A home loan, or mortgage, is likely to be one of the biggest financial decisions you’ll ever make, so it’s important to know all the facts!
What is a home loan?
A home loan, or a mortgage, enables you to purchase a home without having to foot all the cash out of your pocket when purchasing. You will, however, need to make a down payment, which is typically between 3.5-20% of the home’s appraised value, along with closing costs and some other fees. The lender then finances the rest of the purchase. You’ll repay the loan, along with interest, usually over the course of 15 to 30 years.
Are all home loans alike?
Before you get started, you’ll need to choose a mortgage type. A good lender will help you find the right one for your needs. A conventional loan usually requires a 5-20% down payment, an FHA loan may also be an option, which typically requires a smaller down payment, but requires you purchase mortgage insurance. If you’re a military veteran, consider obtaining a VA loan, which lets you buy a home with zero down payment.
Once you’ve chosen the kind of loan that’s best for your family, you may be given a choice of repayment arrangements for the loan. Here are the three common types of mortgages:
1. 30-year fixed-rate mortgage. The interest rate on this 30-year mortgage will remain fixed no matter the changes to the national rate.
2. 15-year fixed-rate mortgage. This mortgage will also have a fixed interest rate, but the term lasts just 15 years. The monthly payments will be higher, but the overall interest paid over the course of the loan will be significantly lower.
3. Adjustable-rate mortgage (ARM). An ARM gives the borrower a lower interest rate in the early years of the loan, and then a gradual increase (adjustment) in rate over the rest of the life of the mortgage.
What do I need to know before applying for a home loan?
A home is likely to be the largest purchase you’ll ever make. To qualify, you’ll need documentation that shows you can afford the monthly payments.
The primary way lenders gauge your financial responsibility is through your credit score. This number is like a grade that tells lenders how you’ve handled your past credit accounts and other debts. It will include the length of time you’ve had credit accounts and loans open, the timeliness with which you’ve made your payments, the trajectory of your debt and the amount of available credit you might use. You can request a free credit report from all three major credit bureaus once a year at AnnualCreditReport.com.
Another crucial factor in determining your eligibility for a mortgage is your debt-to-income ratio or your DTI. Lenders want to know how big your collective outstanding debt will be in relation to your income.
If you’re considering buying a home, make sure to pay all your bills on time, don’t open new credit cards and work on paying down your overall debt. A higher credit score will help you get approved quicker and obtain a lower interest rate on your loan.
When should I apply for a home loan?
While you won’t need the loan until you are ready to close on a house, it’s a good idea to start the process before you begin house-hunting. If approved, your lender will provide you with a pre-approval letter showing the amount you’re qualified for. Having this letter in hand shows sellers you’re serious about buying. Most pre-approvals are only good for 60-90 days, so make sure you’re ready to start house hunting before you get yours.
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