It is advisable to get pre-qualified before you start looking for a home to purchase. By obtaining a pre-qualification, you will know what price range you can afford. It is also an advantage to have a formal pre-qualification letter when presenting an offer to a seller.
To get pre-qualified, you must meet with a mortgage broker, mortgage banker, bank, savings and loan, credit union, or private lender. You may select a lender of your choice. Referrals can be provided upon request.
For a pre-qualification to be accurate, it is necessary for you to fully disclose all of your financial details to your lender. Typically, a lender will review three areas before issuing a pre-qualification. The three areas are as follows:
1) Down payment--The purchase price minus the mortgage is what is called the down payment. A down payment is usually 5% to 25% of the purchase price. Your lender can advise you on verification requirements and acceptable sources of a down payment.
2) Credit report--To obtain the best rates, good to excellent credit is required. If your credit is poor, you may be declined for a loan or may have to pay a higher rate and higher fees to obtain a loan. The lender will require payment for the credit report before it can be ordered. (See section below regarding your FICO score.)
3) Debt ratios--Formulas called debt ratios are used to determine how much of a loan you will be offered. Generally, your monthly house payment (PITIA) should not exceed 28% to 32% of your total monthly gross income. You may find some programs with more lenient qualifying ratios. PITIA includes principal, interest, taxes, hazard and mortgage insurance, and association dues. Your monthly debt, which includes your PITIA and other debts, such as, but not limited to, car payment, other loans, credit cards, etc., may not exceed 36% to 40% of your gross income.
A FICO score is a number that tells a lender how likely an individual is to repay a loan, or make credit payments on time. Listed below are the five main categories of information on a credit report that Fair, Isaac scores evaluate, along with their general level of importance. A score takes into consideration all these categories of information, not just one or two.
1) PAYMENT HISTORY - Approximately 35% of your score is based on this category. The first thing that any lender would want to know is whether you have paid past credit accounts on time. This is also one of the most important factors in a credit score. However, late payments are not an automatic "score killer." An overall good credit picture can outweigh one or two instances of, say, late credit card payments. By the same token, having no late payments in your credit report doesn't mean that you will get a "perfect score." Your score takes into account: a. Payment information on many types of accounts (Visa, American Express, department store, car, mortgage, etc.) b. Public record and collection items -- reports of events such as bankruptcies, judgments, suits, liens, wage attachments, and collection items. c. Details on late or missed payments and public record and collection items - specifically, how late they were, how much was owed, how recently they occurred, and how many there are. d. How many accounts show no late payments.
2) AMOUNTS OWED - Approximately 30% of your score is based on this category. Having credit accounts and owing money on them does not mean that you are a high-risk borrower with a low score. However, owing a great deal of money on many accounts can indicate that a person is overextended and is more likely to make some payments late or not at all. Part of the science of scoring is determining how much is too much for a given credit profile. Your score takes into account: a. The amount owed on all types of accounts. b. How many accounts have balances. c. How much of the total credit line is being used on credit cards and other "revolving credit" accounts. d. How much of installment loan accounts is still owed, compared with the original loan amounts.
3) LENGTH OF CREDIT HISTORY - Approximately 15% of your score is based on this category. In general, a longer credit history will increase your score. However, even people with short credit histories may get high scores, depending on how the rest of the credit report looks. Your score takes into account: a. How long your credit accounts have been established. b. How long it has been since you used certain accounts.
4) NEW CREDIT - Approximately 10% of your score is based on this category. People tend to have more credit today and to shop for credit via the Internet and other channels. Fair, Isaac scores reflect this fact. However, research shows that opening several credit accounts in a short period of time does represent greater risk-especially for people who do not have a long-established credit history. This also extends to requests for credit, as indicated by "inquiries" to the credit reporting agencies-an inquiry is a request by a lender to get a copy of your credit report. Your score takes into account: a. How many new accounts you have. b. How long it has been since you opened a new account. c. How many recent requests for credit you have made, as indicated by inquiries to the credit reporting agencies. d. Length of time since credit report inquiries were made by lenders. e. Whether you have a good recent credit history, following past payment problems.
5) TYPES OF CREDIT IN USE - Approximately 10% of your score is based on this category. The score will consider your mix of credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans. It is not necessary to have one of each, and it is not a good idea to open credit accounts that you don't intend to use. Your score takes into account: a. What kinds of credit accounts you have, and how many of each.
Using Score Reason Codes to Understand Your Score
When a lender receives your Fair, Isaac credit bureau risk score, up to four "score reason codes" are also delivered. These explain the top reasons why your score was not higher. They say things like "Number of accounts with delinquency." If the lender rejects your request for credit, these reason codes can help the lender to tell you why your score wasn't higher.
