Ready to buy your first home? Applying for a mortgage is the place to start. Here are 9 manageable steps to help you navigate this sometimes overwhelming process.
Buying your first home is an exciting journey. But, once you get started, navigating the process can start to feel intimidating fast.
There’s so much to do. You’ll want to start with getting your finances in order and understanding your mortgage options.
We want you to feel confident in finding the best way to finance your dream home. That’s why we’ve broken the process of preparing for a mortgage down into 9 manageable steps for first-time home buyers like you.
Each section starts with clear action items that you can use to keep track of your progress over time. Then we explain each item to help you understand what it means and why it matters in your home buying journey.
Remember, there’s no need to feel overwhelmed. Just take it one step at a time.
You can save this article on your computer or print it out, then come back to it whenever you need guidance.
PREPARING YOUR FINANCES
Get your credit in shape
- Make sure all your bills are paid on time and that you have no overdue bills outstanding
- Get your credit utilization score as low as possible
You typically need a credit score of 620 or higher to be approved for a conventional mortgage. And the better your score, the lower your interest rate will be – that’s why it pays off to look at how you can improve your score.
The first and most important step in working on your credit score is making sure that you don’t have any late bills outstanding. This includes all your bills, not just credit cards. Timing on bills like rent, utilities, and student loan payments all get factored into your score, too.
Late payments are a big factor in lowering your credit score, so you want to avoid them whenever possible and fix them as soon as you can when they happen.
Once your payments are on time, start working on your “credit utilization.” This is one major factor in your credit score that you actually have a lot of immediate control over.
Your credit utilization is the percentage of the total limits on your credit cards that you’re currently using. So, let’s say your current balances on your credit cards add up to $1,000 and your total credit limit across those cards is $5,000. In this case, your credit utilization would be 20% ($1,000 / $5,000 = 0.2 or 20%).
Once you’ve made sure that you’re current on all your payments, you can consider asking your credit card companies for higher credit limits on your cards.
Keep in mind that you don’t want to use those higher limits to spend more. What you really want is to have higher limits while keeping your spending the same (or lower if you can manage).
That will help keep your credit utilization low, and give you the chance for a quick win in raising your score.
Get your down payment together
- Figure out how much money you’ll be able to set aside or save up for a down payment without missing any other financial obligations
When you apply for a mortgage, your lender or mortgage broker will ask you to show proof of sufficient down payment funds in your financial accounts (checking, savings, etc).
The first step in preparing for this is figuring out how much money you can put together for a down payment.
Consider how much money you have saved up right now, and how much money you could save up between now and when you plan to buy your home without missing any other financial obligations.
If you have someone in your life who would be willing to contribute money towards your down payment as a gift, like a parent or other close relative, factor that amount in, too.
Add those together to come up with a solid estimate for your down payment that you can use as you research your options for financing.
Calculate your debt-to-income ratio
- Add up all your monthly debt payments
- Divide that by your monthly income
- Compare your DTI to the maximum that’s usually allowed to qualify for a mortgage
Your debt-to-income ratio (DTI) is one of the first things that a mortgage lender will calculate to make sure you can afford a mortgage.
Luckily, calculating your DTI is easy. Knowing it ahead of time will make you better prepared once you start determining which types of financing best fit your situation.
To calculate your DTI:
- Add up all your monthly debt payments (your current rent and all your loan payments)
- Divide them by your total monthly income
When it comes to DTI, your monthly debt payments include your current rent or mortgage, auto loan, student loan, credit card, and child support or alimony.
As an example, let’s say all your monthly debt payments add up to $2,500, and your total monthly income is $6,000. In this case, your DTI would be about 42% ($2,500 / $6,000 = 0.42, A.K.A. 42%).
Now for the important part: your DTI will likely need to be less than 45% to get approved for a typical mortgage.
If your DTI is more than 45% right now, that doesn’t necessarily mean you can’t become a homeowner. Keep reading, because in the next section we’ll give you a promising alternative to mortgages that may work for you.
UNDERSTANDING YOUR OPTIONS
Consider your financing options
- Look into the types of mortgage that will work best for you based on your credit score and down payment
- Consider your backup options in case you can’t qualify for a mortgage
The most common way that people finance their first home purchase is by getting a mortgage loan.
There are multiple types of mortgages out there, some of which we’ll explain in more detail later in this post.
What’s important to understand right now is there are two common types of mortgages:
- Government-backed mortgages
- Conventional mortgages
Government-backed mortgages are supported by government programs intended to increase homeownership among specific groups of Americans, such as low-income families or Veterans.
Government-backed mortgages usually require a down payment of at least 3.5% and a credit score of 500. However, these are just the absolute minimums and do not guarantee that you will qualify.
Conventional mortgages are traditional mortgages such as those offered by banks and credit unions, and will usually require a down payment of between 3% and 20%, and a credit score between 620 and 740.
We know those are big ranges, so keep in mind that the lower end of those numbers are just the minimum requirements in each area. The higher your down payment and credit score are, the more likely you are to qualify for one of these mortgages, and the lower your monthly payment will be if you do.
Worried that your credit score or down payment isn’t high enough to qualify for one of these mortgages?
Don’t be discouraged. Mortgages aren’t your only option.
At Divvy, we offer homeownership programs that allow you to move in now to the home you want to own. You build towards ownership with every monthly payment. It’s a structured program that’s as simple as renting, but gives you all the benefits of owning.
We want to make sure that you can have a home of your own, even if you can’t qualify for a mortgage right now.
Click here to learn more about Divvy and get started on finding your forever home.
Is an FHA loan right for you?
