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Homeward Bound: 6 Steps to Getting a Mortgage

photo: haglundc

You’ve heard it before: mortgage rates are at historic lows and housing prices are more affordable than they’ve been in years. But no one said buying a home was any easier.

If you’re hoping to become a homeowner this year, you still have to brace yourself for a lengthy process – not least confusing of which is securing a mortgage loan. Here are six tips to get you started.

1. Get Organized

Since the mortgage meltdown, lenders have tightened the requirements on loan documentation. Even highly qualified customers are no exception. Be prepared by taking some time to organize your latest financials in advance.

With stricter lending guidelines, for example, you’ll need to explain any anomalies in your paperwork.

Did you have an employment gap in the past two years? Were you late on a credit card payment? You may need to provide written explanations for these sorts of mishaps, in addition to proving your income and assets. Start collecting:

* Pay stubs from your current employer from the most recent one-month pay period,

* The past two years’ W2s from all employers,

* A two-year history of your employment, including names, address and phone numbers,

* Two months of bank statements on each and every account, including investments, IRAs and your 401(k),

* Two years of tax returns. (Tax returns aren’t required just from self-employed applicants these days. Many lenders require two years of tax returns for every customer.)

* Documentation of any other sources of income for the past two years, such as received child support payments,

* Divorce decree and separation agreement, if applicable, and

* Driver’s license numbers

Note that lenders won’t accept documents that are older than 60 days.

2. Know Your Credit Score

To get the lowest interest rate and the best possible loan pricing, lenders now require the cream of the crop of credit scores – you have to have a FICO score of at least 740, up from 720 in recent months. And if you have a score below 620, most lenders will not consider you for a loan application, even at higher interest rates.

Typically, lenders will look at the FICO credit scores from all three credit bureaus and use the median (or middle) score. So if your scores are 705, 725 and 745, lenders will use 725.

According to the most recent pricing and guidelines from Credit Sesame partners, a range of 700 to 739 is considered “excellent,” 699 – 680 is “good” credit, and 679 – 620 is “fair”.

Applying with a co-borrower? Lenders will use the lower of the borrower and co-borrower’s median credit scores. (So if your median score is 725 and that of your co-borrower is 695, the lender will make a decision based on a 695 score.)

If you have a co-borrower with a lower credit score whose income or assets are not required to qualify for this loan, you many wish to drop him/her from the loan application.

3. Review Your Credit History

In addition to the score, lenders review your credit history to check for delinquencies and liens, among other factors.

Make sure you review your credit reports before applying. If you find errors, dispute them. But keep in mind that disputes filed right before the mortgage application process will not make a good impression with lenders. Most lenders require an undisputed record of credit, and since it takes at least 60 days for credit bureaus to respond to disputes, it’s best to check up on your credit well in advance.

4. Know How Much You Can Afford

Lenders use a debt-to-income ratio (DTI) to judge your capacity to repay the loan. Your DTI ratio is the percentage of your total monthly obligations, such as existing car loans and credit cards, including the home loan you are applying for, out of your total income. The standard DTI ratio requirement today is 38%; however, lenders will accept solid borrowers who are approved, with a DTI up to 41%. Most lenders are looking for a DTI that is lower than 45%.

5. Shop Around and Ask Questions

Rates and fees can vary widely. Shop around online, talk to numerous lenders and make sure that you are searching for not only the best rates, but also the lowest fees.  Some cost are negotiable, others are not.

Real costs (non-negotiable) include your home’s appraisal, the fees to buy copies of your credit report, and home inspection fees. This will also include fees paid to the government for the transfer of the home’s title, known as title costs.

Also, expect to pay processing fees, which are the cost for a loan processor to order the title, insurance, the appraisal, and put it all in order for the lender. This fee should not exceed $400.

Real costs also include the first year of homeowner’s insurance and taxes on the property, pro-rated for the amount of time you will own it for that year. You will also have to pay some interest on the home upfront. If you close on March 25, for example, you would be charged six days of “prepaid interest” for the remainder of that month.

Commission costs, on the other hand, are negotiable. Yes, your lender should be paid for his work. But not overpaid. Currently, lenders are earning an origination fee (one point) and one additional point. (One point equals 1% of the loan amount.) Lenders can earn up to three or four points more to offer borrowers a discount on the interest rate!

6. Don’t Forget the Down Payment

Depending on your credit, income and the cost of the home, you will generally need a down payment of 10% to 20% of the home’s value.

Saving for a down payment is the first step toward home ownership, helping you prepare for the extra financial burden of owning a property. If you do not have enough savings for a down payment, you may want to reconsider homeownership for the time being. Also, keep in mind that when you apply for a mortgage, lenders will want to see that you also have three months of mortgage payments in savings, or “cash reserves.” Finally, most lenders will want to know where your down payment is coming from, limiting how much can come as gifts from family and friends.

Homeward Bound: 5 Steps to Getting a Mortgage was provided by CreditSesame.com, a free tool that helps people manage their credit, mortgage and debt.