have to be your experience! Let’s start with the mortgage basics, so you can navigate the home loan process with ease.

What’s a mortgage?

A mortgage is a loan you take out to buy a home. Most homebuyers don’t have the funds to purchase a home in cash, so a mortgage is a way to pay for the home over time. With a mortgage loan, you borrow the money to buy a home, and pay it back through monthly payments over a set period of time, typically 15 or 30 years. Mortgage loans also carry interest, meaning you have to pay to borrow the money over time.

What do lenders look for when they give you a mortgage?

When a lender decides whether to give you a mortgage, the biggest thing they’re looking for is risk. Think about it from the lender’s perspective: They’re about to fork over a huge sum of money so you can buy your dream home. If they don’t perform their due diligence, that money could be at risk.

How do lenders avoid risk? They look for buyers with solid credit, steady and provable income, and relatively low debt. If you’ve got all three, you should be in good shape to get pre-approved and start home shopping. If one or two areas need a little work, you might need to repair your financial situation before you can qualify for a loan.

Understand the different types of mortgages

Different types of mortgages service different buyers. For the most part, there are 5 main types of mortgages, each with different requirements and payment terms. Let’s dive into the options:

  1. Conventional loan (conforming): Conventional, conforming mortgages are private bank loans for homes up to a certain value, typically $453,100. These loans require at least 3% down, and are mostly issued to buyers with strong credit (min. score 690) and financials. Check out the pros and cons of conventional loans here.
  2. Conventional JUMBO loan (non-conforming): Conventional JUMBO non-conforming mortgages are private bank loans for larger amounts that aren’t covered by conforming loans. If you want to buy a million dollar home with a mortgage, you’re most likely going to need a JUMBO loan to do it. These loans come with stricter qualifications — think credit scores of 720 or above  —  and larger down payments. Learn more about the ups and downs of conventional JUMBO loans here.
  3. FHA loan: FHA mortgages are government-backed loans offered by the Federal Housing Administration. These loans are for buyers who don’t qualify for conventional loans, and they have less strict requirements for credit scores (they go as low as 580 for 3.5% down, or as low as 500 for 10% down). Though you’ll pay higher interest rates, FHA loans are good options for buyers with average credit. Explore the pros and cons of FHA loans here.
  4. VA loan: VA loans are offered by the U.S. Department of Veterans Affairs for military service members and their families. These loans don’t require down payments, and offer lower interest rates than average. However, there’s a catch: in most cases, qualifying buyers need a minimum credit score of 620. For more on the advantages and drawbacks of VA loans, check out our primer.
  5. USDA/RHS loans (formerly sec 502): USDA and RHS loans are government-backed loans for homes in rural areas (covering around 97% of the country), and they’re meant for buyers below a certain income level. These loans require a minimum credit score of 640, but you’ll also enjoy lower-than-average mortgage rates. To find out more about the pros and cons to USA/RHS loans, head on over to our Prepare page.

For a full breakdown of the different types of mortgages, their requirements, and pros and cons, check out our Prepare page.

Navigate mortgage interest rates

What’s a mortgage rate?

Your mortgage rate is the interest you’ll pay on your home loan over time. If you borrow $200,000 from your lender, you’re not going to pay back exactly $200,000 (this number is known as your principal, or the amount you’re borrowing). You’ll pay back $200,000, plus, say 4% interest. And that interest really adds up over time — often to tens of thousands of dollars.

Who sets mortgage rates?

Mortgage rates are set by lenders. Rates are pretty complex and they can change on a minute-to-minute basis, depending on a whole bunch of economic factors.

The Federal Reserve interest rate is the biggest factor that affects mortgage rates. The Federal Reserve rate is the foundation of what mortgage rates are built around. But you can expect your mortgage rate to be a bit higher than the Fed rate. That’s because mortgages cost a lot of money to produce, and unfortunately, those costs are passed on to you.

The rate you’re offered by a lender will depend on all those outside factors, plus the specifics of your financials, like your credit score, down payment amount, and more. The better shape your financials are in, the lower rate you’ll pay, and the more you’ll save on your home over time.

The different types of mortgage loan interest, explained

There are three main types of mortgage loan interest: fixed rate, adjustable rate, and interest-only ARM. They each have pluses and drawbacks, depending on the buyer.

