Applying for a mortgage, especially for your first home purchase, can seem confusing and overwhelming for some people. Maybe you struggle to stay organized with your financial affairs. Perhaps the thought of proving your financial preparedness to take on a large amount of debt feels akin to writing that dreaded college application essay.
Being approved for a home mortgage does take time and energy, but, with the guidance of a trusted financial advisor and a reputable lender, the process does not have to be complicated. The following step-by-step guide shows what you should consider and items you will need to provide to the lender as you finance the purchase of your first home.
A lender will want to understand your debt-to-income ratio to determine your ability to pay your mortgage along with any existing debt.To calculate your ratio, lenders will ask for the following documents early in the process, so start gathering them now:
- W-2 form [ or 1099 form for business owners ] from previous 1-2 years
- Recent earnings statements
- Tax return from previous 1-2 years
- List of minimum monthly payments and balances for any debts, including credit cards, student
loans, car loans, or child support payments
- List of assets—including bank statements, investment account statements, titles to real estate
- Proof of rent [ or mortgage ] payments
Note: Your financial planner should already have these types of documents on file for you and will work with a reputable lender to provide the necessary documents on your behalf.
Check your credit
A lender will want to see your level of responsibility with credit in the past to determine the riskiness of lending to you, so take the pre-emptive measure of obtaining your credit score and credit history report now. You can request a free copy of your credit report from each of the three major credit reporting agencies [ CRAs ] — Equifax, Experian and Transunion — once a year at annualcreditreport.com. Your credit card company may provide your credit score free of charge. Alternatively, you can purchase your credit score from any of the CRAs. Avoid applying for new credit in the months prior to applying for a mortgage to protect yourself from extra scrutiny by your lender.
Determine what you can afford
A good rule of thumb is for your monthly housing costs-including principal, interest, taxes, and insurance-plus your other recurring debt payments to total no more than 36% of your monthly gross [ pre-tax ] income. Look at your existing monthly budget to determine a responsible amount to spend per month on housing costs. Check with your financial advisor to help you think about your monthly mortgage payments in light of your long-term cash flow projections.
Decide on a down payment
Conventional mortgages may allow you to put down as little as 5% of the home purchase price, but to avoid having to pay for private mortgage insurance, you should put down at least 20%. The more you put down when you purchase a home, the more you will save over the term of the loan. Check out Zillow’s mortgage calculator to estimate your mortgage payment using different variables of home prices, down payments and interest rates.
To put into perspective: if you were to put down 20% on a $300,000 home with a 30-year loan at 4% interest, you would end up paying about $172,000 in interest over the life of the loan. If you purchased the same home with a 10% down payment, you would end up paying about $194,000 in interest—a difference of nearly $22,000 or 12% over the life of the loan!
A savings of $22,000 over the term of your loan means being able to pursue other personal dreams. For some, those savings could mean the ability to hire a monthly cleaning service for your new home. For others, it may mean putting away a little more each month for retirement and letting your money grow. Ask your financial advisor to help you think through the best strategy to not only obtain a mortgage, but also to accomplish your personal goals.
While the mortgage application process can seem daunting, careful planning will set you up for success—and keep you level headed—as you embark on finding your perfect new home.