Owning a home has long been the epitome of the American Dream. However, few people actually have the cash in their bank accounts to buy a home outright. They must rely on financing to cover their purchase costs.
People who are interested in buying a new home have the option of applying for and getting a mortgage. You can approach the finance application and home buying process more confidently by knowing what a mortgage is and what requirements typically are associated with being successfully approved for one.
What is a Mortgage?
A mortgage is a type of loan that is used to buy or refinance a home. It provides a way for a person to buy a home without him or her needing all of the cash for the purchase price upfront.
A mortgage is different than a typical bank loan. It is used specifically to finance a piece of property like a home. The house acts as the collateral for the mortgage, and the borrower promises to make on-time payments each month on the mortgage. If he or she defaults on the home loan, the borrower risks having the home repossessed by the bank, a process known as foreclosure.
There are a number of different mortgages that banks use to finance home buyers. These include:
• Conventional or fixed rate
• Adjustable rate
• Interest only
• Piggyback or combo
There are also mortgages that are secured and underwritten by government entities like the Federal Housing Administration, the Department of Veterans Affairs, and the U.S. Department of Agriculture.
Potential homebuyers consult with mortgage lenders to determine which one is the right choice for them. Factors that go into finding the right mortgage for a borrower include his or her credit score and credit history, along with the borrower's income and how much money, if any, that he or she has for a down payment to pay toward a house.
Getting Pre-approval for a Mortgage
Pre-approval for a mortgage is entirely different than pre-qualification. Pre-qualification determines how much you can afford to spend on a home. Pre-approval, however, is more valuable because it verifies that you have the credit and income to potentially buy a house.
Pre-approvals for mortgages can be valid for up to 90 days. The lender that pre-approved you can provide you with a letter that you can present to your Realtor to you and the lender have discussed loan options and also that the lender verified your income and credit. The letter additionally outlines the maximum amount that you can borrow for a mortgage, which allows you and the Realtor to set your price range.
Some of the requirements that your lender will ask you to bring to your pre-approval include:
• Proof of income like W-2s, 1099s, paycheck stubs or your last two years' tax records
• Proof of assets like bank statements and investment account statements
• Knowledge or proof of your credit score
• Employment verification like a letter from your employer or tax records if you are self-employed
• Proof of your identity like your driver's license and Social Security card
During the pre-approval meeting with the lender, you will be asked to allow the bank or mortgage lender to run a credit check on you and anyone else who is applying for the mortgage with you.
Types of Mortgages
As mentioned, there are many different kinds of mortgages that lenders can use to help a borrower buy a home. However, the most popular and most commonly used are those that are designed to assist low-income and first-time home buyers.
An FHA mortgage, for example, is designed for buyers with weak credit and first-time home buyers. The FHA underwrites these mortgages, and they have interest rates as low as 3.5 percent. People approved for FHA loans may also receive assistance with their down payments.
VA loans are for borrowers who are connected to the military. They often have no down payment or FICO sore requirements. The Department of Veterans Affairs underwrites these home loans.
USDA loans are for buyers who purchase houses in rural or suburban areas. They offer 100 percent financing and can be extended with no down payment requirements. However, there are income limits for USDA loans, and most lenders who offer these mortgages require FICO scores of at least 640.
Fannie Mae and Freddie mortgages are conventional home loans that require a three percent down payment on the home's purchase price. These loans also require a FICO score of at least 620 and a debt-to-income ratio of less than 50 percent. In general with these loans, the higher the credit score and lower the debt-to-income ratio, the better chance a person has of being approved.
Finally, many states like Arizona have home-buying loan programs. Arizona's first-time buyer program also provides assistance with closing costs and down payments. Homes must be located in Arizona and used as a primary residence.
First-time Home Buyer Loans
People who are buying a home for the first time have a unique opportunity to apply for and use first-time homebuyer mortgages. Despite these loans' names, first-time mortgages can go not only to people who are genuinely first-time home buyers. They can also be extended to people who have not purchased or owned principal residences in the last three years. Additionally, the home that the applicant is purchasing must be used as a primary residence and not a second or vacation home.