- Understand the advantage of FHA loans if you have lower credit
- Figure out if your credit score and down payment meet FHA minimums
The Federal Housing Administration (FHA) is an agency of the U.S. Government that insures mortgages to low and moderate income borrowers.
The main advantage of an FHA loan is that borrowers can typically qualify with a lower credit score and down payment than they could for conventional loans.
To qualify for an FHA loan, you’ll need either:
- Minimum 500 credit score and 10% down payment
- Minimum 580 credit score and 3.5% down payment
You also cannot have had a bankruptcy in the last two years, or a foreclosure within the last three.
While FHA loans can be more accessible than conventional loans to people who have lower credit, one downside is that your payments will likely be higher than with a conventional loan.
This is because lenders consider loans with lower down payments to be more risky, so borrowers are required to pay an FHA Mortgage Insurance Premium (MIP) every month in addition to repaying the borrowed principal and interest.
Is a VA loan right for you?
- Understand the powerful benefits of VA loans for U.S. military veterans
- Understand the drawbacks of VA loans in the homebuying process
Veterans Administration (VA) loans are available to veterans of the U.S. military.
If you or your co-buyer are a veteran, a VA loan can offer you powerful benefits.
The primary benefits of VA loans are that there is no minimum credit score or down payment to qualify. This does not mean that veterans are guaranteed a loan, but it does mean the barriers to qualifying are substantially lower than conventional or even FHA.
One downside of VA loans is that they’re known for taking substantial time to go all the way through the approval process. This means that some sellers’ real estate agents will discourage them from accepting your offer if it is made with a VA loan.
With these concerns about timing in mind, some veterans have used Divvy’s homeownership program to secure and move into the homes they love quickly.
Then, with the pressure off, they’re able to work through the VA loan process and finally purchase their home.
Click here to learn more about Divvy and how we can help you move into your forever home immediately.
Understand mortgage interest rates
- Get to know the basics of how interest rates work
- Understand how your personal financial situation affects your interest rate
When a lender issues you a mortgage, they’re essentially letting you borrow money to purchase a home, and expect you to pay that money back over time.
Lenders don’t let you borrow money for free, though. The interest rate on your mortgage is the premium you pay for being able to borrow that money.
Rates are usually referred to in annual terms. So, if your mortgage rate is 4%, that means that you are paying 4% of your loan balance every year as interest, in addition to paying back the money that you borrowed (usually called the “principal”).
Your mortgage rate is extremely important because it determines the cost of your housing payment every month.
Of course, a lower rate is better. But how much difference does it actually make? Quite a bit. For example, a 1% higher rate could add $200 to your monthly payment on an average-priced home. This is why it pays off to seek out the lowest rate possible.
The rates that you get quoted by lenders will vary based on a number of factors, based on both the state of the economy and your personal situation.
Unfortunately, you probably can’t control the economic factors that influence interest rates. But, you do have some control over the pieces of your personal situation that a lender will consider when setting your rate. These include:
- Your credit score
- Your down payment
- The stability of your income and employment history
- How often you pay your bills on time
- The location of the property you want to purchase
The stronger those components are, the more leverage you’ll have in getting your lender to give you the lowest possible rate.
If any of those areas above have been challenging for you in the past and prevent you from qualifying for a mortgage or getting a reasonable interest rate, Divvy may be able help you get started on your journey to homeownership. Learn more here.
WORKING WITH LENDERS
Get your documents ready
- Gather the following documents:
- W-2’s for the past 2 years from your employer
- Pay stubs for at least the last 30 days
- Income tax returns for at least the last 2 years
- Bank statements for at least the last 2 months
- Retirement and investment account statements for at least the last 2 months (if applicable)
- Alimony and child support – court order along with bank statements and cancelled checks (if applicable)
- Gift letter (if someone is gifting you funds for the down payment
When you apply for a mortgage, you’ll need to have all kinds of documentation ready to share with the lender.
The list above is just the bare minimum, and your lender may end up requesting additional documents depending on your situation.
Get pre-approved by multiple lenders
- Gather all of the information from the previous steps in one place
- Reach out to mortgage lenders
- Find a lender who is patient with you and answers all your questions
- Make sure to talk to more than one lender so you can best understand your options and avoid overpaying
This is where the rubber meets the road, and all your hard work from the previous steps will come together.
Getting pre-approved for a mortgage means that a lender will get to know your personal situation and review all the necessary information you provide them, then tell you whether they can approve you for a mortgage, and, if so, how much they can approve you for.
This is a crucial step, because it will give you a firm price range that you can use to get started shopping for your new home.
Gather all of the information from the previous steps in one safe place, whether printed out in a file or stored electronically.
This will save you a lot of time once you’re talking to lenders, because you’ll be prepared with most of the information they’ll ask you for to get started.
As you start looking for lenders, consider asking friends and family who own homes if they would recommend the lender they used.
If you’re working with a real estate agent already, they will likely know multiple lenders who they can introduce you to. Reading lenders’ reviews on online sites is also a way to find potentially trustworthy lenders.
Make sure to find a lender who is patient with you and answers all your questions. Buying your first home is one of the largest financial decisions you will ever make, and you deserve someone who puts your interests first.
It’s also important to talk to multiple lenders. Every lender has access to different loan products and charges different fees. The more lenders you work with in the beginning, the more likely you are to end up with the lowest possible rate and best possible mortgage for you.
Congratulations! Now that you’ve figured out how you’re going to finance your new home, it’s time to go find the right one for you. Check out our checklist of The 8 Steps to Finding and Buying Your First Home to get started now.
Download the printable PDF checklist by clicking the image below: