What documents will I need to get a mortgage?

Applying for a home loan may be one of the more paper-intensive processes you’ll go through in life. Fortunately, much of what you need you’ll already have on hand or can easily access.

The documents mortgage lenders require generally fall into three categories: those documenting your income, your debts, and your assets. In addition, a variety of miscellaneous documents may be necessary given your situation.

At the top of the list is documentation of your current income, as well as how much you earned the past two years. Lenders will typically want to see your most recent two tax returns.

If you work for an employer, you’ll additionally need to present your latest W-2 form and last two pay stubs, as well as the names and addresses of any other employers over the last two years. Meanwhile, the self-employed will need to provide a year-to-date statement of profits and losses, as well as two years’ worth of 1099s and tax returns documenting the self-employed income.

The next bucket of documentation concerns debts. You’ll need to list all of your current debt balances and monthly obligations, including auto loans, student loans, and credit card balances. You won’t need to provide statements, though, as the lender will verify information against your credit report.

Next comes asset documentation. This includes the last two months of statements for any bank, CD, retirement, and investment accounts you hold, as well as for any life insurance policies with a cash value or owned real estate.

Lastly, various miscellaneous documents may be required given your specific situation, such as a letter confirming any received gift money is not expected to be repaid, proof of one year’s rent payments if you are a renter, or your divorce decree if you’ve divorced.

What are mortgage points and should I pay them?

One of the most confusing mortgage choices is whether to pay points. It doesn’t help that the term is used two different ways, or that the right answer varies by situation. But the good news is that you can boil your decision down with a simple math calculation.

 A “point” refers to one percent of your loan amount. So on a $200,000 mortgage, one point equals $2,000. You also need to be aware that lenders quote two kinds of points. Origination points are a fee you pay the lender for their services, and you may or may not be able to negotiate it.

 But discount points are different, and are the ones borrowers find themselves dithering over. A discount point is a pre-payment of interest at the time of closing in exchange for a lower mortgage interest rate. It allows you to “buy down your rate”.

 Lenders often let you pay one to three points, but we’ll use an easy one-point example. Opting to pay a point at closing typically lowers your mortgage APR by about a quarter percent (though lenders vary). So for a $200,000 mortgage with a 30-year fixed rate of 3.75 percent, paying one point, or $2,000, could lower your rate to 3.50 percent, which would drop your monthly payment from $926 to $898.

 Now divide the cost of the point ($2,000) by the monthly savings ($28) to see how long it will take to break even. In our example, it would take 72 months, or six years, to earn back your $2,000 investment. Expect to stay in your home longer than that? Then buying points makes good sense.

 Of course, if you can’t afford to bring more money to closing, or you have a higher-priority use for your funds, a no-point mortgage will be your own smart mortgage choice.

To escrow or not to escrow

Although mortgage calculators are infinitely useful for testing how different loan amounts, rates, and terms would impact your payments, the actual amount you’ll owe the bank each month will likely be hundreds of dollars more than what the calculator spits out.

 That’s because most mortgage lenders require an escrow account to collect money from you throughout the year for the annual – and often hefty – bills of property tax and homeowner’s insurance (and private mortgage insurance if your loan requires it).

 But do you have to escrow? Is saving the money on your own and taking responsibility for making those once-a-year payments an available option? For some borrowers, it is. But even if you can opt out of escrowing, you may not want to.

 With some mortgages, you’ll have no choice. All FHA loans require an escrow account, as do most VA loans. Many conventional mortgages require escrowing, too, especially if you make a down payment below 20 percent.

 But even when it’s not mandatory, many homeowners opt to escrow because they like the savings discipline it imposes, the predictability of a monthly “all-in” payment, and the convenience of the bank handling their tax and insurance bills.

 You may feel confident you can save for these large yearly bills on your own, though. Or maybe you have an irregular income. That’s when a non-escrow mortgage might make sense. You’ll have to ask for it, and it’ll probably cost you a waiver fee or a higher interest rate. But you can offset this with interest earned on your savings during the year.

 In the end, the right choice will depend on a combination of factors that include your savings personality, your interest in handling tax and insurance on your own, and how much your lender will charge you for the non-escrow privilege.

3 Things To Do Before Applying for a Mortgage

If you’re considering buying a new home, first ask yourself where you stand financially. How strong or shaky you are on three factors lenders care about — your credit score, cash on hand, and debt — will determine how favorable (or not) a mortgage you’ll be offered, or if you’re approved at all. So you may want to bolster these before applying.

Start by looking up your credit score, as well as that of anyone else who will be on the mortgage. Unless you’re already above 760, boosting your score can land you better rate offers from lenders.

Raising your score can generally be done by making all of your payments on time, paying down debt, and not opening any new cards or loans shortly before applying for a mortgage.

Reducing debt is doubly important because it also lowers your debt-to-income ratio. Lenders use this calculation to compare your income to your total debt (including car loans, student loans, credit cards, and any other debt), and the lower your monthly debt obligation, the stronger your application.

Although paying off a loan or card entirely is great, any debt reduction will improve your ratio. Consolidating multiple debts into one lower monthly payment can also help.

The third critical lender consideration is how much cash you have. In addition to wanting to see you’ll have funds in reserve after making your down payment, they’ll also look at how much you had two months ago, not just today. So save as much money as you possibly can, and don’t rely on a large cash gift from a relative right before applying.

When aiming to maximize the size and rate of your new mortgage, fortifying your credit score and savings, while reducing your debt, are surefire ways to put your best application forward.

Should I consider an adjustable rate mortgage?

Anyone who’s ever shopped for a home loan knows they come in two main flavors: fixed rate and adjustable rate mortgages, or ARMs. While traditional 30-year fixed mortgages have long been a homeowner favorite, sometimes an ARM can be a smart move.

Here’s how ARMs work. For a period of years – usually 3, 5, 7 or 10 – the mortgage behaves like a standard fixed-rate loan. You’ll know your rate upfront and it won’t change during that initial period.

After that, your lender can adjust your rate, raising it if national rates have moved higher, or lowering it if rates have dropped. Therein likes the risk with ARMs since no one can reliably predict where rates will move several years in the future.

Of course, you’ll earn a trade-off in exchange for an ARM’s risk. You’ll notice that ARM rates are noticeably lower than 30-year fixed rates. So while they are less predictable over time, you’ll be guaranteed to pay a lower rate for the initial period.

That means an ARM could be a wise choice if you expect to stay in your home less than the number of years in the ARM’s fixed period.

But if your expectations prove wrong and you live in the home long enough to reach your ARM’s adjustable period, you’ll find yourself at the mercy of current market rates. Right now, rates are forecasted to be on an upswing given the Federal Reserve’s movements. But after that, it’s impossible to know where rates will be headed.

In the end, adjustable rate mortgages are an easy choice when you know you won’t live in your home for the long haul. But if you’re like the many homebuyers who aren’t sure how long they’ll stay, a fixed-rate mortgage can be the safer and more penny-wise move.