How to Get a Home Loan: What You Need to Know Before You Apply

Buying a new home is a big deal. To pay for one, you’ll likely need financial assistance, but the process of applying for a mortgage loan can overwhelm new homeowners. There are many factors involved, all of which will determine what impact a mortgage loan will have on your finances—not to mention your life in general.

Here, we’ll go over some of the finer details that you should be aware of before applying for a mortgage.

Consider Your Credit Before You Apply For A Mortgage Loan

Before you apply for a mortgage loan, you need to know about credit and how your credit score will work for or against you.

In general, your credit is made up of several components, including how much money you have borrowed and paid back in the past, how reliable you are at making payments, and other factors that are important for lenders to consider before considering you for a loan. These factors all go into your credit score, which is a numerical representation of your reputation as a borrower.

If your credit score is below a certain level, it will be harder for you to get approved for a mortgage loan. If you do qualify for the loan, a lower credit score could mean a higher interest rate. Since it’s considered higher risk to lend to someone with a lower credit score, a higher interest rate on the loan is used to help cover that risk.

In general, any score above 720 is considered to be high, while a mid-high range is between 650 and 720. Anything below 650 will make it difficult to get approved for a mortgage loan. These ranges may vary depending on the lending institution you work with.

Know Your Price Range For Buying A Home

Another important aspect of applying for a mortgage loan is how much house you can actually afford. This is determined by how much you earn versus the amount you pay toward the mortgage each month.

Try our home affordability calculator here.

Each loan is set to a specific timeframe, such as 30 years for a mortgage, and the loan has to be paid off within that period of time. That means a larger mortgage will have higher monthly payments to make sure it’s all paid off within the set life of the loan.

If the monthly payments are too large in proportion with how much you earn, you may not get approved for the loan. The proportion of your debt to your income is called your debt-to-income ratio, and it’s calculated by dividing your expected monthly payments by your monthly income. This not only includes the mortgage, but also any current debts you have, such as auto loans, student loans, and credit card debt and so on.

Most lenders go by a standard of 36% debt-to-income ratio as the absolute maximum, but some will go higher than that. Generally speaking, though, it’s best to borrow below that amount since it will make repayment easier.

How does your debt-to-income ratio (DTI) factor into your price range?

Simply put, the pricier the house, the more you’ll have to borrow to finance it. The larger the mortgage, the higher the payments. Ultimately, the house you can afford will depend on your ability to make monthly payments over the life of the loan.

It’s also important to note that just because you can afford a certain amount does not mean you have to get a loan for that full amount. You should keep your current and future financial goals in mind while considering just how much to spend on your home purchase.

Determine How Much You Need for a Down Payment

Another way that banks and other lenders will reduce the amount of risk they take on with mortgages is through down payments. A down payment is an upfront amount that you pay for the loan, and it’s represented as a percentage.

Often, mortgages require a 10% to 20% down payment, but there are situations in which you may qualify for 100% financing, which means no down payment. The amount you borrow is the full value of the home.

Naturally, a higher credit score will make it more likely that you’ll qualify for a low—or no—down payment, which can be good if you don’t have a lot of cash to cover the upfront cost.

However, it can also be beneficial to make a large down payment if you are able to. This is because you essentially reduce the amount you borrow and can avoid PMI or Private Mortgage Insurance, thereby lowering monthly payments and the total amount of interest you pay over the course of the loan.

Learn the Difference Between Fixed-Rate and Adjustable-Rate Interest Loans

With all mortgages, you will end up paying interest in some form. This is a percentage of the loan payments that you will have to pay extra each month, so you want these rates to be as low as possible. There are two basic options when it comes to the rates you choose:

Fixed-rate mortgage loans

For a fixed-rate loan, you get a set interest rate right at the start and that rate is locked in for the life of the loan. This way, if market rates fluctuate, your loan payments don’t fluctuate with them, which can be good if it seems like they might go up in the near future. If you can lock in a low rate at the start, fixed-rate is usually the way to go.

Adjustable-rate mortgage loans

In an adjustable-rate mortgage, the interest you pay will fluctuate with the market, so you may end up paying less later on, or you may end up paying more. In general, you can get a lower rate at the start with these loans than you would with a fixed-rate mortgage, though there is a good chance your payments will increase later on.

In general, an adjustable-rate mortgage tends to be riskier, but it can work fairly well with a shorter-term mortgage (15 to 20 years). A fixed-rate loan is more stable and predictable, but may end up costing you more if interest rates are high when you apply.

There are hybrid loans available as well. In these, you start with a fixed rate for a set number of years, and after that point, the loan converts to an adjustable rate.

Understand Your Mortgage Terms and Options

There are many options when it comes to applying for a mortgage. Conventional fixed- and adjustable-rate loans are fairly straightforward: you pay off the principal and interest each month over the life of the loan, which is often between 15-30 years.

When deciding on the type of mortgage you should apply for, it’s important to take your financial situation, credit score, and local market into account. Your banker can help you determine exactly what will work best for you.

Original Publish Date: December 28, 2021
Article Revised: December 20, 2023