Buying a home is the largest investment many Americans will make, and, especially for first-time homebuyers, this process will raise a number of questions about navigating the mortgage process.
While the home-buying process is unique to each individual homebuyer and dependent on their personal financial situation and the contract they negotiate on the home they are buying, there are several factors they should be aware of in advance to avoid confusion. Homebuyers who are informed entering into the process will have a more successful homebuying experience.
Here are some of the most popular questions homebuyers ask when preparing to take out a mortgage, or in the midst of the homebuying process.
What is a mortgage?
A mortgage is simply a loan that borrowers take out to purchase their home. Similar to buying a car, the amount of the mortgage the borrower is able to obtain will depend on the value of the home as well as their own financial situation.
Borrowers can also choose from varying loan types such as a fixed-rate loan (usually set for 15 or 30 years) where the interest rate on their loan remains unchanged for the life of the loan, or an adjustable-rate mortgage (ARM), which are often set for five years, and after these five years the interest rate of the loan will change to the current market rate.
There are several mortgage options for first-time homebuyers or even returning homebuyers that allow them to put less money down. Other mortgage options could require more money down, but have more flexibility on other things such as the borrower’s credit profile. When borrowers apply for a mortgage, a mortgage lender will typically review their application and discuss the best options available to them.
How do I qualify for a mortgage?
There are various mortgage options available on the market, but one of the most common types of mortgages is the conventional conforming loan. Another kind of loan is called a non-QM, which is also described below.
Conventional loans are provided by a private lender and backed by the government through Fannie Mae and Freddie Mac, and typically provide lower interest rates for borrowers as well as additional protections to help avoid foreclosure if borrowers begin struggling with their payments or face a hardship.
First-time homebuyers can obtain a conforming mortgage with as little as 3% down, while other borrowers can put as little as 5% down for these loans. Here are a few of the other requirements to qualify for a conventional mortgage:
- Income: Borrowers must make at least 80% of their area median income.
- Credit Score: Most borrowers will need a credit score of at least 620.
- Debt-to-income ratio (DTI): This is the percent of your total income to total debt. After adding up your total monthly payments toward debt such as student loans or credit cards, it must not surpass 50% of your monthly pre-tax income.
What credit score do I need to get a mortgage?
For a conventional mortgage, one of the most popular mortgage types, most borrowers will need a credit score of at least 620. However, there are other options, such as government non-conventional loans. For example, many first-time homebuyers choose to take out a mortgage through the Federal Housing Agency (FHA) due to its low 3.5% down payment option and credit score requirement of just 580. But these loans could ultimately cost borrowers more money per month due to their additional mortgage insurance requirements.
USDA mortgages have a minimum credit score requirement of 640 while VA mortgages require a credit score of at least 580.
Private lenders may also choose to do a non-conforming loan, which is a loan created by a private lender and not backed by Fannie Mae or Freddie Mac since it typically does not meet the criteria for a conforming loan. For non-conforming loans, lenders can set their own credit score minimums, but often charge higher fees for these types of loans.
How much money do you have to put down for a mortgage?
The industry standard for a mortgage down payment is typically thought of as 20%, however, there are many options that require less down payment or even no money down. In fact, the average first-time homebuyer puts 6% down on their home while the average repeat homebuyer puts 13% down, according to data from Rocket Mortgage.
Conventional conforming loans require 3% down for first-time homebuyers and 5% for everyone else, while an FHA loan requires 3.5% down for all borrowers. Both USDA and VA loans do not require a down payment.
But borrowers should keep in mind they will also need to pay closing fees. These usually total about 3% to 6% of the total loan amount, but these may be rolled into the total cost of the loan and paid out over time for some borrowers.
What is the difference between a conventional, FHA, USDA and VA mortgage?
A conventional mortgage is a non-government loan created by a private lender. These loans may be either conforming, meaning they meet Fannie Mae and Freddie Mac’s standards to be backed by the mortgage giants, or non-conforming.
Government loans include loans created by the FHA, USDA and VA. Here are some of the key differences:
FHA loans may be taken out by any qualifying borrower, but can often cost more than a conventional loan due to added fees. For example, FHA loans include a mortgage insurance fee that can be as high as $200 per month for the life of the loan. Conventional loans may also require mortgage insurance for those who put less than 20% down, but the insurance fees are typically lower and can easily be removed once a borrower holds at least 20% equity stake in their home.
USDA loans do not require a down payment or have mortgage insurance but they require a 1% upfront fee which are typically wrapped into the total loan amount and included in the borrower’s monthly payments. These loans are available to qualifying borrowers who purchase a home in a rural area and do not make more than 15% more than the area’s median income. But borrowers should check with their lender to see if they qualify for this loan- oftentimes in rapidly growing areas some suburbs could still be classified as “rural.”
VA loans are available to qualifying borrowers who are veterans or active members of the military. Similar to USDA loans, VA loans do not have mortgage insurance requirements but there is an added funding fee that may be wrapped into the total loan amount.
What is a non-QM mortgage and should I get one of those instead?
Potential homebuyers who do not want to go down the route of the conventional mortgages process described above should consider a non-Qualified Mortgage. These mortgages are for private investments as opposed to being linked to the government entities above, and the market for non-QMs is growing!
Non-QM loans allow alternative methods to qualify for the loan. So instead of traditional income verification methods, like pulling tax records, bank statements and/or investment assets, can be used to verify the borrower’s ability to repay the mortgage.
Is a non-QM a riskier loan? No. No, it’s not. Don’t let the name fool you, these loans still meet and exceed qualifications. In fact, lenders employ a higher set of standards when utilizing non-QM lending, according to Business Insider. However, this means lenders will charge more for the extra work that goes into a non-QM loan. This could take the form of a higher fee or slightly higher interest rate to offset the additional cost to originate a non-QM.
How long does it take to close on a mortgage?
It typically takes up to a month or more to close on a mortgage loan, although some lenders who use more digital processes can close on a loan much faster.
How can I get started applying for a mortgage?
Getting started can be as simple as filling out an application in person or online with a mortgage lender. Lenders will then be able to analyze the borrower’s credit profile and provide the best options available as well as an estimate for how much of a loan they qualify for and what the monthly payment might be.
Even borrowers who are not quite ready to purchase a home could benefit from applying early. This gives lenders the opportunity to review borrowers’ finances and advise them on some of the best ways to improve their credit score or prepare their profile to qualify for a mortgage in the coming months.
Still have questions on non-QM lending? Check out our full list of frequently asked questions or send us a message at [email protected].