First-time home mortgages can also be used to buy properties in neighborhoods that are categorized as redevelopment areas. People who are approved for these loans enjoy a number of benefits that elude other mortgage holders, such as low or no down payments, federal tax credits, access to grants for home improvement, and forgivable loans that help with additional expenses like closing costs and down payments.
It is important to note that there can be income limits for qualifying for a first-time home mortgage. However, most major lenders offer first-time homebuyer programs. If you want to find one that is tied to a government-based housing agency, you need to use a lender that is approved by that agency. You can typically find lenders on the agency's website.
FHA Loan Requirements
An FHA mortgage is a home loan that is secured by the Federal Housing Administration. It is popular with first-time homebuyers, as well as low-income earners and people who do not have much money for a down payment.
It can also be ideal for people who have low credit scores and have challenges on their credit records like bankruptcy, judgments, federal debts, and foreclosures. To be approved for an FHA loan with a 3.5 percent down payment, applicants only need a credit score of 580 and a debt-to-income ratio of less than 43 percent.
For a down payment of 10 percent, the credit score range is 500 to 579. Other requirements for an FHA loan include:
• MIP or mortgage insurance premium policy if the down payment is less than 20 percent
• Home being used as a primary residence
• Steady income
• Proof of employment or self-employment
FHA borrowers who need help with their down payments may be able to get assistance through programs like the HOME down payment assistance program. Down payment assistance programs, however, can have their own credit, income, and debt-to-income ratios that applicants must meet to be approved.
VA Home Loan Requirements
Like the FHA, the VA also has its own set of criteria that interest home buyers must meet in order to be approved for a VA-underwritten loan. The most obvious requirement, of course, is for the applicant to be connected to the military in some way, either by being a current or former member of the military, reserves, or national guard. However, spouses may also be able to apply jointly for a VA home loan with their military member husband or wife.
The requirements for a VA loan vary according to what time frame the applicant served in and for how long he or she was enlisted. There are also different requirements for applicants to meet if they are or were reserve or national guard members.
Current military members, for example, need to have served for at least 90 days to be considered for a VA loan. Former members need to have served for anywhere from 90 days to two years depending on when they were enlisted. The VA uses a different set of criteria for applicants who were either officers or served in the Korean, Vietnam, or Gulf Wars.
While the VA technically does not stipulate a minimum FICO for approval, lenders who extend VA loans generally prefer that applicants have credit scores of at least 620. However, some lenders approve applicants with lower scores, especially if they are currently serving in the military.
How Much Money Do I Need for a Down Payment for a House?
A down payment is a money that you pay to the seller to lock in the home's purchase price. It serves as proof that you are invested fully in the home purchase and committed to buying the house and making timely mortgage payments on it.
Your down payment also has a significant influence on the overall cost of the home. It can determine the interest rate of your mortgage. In general, the more money that you put down on the house that you want to buy, the lower the interest rate that you can get on your mortgage. You pay less for the home that you want to buy.
Further, the amount that you need to pay down on a home will depend on factors like your credit score, debt-to-income ratio, and the type of home loan that you apply for and receive. A conventional belief among interested home buyers is that you need to pay at least 20 percent for a down payment on a house. However, your payment can be significantly lower, around 3.5 percent, or perhaps even non-existent if you are approved for first-time, redevelopment, rural or suburban, VA, or other types of federal or state government-based mortgage programs.
Even conventional or fixed-rate mortgages may not require a full 20 percent down on a home. Some lenders extend home loans to applicants with good credit and higher incomes that only require a three percent down payment. Regardless of what kind of mortgage that, you are approved for, you generally have the option of using programs like HOME for down payment assistance if needed.
A mortgage is a vital tool that most people need to use to buy a home. There are numerous different mortgages that lenders can use to help applicants cover a home's purchase price. You can apply for and could be approved for VA, FHA, USDA, and other types of mortgages that allow you to realize your dream of becoming a successful homeowner.