Explaining the Home Loan Process

Buying a new home is one of life’s most exciting decisions, but it can also be one of the most challenging — especially if you don’t know what to expect during the mortgage process. Understanding how home loans work and getting prepared can help set you up for success.

Pennymac has developed a blog series, "Explaining the Home Loan Process," to support homebuyers in navigating the entire mortgage journey, from preparation to closing and beyond. Follow our educational guide and gain insights into the following and more:

• The people involved in the mortgage process
• The loan application
• Required documents and forms
• Underwriting
• The closing process
• Loan servicing

Ready to dive in? Let’s start at the beginning. Before filling out your loan application, you’ll want to lay down the home loan groundwork.

Understand and Evaluate Your Financial Health

Before you start the loan application process, getting an accurate picture of your financial health is essential. Having insight into your current financial standing will make it much easier to discuss what you can afford with your lender.

Gathering the necessary information at the start will facilitate the process and may increase your lender's likelihood of approving you for a loan. While it may be tempting to start searching for your ideal home immediately, ensure you take care of these three steps first.

1. Assess Your Credit Score

All lenders will require a credit report before they let you take out a new mortgage. Having a good credit history and avoiding common credit score mistakes are critical to securing a mortgage, and these factors will impact the type of loan you’ll qualify for.

Before contacting any lender, check your credit report from all three credit bureaus: Equifax, TransUnion and Experian.

Scrutinizing your credit report in advance gives you the opportunity to:

• Repair your credit if needed, including paying off or reducing debts as much as possible
• Rectify any errors in your credit report, including those due to identity theft, outdated information or incorrect notations on closed accounts

By law, you are entitled to one free credit report per year from each of the three credit bureaus. To request your reports, visit AnnualCreditReport.com.

2. Weigh Your Savings Against Settlement Costs and Expenses

Buying a home is likely the single largest purchase you’ll ever make, so it’s important to start setting aside money as soon as possible. Here are some expenses to consider:

Down Payment

The down payment is a percentage of the home's purchase price the buyer pays upfront before taking out a mortgage for the remaining amount. Except for VA mortgages, most loans require at least a 20% down payment to avoid costly mortgage insurance. For example, a $250,000 home would require at least $50,000 down to avoid mortgage insurance.

Settlement Costs

Commonly known as closing costs, settlement costs are the extra fees buyers and sellers pay to close on a real estate transaction beyond the home’s purchase price. Closing costs vary depending on the lender, the home’s location and the loan type, but some fees and expenses that you may potentially be responsible for include:

• Application fee
• Appraisal fee
• Attorney fees
• Closing fee
• Courier fee
• Credit report fee
• Discount points
• Escrow deposit for property taxes, premiums, homeowner’s insurance, homeowner’s association (HOA) fees and mortgage insurance
• Flood fee
• Inspection
• Origination fee
• Prepaid interest
• Rate lock fee
• Recording fee
• Title search fee
• Transfer tax
• Underwriting fee

Most closing costs typically fall on the buyer, but some sellers may negotiate and contribute a portion of these expenses. In specific states, it’s customary (though not mandatory) for sellers to cover particular fees, such as owner's title insurance and/or transfer taxes.

Closing costs can be significant, but sometimes, a lender will roll them into the mortgage amount. Doing this, however, means you are borrowing the funds for your closing costs, which may result in a higher overall loan amount and potentially higher monthly mortgage payments.

3. Establish a Realistic Budget

Creating a realistic budget is a must for helping you assess what you can comfortably afford each month. It’s best to base your budget on your typical monthly spending habits and obligations as well as your financial goals, such as how much you allocate to savings, retirement, etc.

Remember, different loans and terms will affect the size of your mortgage payment. Therefore, it’s important to establish your monthly mortgage budget before discussing loan terms with your lender. A mortgage calculator is a helpful tool for estimating how much your monthly mortgage payment could be, depending on the purchase price, down payment, term, interest rate and other variables such as property taxes. Input different scenarios and see how the results align with your financial situation.

Some lenders may even refer you to a homeownership education counselor for assistance. This representative will work with you to evaluate your current financial health and flexibility to help you make informed decisions. While a homeownership education counselor or course can be valuable for many first-time homebuyers, it may be required for some programs.