  1. Fixed rate mortgage: With a fixed-rate mortgage, you have the same interest rate over the entire life of the loan. That means you make the same payment throughout the loan term, whether it be 30 or 15 years. To learn more about the pros and cons of fixed rate mortgages, check out our Prepare page.
  2. Adjustable rate mortgage (ARM): With an adjustable-rate mortgage, you pay a lower interest rate for an introductory period of 5, 7, or 10 years, and then your rate adjusts to the market rate each year for the rest of the loan term. Learn more about the ups and downs of adjustable rate mortgages here.
  3. Interest-only ARM: An interest-only ARM is a loan where you pay only interest for a fixed period of time, like 5 or 10 years, after which your payments go up significantly for the rest of the loan term, while you pay both interest and principal. Get all the info on the advantages and drawbacks of interest-only mortgages here.

For more on the different types of loan interest, and the pros and cons to each option, head over to our Prepare page.

What’s going on with mortgage rates now? Look at the trends

Over the past few years, mortgage rates have fallen to near historic lows. It’s basically never been cheaper to take out a mortgage. With the recent Covid pandemic, the Federal Reserve forecasts that it expects interest rates to remain at their current all time low through the end of 2022!  That means it could be a great time to buy a house if you have the means to make the plunge into home ownership. For more on mortgage rate trends over time, check out our Prepare page.

Figure out what type of mortgage lender is right for you

There are four main types of mortgage lenders: Traditional banks, mortgage lenders, FHA community banks/credit unions, and mortgage brokers. Let’s take a look at each option, and what makes them unique.

The four main types of mortgage lenders, explained

  1. Traditional banks: These are the major banks like Wells Fargo, Chase, Bank of America, and the like. This group also includes mid-to-smaller firms that lend money directly. In this scenario, the bank is lending you the money directly, and you may get special pricing if you already have a preexisting relationship. To learn more about traditional banks, head to our Lender Comparison chart.
  2. Mortgage lenders: These are mortgage companies (think Quicken Loans, or Better Mortgage) that underwrite mortgages and fund loans with their own money. But the big difference here is, 30 to 60 days after close, mortgage lenders will usually sell your loan to a large bank. For more on mortgage companies, check out our Lender Comparison chart.
  3. FHA community banks/credit unions: Community banks and credit unions can also issue mortgages to homebuyers. Sometimes, they even have incredibly competitive pricing, not to mention individualized service. However, it’s much more challenging to find a lender in this category, so it helps to already have a relationship with one. Find out more about FHA community banks and credit unions on our Lender Comparison chart.
  4. Mortgage brokers: A mortgage broker is a professional that shops around for loans for you. They tend to have their own lender networks, meaning they can get you competitive rates. Plus, you have someone to take a lot of the work of getting a mortgage off your hands. The catch? Mortgage brokers tend to take 1% of the loan amount as a fee for their efforts. Want more info on mortgage brokers? Check out our Lender Comparison chart.

For more on the four types of lenders, including pros and cons and top tips for buyers, check out our Prepare page.

VI. Explore homebuyer programs that could save you money

What if there was a homebuyer program that could, say, help you out with your down payment? Or a home renovation loan so you can buy that fixer-upper you’ve been eyeing? There are tons of programs out there for buyers — especially first-time homebuyers.

Special programs for first-time buyers

  • Down payment assistance programs: Need help with your down payment? You’re not alone. Around two-thirds of Americans say the down payment is their biggest obstacle to buying a home. Thankfully, there are down payment assistance programs to help. These tend to be grant programs, many of which don’t even require you to pay the money back. Using one of these programs can save you big money. According to recent research by RealtyTrac, down payment assistance programs save homebuyers an average of $17,000 over the life of a loan. To find a program in your state, check out this state-by-state guide by The Mortgage Reports. You can also see if you’re eligible for a program through Freddie Mac site, Down Payment Resource.
  • Fannie and Freddie programs: Both Freddie Mac and Fannie Mae (the U.S. government-backed mortgage companies) have a plethora of options for first-time homebuyers, including down payment assistance and low down payment programs.
  • Renovation loans: Fannie Mae also offers renovation loans for fixer-uppers, such as their HomeStyle Renovation Mortgage. So, if you’re planning to buy a home that needs some work, you may be able to take out the renovation cost along with your mortgage.
  • Good Neighbor Next Door: This is a HUD program for educators, EMTs, firefighters, and law enforcement officers. With this program, you can save up to 50% off a home’s list price, so long as the home is in an area designated for revitalization. Another catch? You have to stay in the home for at least 3 years.

