What is a mortgage? The Basics of Getting a Loan for First Time Homebuyers

Mortgages and Homebuying: Everything you need to know

How To Get A Mortgage: A Step-By-Step Guide

6 Steps to Getting a Loan:

1. Budget Your Monthly Payments: look at your expenses, income, debts and debt-to-income ratio
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2. Get Pre-Approved: first step is to get pre-qualified for a mortgage by a lender, then get pre-approved
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3. Get the best interest rate: You can try to get a better mortgage interest rate from a different lender, so some buyers like to get a second (or more) opinion
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4. Apply for Loan: once you’ve chosen the best lender (and rate) for your situation, submit your official mortgage application for approval
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5. Sign Loan and Get Funds: sign on the mortgage terms with the lender, funds are deposited into your escrow account to purchase the home
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6. Pay Your First Monthly Bill: your first monthly mortgage payment is usually due one month after your closing date.

Congratulations you’re officially a homeowner!

Homebuying 101: What is a mortgage?

Mortgage loans and interest rates are a fundamental part of the home buying process. In fact, buyers normally begin their real estate process by first meeting with a mortgage lender to discuss options for financing a new home.

As a first-time homebuyer, or even an experienced buyer, it is essential to understand the basics of mortgages.

Getting a mortgage involves planning and preparation - from figuring out what amount of money you can afford for your down payment to making sure your income covers the monthly payments on your loan, there is a lot to think about.

There are also a lot of options to consider when it comes to borrowing money from a mortgage broker. When you start thinking about purchasing a home, it is smart to kick off the journey by getting a pre-approval done with a mortgage lender. Getting pre-approved simply means that a lender has reviewed your finances and determined the amount of money you are able to borrow from them in order to purchase a home.

The amount you are pre-approved to borrow will determine your affordability, essentially what purchase price you can pay for the home.

Why get your pre-approval done before home shopping?

1. It’s wise to determine exactly what you feel comfortable spending on a home before you start shopping
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2. Once pre-approved, you will be able to move more quickly to write an offer on a home you love and not be scrambling to submit paperwork to get your pre-approval

Pre-qualification and Pre-approval: First Steps in the Mortgage Process

As a first-time homebuyer, getting a mortgage might feel a bit daunting, and collecting all of the documents needed for your pre-approval can take some time, so be sure to prepare for this early in the process.

The preliminary step is to meet with a mortgage lender, credit union, or other lender/underwriter to get pre-qualified, with the end goal of being pre-approved.

The main purpose of pre-qualification is to get an estimate of affordability, or how much home you might be able to afford if the lender approves you for a loan. It is not a guarantee that you will get a loan or a mortgage approved, but it does give you an estimated budget so that you can start lightly looking at homes that could be in your price range.

At this stage, the lender normally just does an informal, high-level evaluation of your income, debts, and assets, based off information you have self-reported. The more detailed review of your financial health (and the corresponding documents you’ll need to provide) will come at the next step, the pre-approval stage.

Once you have your pre-qualification, it is time to get pre-approved for your mortgage loan.

For a pre-approval, you’ll need to provide the lender or underwriter with more detailed financial information about your income, debts, and assets. The documentation the lender will ask for includes, but is not limited to: account numbers and your two most recent statements for all of your financial accounts, W2s, signed personal and business tax returns from the past two years, copies of pay stubs showing your most recent 30 days of income, details on any debts, and any other details impacting your assets and monthly income.

Below are examples of documentation needed for the mortgage pre-approval process:

1. Proof of income documents: These can include things like pay stubs, your W-2s, or tax returns, or other self-employed documentation
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2. Debts and other liabilities: This includes information about any car or other loans, any credit card balances, previous foreclosures, student loans, or other outstanding debts that affect your net worth
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3. Assets: This means all of the money you have on hand (or in accounts and investments) and includes your savings, checking accounts, and any other investment accounts (stock portfolios, Robinhood, BitCoin, etc)

Debt-to-income Ratio (DTI) and Down Payments

Once you have sent this information to your lender, it is used to calculate your debt-to-income ratio, which summarizes how much money you owe (debt) compared to your total income.