These reason codes are more helpful than the score itself in helping you to determine whether your credit report might contain errors, and how you might improve your score over time.
Fair, Isaac credit bureau risk scores provide the best risk guide available based solely on credit report data. The higher the score, the lower the risk. While many lenders use FICO scores to help them to make lending decisions, each lender has its own strategy, including the level of risk it finds acceptable for a given credit product. There is no single "cutoff score" used by all lenders
Different Types of Financing
There are many different types of financing available in today's financial marketplace. Below are a few of the most common.
Fixed-Rate Conventional Mortgage. This type of financing is popular because the interest rate and the monthly payment remain the same for the life of the loan. The term is most often for 30 years. However, fifteen-year, fixed-rate loans are available at a slightly lower interest rate--a very good loan if the rates are low when you purchase or refinance, and you plan on staying in the home for at least three to five years. This loan requires at least 5% down.
Adjustable-Rate Mortgage (ARM). The interest rate on this loan may go up or down over the years and is tied to a financial market index such as Treasury bills. The interest rate may be adjusted at six-month or one-year intervals. The initial interest rate is usually less than that of a fixed-rate loan. This is a good loan when you purchase during a time of high interest rates, or you plan on keeping the loan for less than three years.
Five or Seven-Year Fixed-Rate Loan. This loan is fixed for five to seven years; then, it converts to an adjustable-rate loan. It is a mix of the fixed-rate and adjustable loan and usually offers a lower rate than the fixed rate, but a higher rate than the adjustable-rate loan. It is a popular loan for buyers who purchase while rates are low and plan on staying longer than two to three years but less than eight to ten years.
VA Loan. Qualified veterans can take out loans up to a specified limit with no down payment. The costs on this loan are typically higher than conventional loans; however, many of the costs can be paid by a seller or financed into the loan. It can be a good loan for a buyer with little or no down payment.
FHA Loan. Insured by the Federal Housing Authority (FHA), this loan is a low-down loan; however, the loan costs are high. Like a VA loan, a seller can pay many of the costs, or they can be financed into the loan. This is often a good loan for a first-time buyer.
Easy-Qualifier Loan. This loan usually requires a 20 or 25% down payment. Good to excellent credit is required, but the debt-ratio factor is either eliminated or made easier. The loan may be a fixed or an adjustable-rate mortgage. The rate is usually slightly higher due to the relaxed debt-ratio factor.
80/10/10 Loan. This loan requires a 10% down payment, and the seller must carry back at least 10% of the purchase price. An institutional lender provides the 80% first mortgage. The advantage is that it usually eliminates the requirement of Private Mortgage Insurance (PMI). PMI is when the lender has a private company insure a part of the mortgage in the event of foreclosure. It is often required on loans of less than 20% down. PMI is a cost paid by the borrower.
The Loan Process
Most home purchases require a loan. Although the loan process may vary slightly from lender to lender, the companies that purchase loans from lenders set standards under which most lenders underwrite loans. These standards act to regulate the industry.
Although most buyers do not like the process that lenders put them through to obtain a loan, it is necessary to understand that, to some degree, interest rates are affected by keeping the default rate low. You will be asked to provide a considerable amount of information that is subject to verification.
Below is an outline of a typical loan process:
1) The loan application. The process starts by meeting with the lender and completing a loan application. The application form is a standard form used by most institutional lenders. You will also be asked to sign release forms to allow the lender or broker to obtain verifying information.
2) Loan application reviewed. The lender or mortgage broker reviews the application to be sure that the buyer/borrower meets the qualification guidelines.
3) Assignment to a processor. The loan application is assigned to a processor. The processor will order or obtain such items as, but not limited to, the credit report, appraisal, employment verifications, down payment verifications, title information, association information, Residential Purchase Agreement, escrow instructions and any amendments, tax returns, etc.
4) Loan packaged. After all the needed information is gathered by the processor, (s)he will review the package to be sure that it is complete and meets the lender's guidelines.
5) Underwriting. The loan package is sent to the lender's underwriter. The underwriter reviews the package in detail and will take one of these four actions: A) Approve the loan unconditionally; B) Approve the loan conditionally; C) Suspend the loan; D) Deny the loan.
Rarely is a loan approved unconditionally. More often, the loan is approved with conditions. This means that something considered minor is required to obtain an unconditional approval. If a loan is suspended, this means that the underwriter needs more information to make a final determination. The item/s are usually more substantial than what is needed for a conditional approval. If a loan is denied, this usually indicates that the underwriter has determined that the loan package is complete but does not meet the required guidelines and is, therefore, denied.
6) Order loan documents. After a final approval is obtained, the lender prepares the loan documents and sends them to the escrow company. You will be notified by escrow to come in and sign the loan documents.