Familiarize Yourself With Real Estate Basics

Before looking into a specific loan, potential homebuyers should familiarize themselves with common real estate and mortgage terminology. We suggest starting with the basics, such as understanding home loans, rates and terms.

Common Loan Types, Rates and Terms

It’s essential to carefully consider your financial situation, future plans and risk tolerance when deciding which home loan is right for you. Consulting with a loan officer, such as a Pennymac Loan Expert, can help you compare options and determine the most suitable choice for your unique circumstances.

30-Year and 15-Year Mortgages

30-year and 15-year mortgages are two common types of home loans. Both feature fixed interest rates, which results in stable monthly mortgage principal payments.

• 30-Year Mortgage: A 30-year mortgage spreads payments over three decades. The extended repayment period allows for lower monthly payments than a shorter-term loan. However, it results in higher overall interest paid over the life of the loan compared to shorter-term mortgages.
• 15-Year Mortgage: A 15-year mortgage is a home loan designed for quicker repayment than a 30-year mortgage. Due to the shorter loan term, the total interest paid over the life of the mortgage is significantly reduced, but the monthly principal payment will be higher than a 30-year loan.

Adjustable Rate Mortgage (ARM)

While the majority of homebuyers select a fixed-interest mortgage, others opt for an adjustable-rate mortgage (ARM).

An ARM, or variable-rate mortgage, has an interest rate that varies based on market conditions. Initially, these mortgages may offer a lower fixed interest rate for a defined period, but the rate is subject to subsequent adjustments, potentially increasing or decreasing.

An ARM may be a good choice if you plan to stay in your home for only a few years or anticipate an income increase before the rate adjusts.

The Difference Between Annual Percentage Rate (APR) and Interest Rate

Homebuyers sometimes confuse the APR with the interest rate, but the two terms measure two different things.

The interest rate determines the cost of borrowing the principal loan amount, whereas the APR includes additional charges like:

• Loan discount points
• Mortgage insurance premiums
• Broker fees
• Closing costs

These inclusions offer a more comprehensive view of the loan's actual cost. A lower APR generally indicates a lower total loan cost. The interest rate does not reflect fees or any other charges.

Other Home-Buying Resources

In addition to the Pennymac website, there are valuable resources on third-party sites to help you with the home-buying process:

• U.S. Department of Housing and Urban Development Home Buying Booklet
• Fannie Mae Home Buying Overview

Understand the Other Steps in the Home Loan Process

Understanding the process as a whole will help you navigate steps like the loan application, underwriting and closing. Read the other installments in our Explaining the Home Loan Process series to learn more.

The Home Loan Application

Part 2 of Explaining the Home Loan Process breaks down each Uniform Residential Loan Application section so you can follow along and better understand the required information.

Loan Processing

Part 3 of Explaining the Home Loan Process discusses how your home loan application moves through the loan process, including collecting proof of assets, ordering appraisals, retrieving credit reports and gathering payoff information.

Mortgage Underwriting

Part 4 of Explaining the Home Loan Process describes the role of the mortgage underwriter, including how they evaluate your borrowing capacity, credit and collateral.

Mortgage Closing

Part 5 of Explaining the Home Loan Process details the closing process, including your role in the mortgage closing, your rights as a homebuyer and the best ways to ensure success at closing time.

Transferring of Loan Service

The final part of the Explaining the Home Loan Process series explains what to expect if the management of your loan is handed off to a new mortgage company after closing.

Navigate the Home Loan Process With Confidence

The best form of preparation is education. We’re happy to provide you with this comprehensive resource designed to help make the home loan process as smooth as possible. To better understand how this would work for your own home loan and financial circumstances, contact a Pennymac Loan Expert. They will explain what to anticipate during each stage of your personal mortgage journey.

Jump to...

• Part 1 - Explaining the Home Loan Process
• Part 2 - 1003 Uniform Residential Loan Application Explained
• Part 3 - Understanding Loan Processors and Mortgage Processing
• Part 4 - Mortgage Underwriting
• Part 5 - The Closing Process
• Part 6 - Loan Service Transfer

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