Find other local homebuyer programs that fit your needs

There are even more local homebuyer programs out there, but unfortunately, there’s no easy database to find them, so you’ll have to do a bit of research on your own. Try searching homebuyer programs + your city, town, or county on your favorite search engine. Another idea is to ask your real estate agent. They’ll have expertise on all the local offerings, and can find you the right program for your needs.

If you need a top real estate agent, head to our Find page, where we can help match you with the best agents in your area.

Appendix: Glossary of important mortgage terms

  • DTI: Debt-to-income (DTI) ratio compares your debt to your income. Lenders look at it to determine how much you can safely borrow. It’s calculated by dividing your debt by your income. Typically, 43% is the upper limit DTI for when you get a mortgage.
  • Down payment: The deposit you put down upfront and out of pocket for a home. Down payments typically range from 3% to 20%, depending on the individual buyer and what type of loan they use.
  • Mortgage rate: This is the interest rate you’ll pay on your home loan over time. Mortgage interest is expressed as a percentage, and is set by your lender based on things like your credit score and down payment amount, plus the Federal interest rate.
  • APR: Your annual percentage rate (APR) is your mortgage interest rate plus all of your financing or lender chargers baked in. APR is also expressed as a percentage, and it tends to be higher than your rate, because it’s more of an all-inclusive rate.
  • Closing costs: Closing costs are one-time fees you pay when you close on your home for things like lender fees, appraisal, homeowner’s insurance, and more. Closing costs are largely non-negotiable, and tend to tack on 2% to 5% to the price of the home.
  • Pre-qualification: A mortgage pre-qualification is usually completed in just a few minutes. The buyer self-reports some financial information like their income and credit score, and the lender automatically generates a pre-qualification letter stating the size of the loan the buyer may qualify for. Since pre-approvals are self-reported by the buyer and unverified by the lender, they don’t carry much weight. They’re really meant to function as estimates for buyers to get an idea of how much home they might qualify for.
  • Pre-approval: A mortgage pre-approval is a bit more involved than a pre-qualification. Typically, you need to actually apply for a mortgage to get pre-approved. That means providing all of your financial documentation, and giving permission to the lender to do a credit pull (which can affect your credit score). With a pre-approval, you get a much more solid understanding of how much home you can afford, and what your rate will be. Although it’s important to note that a pre-approval doesn’t guarantee a loan approval — you still need to go through the financing process before your loan can be approved.
  • Underwriting: This is the process where your lender looks closely at your financials, assesses any risks of giving you a loan, and decides whether or not to approve your mortgage.
  • LTV: Loan-to-value ratio (LTV) looks at the cost of the loan you’re trying to take out compared to the overall assessed value of the home. So, if you’re buying a $250,000 home, and have $50,000 (20%) set aside for a down payment, your LTV would be 80%.
  • Loan estimate: After you apply for a mortgage, your lender is required to give you a Loan Estimate (LE) within three business days. The Loan Estimate includes important information like the terms of your loan, the rate, your monthly payment amounts, estimated closing costs, and more.
  • Appraisal: Before a mortgage can be approved, your lender needs to do an appraisal  on the home. That means an independent appraisal company comes out to look at the home, plus look at all the local real estate data to make sure you’re not overpaying. If your appraisal comes in lower than your offer, it can mean having to renegotiate terms with the seller, or in more extreme cases, it can tank the deal all together.
  • Closing disclosure: When you’re ready to close on your new home, the lender will give you a Closing Disclosure (CD) that includes all the final terms of the loan, including your monthly payments, final closing costs, rate, APR, and more. The purpose of this disclosure is to clearly lay out all fees and payments associated with your mortgage.

LoanCompass simplifies homebuying by providing simple directions through easy to digest steps. Our mission is to empower you with the knowledge and tools you need to get the best possible mortgage and home buying experience. Visit our site and we’ll walk you through each step of the process!

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