How to prepare to apply for a mortgage in the current market

Today’s housing market can be quite intimidating for prospective homebuyers, particularly first-time homebuyers. With today’s median home price of $414,500, according to the U.S. Census Bureau, the road to homeownership seems daunting, if not impossible. With that in mind, it’s vital to plan ahead—especially when it comes to applying for a mortgage. Learn how to navigate today’s housing market so you can feel confident when the time comes to apply for a mortgage.

What you’ll learn:

• Struggles of the current market
• How to set your housing budget
• Saving for a down payment
• Other considerations
• How to apply for a mortgage

Struggles of the current market

While every generation faces unique challenges, undoubtedly one of the largest for millennials and Gen Z is homeownership. Dan Bauer, head of residential lending at Alliant, said in a HousingWire interview that, “One of the biggest deterrents to homeownership is affordability; home prices remain high, and many buyers are concerned about monthly payments at current mortgage rates.” Still, he adds, “Buyers who take steps to improve their credit, get-approved and budget effectively are still finding paths to homeownership despite market challenges.”

A huge issue with these higher prices isn’t simply the higher price itself; it’s the large down payment needed. A 20% down payment on $400,000 is $80,000, which is quite a tall order to save if you don’t have prior equity to use.

Additionally, higher interest rates have dramatically raised the monthly cost of housing, regardless of the actual purchase price. With rates closer to 7% today versus around 3% just a handful of years ago, the monthly cost of a mortgage is often hundreds more.

How to set your housing budget

Before anything else, setting your housing budget is step one—you can’t know how much you need to save for a down payment or begin a focused housing search without one. There’s no single answer for what your housing budget should be. For someone living in a high-cost-of-living area, housing may need to be a substantial part of their expenses, while others may get by with a relatively cheap mortgage.

Here are some general guidelines to put you on the right path:

• While lenders may differ in how much they’ll lend for a mortgage, many follow the 28/36 rule. This maxes out your mortgage at 28% of your gross income and allows no more than 36% of your income to go toward your mortgage plus debt (student loans, car payments, etc.)
• Take the mortgage amount you’re approved for with a grain of salt. While you may be technically approved for that amount, you should always review how that purchase would fit within your overall budget. The maximum amount mortgage lenders give often leaves little room for other expenses beyond a barebones budget.

Saving for a down payment

Even if saving up for a downpayment seems like a steep goal, it may be more achievable than you think. Here are a few tips to get started:

• You may not need a 20% down payment. Options like PMI, a piggyback HELOC, FHA loans and more can get you into a home with significantly less than that 20% down payment.
• This goal won’t happen overnight; it’s highly normal for a down payment fund to take years to build up. Break your down payment into smaller, more achievable yearly or monthly savings goals so you feel like you’re making constant progress.
• Saving for a down payment usually requires intentional budgeting. Determine a system that works for you, such as a zero-sum budget, and then track your expenses carefully to identify where you can temporarily cut back.

Other considerations

Fixed expenses

While mortgage lenders will consider debt payments when approving you for a mortgage, they don’t have your entire financial picture—only you do. Regular, fixed expenses such as your phone bill, subscriptions, car insurance, gas and more all impact how much home you can truly afford.

Will your housing needs change?

Buying a home can make a ton of sense—you can mostly lock in a major expense, all while gaining equity and growing your wealth. However, renting can make more financial sense if your housing needs will change soon. For example, a single person with no kids may be better off renting if they are likely to get married and/or start a family within the next 5-10 years. If they bought as a single person, they’d likely afford a small home or condo, which would then need to be sold to buy a large enough house to accommodate their entire family. This would accumulate many extra costs—closing costs, broker’s fees, moving expenses and more that could wipe out whatever equity was built up.

Closing costs and fees

Beyond the down payment, you’ll also want to have money set aside to pay closing costs. These typically add up to anywhere from 2%-6% of the total loan amount. On a $450,000 home, this would equal between $9,000 and $27,000. Closing costs vary based on your purchase location and the home itself, but common costs and fees include an application fee, attorney’s fee, closing fee, loan origination fee and more.

How to apply for a mortgage

Once you determine your budget and saved for your downpayment, you’re well on your way to being ready for homeownership. Instead of formally applying, you can start by getting pre-approvals. Many lenders offer mortgage pre-approvals as an easy way to check your potential rate and how much a lender is willing to lend without supplying a ton of financial details or a hard credit pull.

It’s a good idea to shop around and compare rates from different lenders. While mortgage rates are very dependent on the overall market, lenders will have slight differences in their rates. Some financial institutions may also offer unique loan programs targeted towards specific groups.

According to Bauer, “credit unions are well-positioned to step in where traditional banks have pulled back. At Alliant, we focus on member-first lending, which allows us to offer competitive mortgage options tailored to a borrower’s financial situation, not just a one-size-fits-all approach. We also provide unique loan programs, such as those designed for medical professionals or first-time buyers, that may not be as readily available through big banks.”

While gaining a foothold in today’s housing market can be tough, it may not be impossible. Smart financial planning, understanding your housing needs and your local housing market and knowing what to consider when applying for a mortgage will all put you in a strong position to afford a home.