A debt-to-Income ratio is a key metric lenders use to establish a borrower's qualification for a mortgage loan. It’s a risk assessment formula and essentially lenders want to see that you will be able to pay your mortgage and cover your monthly payments.

The lenders want to make sure you’re not spread too thin, and they need to see that you can consistently make payments on schedule. Once the lender analyzes all of your data and determines you are a viable borrower, they will tell you what purchase price you are pre-approved for and discuss different mortgage terms and options based on your pre-approval results.

The lender will also determine the amount of down payment required, amount of time needed for repayment of the loan, and will give you the current interest rates available for the mortgage - this is the rate that can be shopped around to other lenders.

It is important to note that the down payment percentage is actually a significant factor in the interest rate decision for your mortgage. Down payment amounts that are under 20% of the home purchase price usually require the borrower to pay private mortgage insurance (PMI), which is an additional charge added to your monthly payment. PMI ensures that the lender will be paid in the event you default on the mortgage loan. Homeowners insurance, HOA fees, and things like closing costs are all separate from the down payment, so be sure to consider all of the costs when budgeting your monthly payment.

Now that you have your pre-approval, you can start to shop for a home with confidence, knowing you can present a solid offer to a seller that will be funded by your loan.

During the mortgage process, through the close of escrow (when the money leaves your escrow account), it’s important to continue to disclose any and all pertinent financial information to your lender.

It is imperative to be honest and timely with your lender if any circumstances arise that could affect your ability to pay your mortgage. You do not want to be in a situation that could cause you serious financial problems or liens on your new home.

A good rule of thumb we use at Aalto: if you have to ask whether or not to discuss something with your lender, then it’s probably something you should be discussing with them.  

It’s important to reiterate that a buyer with a pre-approval letter will be much more attractive to sellers as they are further along in the mortgage process than a buyer with only pre-qualification.

This can be the determining factor for sellers accepting your offer, especially in a more competitive real estate market.

For someone considering moving forward with pre-approval, it’s essential to look at both the current interest rates and also the projections for where the rates could go.

Make sure you look at rates for different types of mortgages that you qualify for as well, for example: 30-year mortgage, 15-year mortgage, FHA loans and FHA mortgages, VA loans, and U.S. Department of Agriculture loans (USDA). Different types of mortgages have different rates and requirements, so it is smart to explore all of your options.

How do lenders decide whether or not to approve homebuyers for a mortgage?

A debt-to-Income ratio is a key metric lenders use to gauge a borrower's qualification and ability to repay a mortgage loan. DBI ratio is a risk assessment formula and essentially tells lenders if you will be able to pay your mortgage back. Mortgage brokers want to make sure you’re not spread too thin, and they need to see that you can consistently make payments on schedule.

A good practice is to update your pre-approval after each quarter to make sure all financial changes are accounted for. A lot can change in a few months and if you anticipate any job changes, increases or decreases in your income, bonuses paid, or debts paid off, this can lead to changes in your mortgage options and rates. 

Mortgage lenders consider a number of factors when deciding whether or not to approve a home buyer for a loan.

Some of the most important considerations for a lender’s decision include:

1. Credit Score: Lenders evaluate a borrower's credit score, which is a measure of their creditworthiness, to make sure they can repay the loan. Borrowers with high credit scores are generally considered less risky and more likely to be approved for a mortgage with favorable loan terms.
   
   
2. Debt-to-income Ratio: This is a measure of monthly debts in relation to monthly income. Lenders use this number to determine whether a borrower can afford the monthly mortgage payments.
   
   
3. Employment and Job Stability: Lenders want to see that borrowers have a steady, legitimate, and reliable source of income. They will look at your employment status, job and industry stability, and income trajectory as well as history.
   
   
4. Down Payment Amount: Ability to pay a large down payment percentage can demonstrate that a borrower is financially stable and has the means to save money. This may also help your chances of getting a loan approval as you are considered less of a risk to lenders.
   
   
5. Home Value and Purchase Price: Lenders will consider the value of the home being purchased and will compare the purchase price to the appraised value of the home. They also take into consideration the home’s condition, any potential repairs, property taxes, or any existing liens on the home that may impact the value or price.
   
   
6. Loan-to-Value Ratio: LTV compares the size of your mortgage loan to the value of the home you’re buying. Lenders prefer to lend money on homes with lower LTV ratios, as it means that the buyer has more home equity.
   
   
7. Debt Obligations and Liabilities: Lenders will also take into account any of your existing debts and obligations. They will evaluate your credit card debt, student loans, car or other loans, and any liabilities you may have to determine your affordability and your ability to repay the loan.

Every lender and mortgage broker is different and may have their own specific criteria for loan approvals, so be sure to do your research, as this is not an exhaustive list.

Pro Tip: Check your credit score on a regular basis so you know of any changes. Use a credit report online from a legitimate source or many credit cards offer credit report and score tracking with their card, so see what your options are.

Types of Mortgages: Terms to know

Below are some of the most common types of mortgages that mortgage lenders will discuss with potential buyers.

These are the usual or expected options for single-family home, townhome, TIC or condominium purchases:

Fixed-rate mortgages 

These mortgages have a fixed interest rate, so the rate will remain the same throughout the life of the loan. The most common types are 30-year fixed-rate mortgages and 15-year fixed-rate mortgages.

Adjustable-rate mortgages (ARMs) 

ARMs are mortgages that have an interest rate that can fluctuate throughout the life of the loan. The interest rate for ARMs is often lower than fixed-rate mortgages. At least in the beginning of the loan, but it can increase or decrease depending on the housing market and economic conditions. ARMs are popular with borrowers who want to capitalize on low interest rates and are willing to accept a bit of risk in exchange for the low rate. 

FHA loans 

These loans are backed by the Federal Housing Administration and are designed to help first-time home buyers or those with limited income or bad credit who would otherwise not be able to buy a home. FHA loans require a smaller down payment than traditional mortgages and may have more flexible credit requirements in order to accommodate a wider range of homebuyers.

VA loans

VA loans are backed by the U.S. Department of Veterans Affairs and are available to active duty military personnel, veterans, and their family memberd. VA loans usually have 0% down payments and more relaxed credit and income requirements than their conventional or traditional mortgage counterparts.

USDA loans

United States Department of Agriculture loans are available to borrowers looking to purchase a home in rural or agricultural areas. USDA loans require 0% down payment and have lenient credit and income requirements compared to conventional mortgages as they are part of a government-sponsored program.

Jumbo loans

A jumbo loan is a type of mortgage loan that exceeds the conventional loan limits set by the Federal Housing Finance Agency (FHFA). These types of loans are popular in places like the San Francisco Bay Area where housing prices and the mortgage loans needed are higher than in other parts of the country. A loan is generally considered a jumbo loan if it is over $548,250. Because of the large loan amount, jumbo loans have stricter lending standards and higher interest rates than traditional or conforming loans. Important to note that jumbo loans are considered non-conforming loans, so they are not eligible to be sold to the government-sponsored entities like Fannie Mae or Freddie Mac.

Mortgage Rate Locks

Another key term for borrowers to know is mortgage rate locks. A mortgage rate lock is the agreement between a borrower and their lender that locks in the interest rate on a mortgage loan for a certain period of time. 

Once the rate is locked, the borrower is protected from any interest rate increases during the time between their application getting processed and the home loan being paid out to them. Mortgage rate locks are useful because they protect borrowers from increases in interest rates that could make their home loan more expensive.

Refinancing

There are always options to refinance as well to get a lower interest rate on your mortgage, just make sure to check your loan terms and ask your lender about the best refinancing options and refinance rates for your situation.

If you already have a mortgage and are looking to refinance it to a lower rate, make sure to research the current interest rates available and compare that to the interest rate on your current mortgage loan.

Warning: Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take.  You can file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD). This article is intended for informational purposes only, this is not financial advice. Meet with a mortgage lender or a financial advisor to discuss your homebuying situation and options for financing.

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Have additional questions on the above or any of the other topics discussed on Aalto's blog? Reach out to us at hello@aalto.com - we love hearing from you! 

If you’re ready to start your homebuying journey, check out our exclusive homes at aalto.com/explore. Or shop Bay Area homes by county: Alameda County, Contra Costa County, Marin County, San Francisco County, San Mateo County, Santa Clara County.