The 6 (Not-So-Simple) Steps to Securing a Home Loan
From the word "mortgage" to the methods used by lenders to determine how much to loan, the home loan process can be confusing to first timers. In fact, one third of the respondents to a 2011 Wall Street Journal survey of homebuyers said that the most difficult part of buying a home was understanding the loan process.
It can also be quite stressful, especially when you've got your eye on a cute Craftsman bungalow and are waiting on pins and needles to learn if you qualify to purchase it.
Let's take a look at the conventional home loan process, from start to finish. Here's a breakdown of the process in six steps to help you get a better understanding of it. (Please note that VA loans, FHA and USDA loans are a bit different.)
Step 1: Loan Application and Pre-Qualification
You've no doubt read and heard that you'll need to be pre-approved for a home loan before you start looking at homes for sale. Don't skip this step – it's probably the most critical one in the homebuying process.
A common question is: "How do I find a lender?" Start with your bank or credit union, especially if you have a business or personal relationship with the manager. If not, ask your real estate agent – he or she most likely knows of several that you can speak with and compare rates.
The first thing you'll do when you visit a lender is fill out a loan application. This is only an application; it doesn't obligate you to any particular loan or to use that lender.
You will be asked to provide the following information:
- Name and address
- Date of birth
- Social Security number
- Current and past employers
- List of assets
- List of debts
The loan officer will order your credit report and, along with the information in your application, it will help paint your financial picture and determine how much money you qualify to borrow.
Lenders use a debt-to-income ratio, or DTI, to make this assessment. You can calculate your DTI by adding up all your monthly debt payments and dividing them by your gross monthly income (your income before taxes).
This is a simplistic look at your DTI because lenders actually calculate what they call a "front-end ratio" and a "back-end ratio." The calculation above will help you determine your back-end ratio. To determine your front-end ratio, the lender will take your housing expenses and divide them by your monthly before-tax earnings, and multiply that figure by 100.
A rule of thumb is that lenders are satisfied with a front-end ratio that doesn't exceed 28 percent and a back-end ratio of 36 percent or lower – but it may vary according to the borrower's down payment, credit score and savings.
At this point, the lender knows what size loan to offer you and you are now, hopefully, pre-qualified for a mortgage. Keep in mind: This is not a commitment from the lender as it's based purely on information in the loan application and your credit report.
Tip: Don't make any changes to your financial picture from this point until the close of escrow on your new home. Even what you may consider to be insignificant purchases can change your DTI ratio and possibly disqualify you for the loan.
Step 2: Initial Underwriting
The loan agent will now collect documentation to prove all the information you stated on the loan application, and will create your file and submit it to the loan processor.
This person organizes all the documentation and sends it to the underwriter – the most important person in the process. The underwriter goes over all the paperwork with a fine-tooth comb, checking to ensure that guidelines are met. He or she will also make a list of additional documents you'll need to submit to complete your file.
If everything falls into place, you will be conditionally approved for the loan.
Step 3: Approval of the Property
Everything comes to a halt at this point, until you make an offer to purchase a home. If the offer is accepted, the wheels of the loan machine begin turning once again.
The lender needs to know all it can about this particular property, and will obtain most of this information from the title report. The report documents the findings of a search of the property's title and details info about the current title holder, if any liens are on the property and any irregularities in the chain of title. A clean title report allows the lender to safely attach a lien on the property, in order to use as collateral should you default on the loan.
The second report that the lender will order (and the buyer will pay for) is the appraisal. The appraisal determines current market value of the home so the lender can be assured it isn't lending more money than the home is worth.
Step 4: Final Approval
The title report, appraisal, and any documentation you've submitted after the initial underwriter examination now go back to the underwriter for final approval. The underwriter will either sign off on the loan or ask for more information. It's at this point that you'll run into trouble if you've made any recent large purchases or opened any new credit accounts.
Hopefully, you followed the advice here and the underwriter approves that the loan is "ready to fund."
Step 5: Loan Documents Sent to the Title Company
When your file is cleared to close, the funding department drafts the closing paperwork and sends it to the closing facilitator. Depending on where you live, this might be an escrow company, a real estate attorney or title company.
The closing facilitator packages up all the other closing documents, such as the deed of trust and HUD statement.
Step 6: Closing Time
At closing, you'll be presented with lots of paperwork to sign and a notary will notarize many of them. These will be sent back to your lender, who will then fund the loan and escrow will officially close.
Finally, grab those keys and move in!