Applying for a home loan is one thing. Getting approved is another entirely.
Whether you’re a first-time home buyer or you’ve taken out multiple home loans, it’s good to familiarize yourself (or refresh your memory) with the process of how to apply for a home loan and get approved.
Steps To Apply For A Home Loan
There are many factors that lenders look at when deciding whether to approve you for a home loan. Here, we’ll walk you through the process of applying for a mortgage and actually getting approved.
Step 1: Gather Information
To start off, you’ll need to get some information together. The right data will help you prepare for the application process and increase your odds of approval.
The first bit of information you’ll need is your monthly income. The more you earn per month—and the more steady your income—the better terms you’ll be able to get. If you don’t earn very much, it will limit how much house you’ll be able to afford.
If your income tends to fluctuate or you’re self-employed, you’ll need to bring more paperwork when it comes to the application process. In addition to your last two pay stubs, you might need to provide tax returns from the last two years as well.
Alongside your income, your current debts are a major consideration as well. The higher your debt, the less you’ll be able to borrow, and if it’s over a certain threshold, it could disqualify you entirely.
Debts you’ll need to collect information on include:
- Personal loans
- Auto loans
- Credit card debt
- Student loans
These plus any other obligations should be taken into account when you go to apply for a home loan.
One final bit of information you’ll need is your credit history. Your credit score is part of this (a major part, in fact), but so too are the individual items on your report. By taking a look at your credit report, you can find where errors may exist and work to get them corrected.
Credit reports can be ordered free every 12 months from AnnualCreditReport.com.
Step 2: Figure Out Your Budget
Once you have your information together, you’ll need to determine out how much house you can afford. This means taking a close look at your budget.
Starting off, you’ll want to find out how much you can pay for a down payment. The more you’re able to pay, the better your chances of approval. In addition, you’ll also reduce your monthly payments and potentially save on interest by paying more upfront.
A down payment of 20% will net you further savings by eliminating the need for private mortgage insurance payments. Lenders will charge private mortgage insurance (PMI) premiums on loans with down payments below 20%, increasing your monthly payments.
The amount of your monthly payments is used to calculate your debt-to-income ratio. If you have too much debt for your level of income, it can disqualify you from securing a home loan.
Your DTI ratio takes the mortgage into account. Typically, if your total amount of debt would exceed 43% of your total monthly income, you probably won’t be approved for that home loan. In that case, you’d need to either increase your income or reduce your debt.
15-year vs. 30-year home loan
The term of the loan factors into your monthly payments and DTI ratio.
With a 15-year loan, you’ll have less time to pay it off and make much larger monthly payments. As such, it can easily take you over the maximum DTI threshold.
A 30-year home loan would mean much lower monthly payments, making it easier to qualify. However, you’ll probably have higher rates and have to pay more interest in the long run, which is worth considering. If you can afford the higher monthly payment, 15-year loans are typically best if you plan to stay in the house for a while.
Step 3: Make Improvements Where Possible
Once you know your finances and budget, you might need to make some improvements to improve your financial situation.
A few ways to do this include:
Dispute credit report errors
If your credit report has any errors on it, you’ll want to dispute those and get them resolved. Sending the credit bureau a letter with copies of supporting documents can result in a very rapid boost in your credit score, so if you’re right on the edge (such as if your credit is just below 630), that can help immensely.
Pay off high-interest debts
If you have any high-interest debts, such as outstanding credit card payments, try to pay those off as quickly as possible. Not only can this increase your credit score (given some time, of course), but it can also improve your DTI ratio.
Save for a down payment
Saving up for a larger down payment will further help your DTI ratio and improve your odds of approval.
Step 4: Get Preapproved For The Right Home Loan
Once your financial situation is stable enough, you’ll need to consider the different types of home loans available. Getting preapproved by different lenders can help you secure the financing you need in advance of actually signing a purchase agreement for a home.
The preapproval process requires the following documentation:
- Pay stubs from the last 2 weeks to 3 months, depending on your situation
- Tax returns and W-2s for the last 2 years
- Credit report (pulled by the lender)
As far as the types of loans available, some are backed by the U.S. Government. These tend to be easier to qualify for and require lower down payments, making them ideal for those with lower credit or income levels.
The most common include:
- FHA loans, for families with middling income
- VA loans, for veterans
- USDA loans, for rural areas
While these may each have a lower down payment and credit requirements, you still need to budget for them. That said, if you don’t quite qualify for a conventional loan, a government-backed mortgage can help.
Simplifying The Process Of Applying For A Home Loan
If you are in strong financial health and have all of the right documentation, these steps to apply for a home loan should have you well on your way to getting approved. After the pre-approval process, you should be good to go to purchase your first house.
Learn more about applying for home loans from these resources: