What a home loan is and why banks care about your finances
A home loan is money a bank lends you to buy a house. You promise to pay it back over time — usually 15 to 30 years — with interest. The bank holds the deed to the house until you finish paying, which means they can take it back if you stop making payments. This is why banks spend weeks examining your finances before they hand over the money: they are betting hundreds of thousands of dollars that you will keep paying.
Banks do not care whether you love the house or whether it is a good investment. They care about three things: whether you have a steady income to make monthly payments, whether you have saved money to put down upfront, and whether you have a history of paying debts on time. If you score well on all three, you get a loan. If you score poorly on any one, you get turned down or offered a worse deal.
Key Takeaways
- Banks examine your credit score, income, and savings before approving a loan, because these three things predict whether you will keep paying.
- A down payment is money you put toward the house yourself — typically 3 to 20 percent of the purchase price — and the bank lends you the rest.
- The loan approval process takes 30 to 45 days and requires documents proving your income, debts, and assets, not just your word.
- Your monthly payment depends on the loan amount, the interest rate the bank offers you, and how many years you take to pay it back.
- A mortgage broker can shop multiple banks for you, but you are responsible for understanding what you are signing, not the broker.
The three things banks examine before saying yes
Credit score is a number between 300 and 850 that summarizes your history of paying debts. It comes from three credit bureaus — Equifax, Experian, and TransUnion — that track every credit card, loan, and bill you have ever missed or paid on time. Most banks want a score of at least 620 to consider you, though scores above 740 get better interest rates. You can see your own score free once a year at annualcreditreport.com.
Income is what you earn from work. Banks want to see at least two years of tax returns or pay stubs proving you have a steady job. If you are self-employed, they want two years of tax returns and possibly a profit-and-loss statement. They also check whether your income is likely to continue — a job you just started last month looks riskier than one you have held for five years. They calculate how much of your monthly income can go toward the mortgage payment, usually no more than 28 percent.
Assets and debts are what you own and what you owe. Banks want to see bank statements showing you have saved money for a down payment and closing costs. They also pull a report showing every debt in your name — credit cards, car loans, student loans, medical bills sent to collections. They add up all your monthly debt payments and subtract that from your income to see how much room is left for a mortgage payment. If you already owe $2,000 a month and earn $5,000, a bank will not lend you $3,000 a month for a house.
How much money you need to put down and what it costs
A down payment is money you contribute toward the house yourself. The bank lends you the rest. Down payments range from 3 to 20 percent of the purchase price. A house that costs $300,000 with a 10 percent down payment means you pay $30,000 and the bank lends you $270,000.
Down payments matter because they reduce the bank's risk. If you put down 20 percent, you have already lost that money if you walk away, so you are more likely to keep paying. If you put down only 3 percent, the bank is lending you 97 percent of the house's value, which is riskier. Banks charge higher interest rates for lower down payments, and they require you to buy mortgage insurance — an extra monthly fee that protects the bank if you stop paying. Mortgage insurance typically costs 0.5 to 1 percent of the loan amount per year, added to your monthly payment.
Beyond the down payment, you also pay closing costs — fees for the loan itself, the title search, the appraisal, the inspection, and the paperwork. Closing costs usually run 2 to 5 percent of the loan amount. On a $270,000 loan, that is $5,400 to $13,500. You can sometimes roll closing costs into the loan itself, but that means you pay interest on them for 30 years.
The loan approval process and what documents you need
The approval process has four stages: prequalification, preapproval, underwriting, and final approval. Each stage takes longer and requires more proof.
Prequalification is informal. You tell a loan officer your income, debts, and credit score, and they estimate how much you could borrow. This takes a phone call and gives you a rough number to use when house hunting. It is not a promise — the bank has not checked anything yet.
Preapproval is the first real step. You submit documents — two years of tax returns, recent pay stubs, bank statements, and permission for the bank to pull your credit report. The bank verifies your income and credit, then writes a letter saying they will lend you up to a certain amount. This letter is what sellers want to see when you make an offer. Preapproval takes 3 to 5 business days.
Underwriting is where a different team at the bank examines everything in detail. They verify your employment by calling your employer. They order an appraisal — a professional assessment of what the house is actually worth — to make sure you are not overpaying. They review the title to the property to make sure the seller actually owns it. They check whether you have any liens or judgments against you. They ask for explanations if anything looks odd — a large deposit, a gap in employment, a recent debt. Underwriting takes 5 to 10 business days.
Final approval happens when underwriting is done and everything checks out. The bank issues a clear-to-close letter. You schedule a closing appointment, sign the final paperwork, hand over the down payment and closing costs, and receive the keys. The whole process from preapproval to closing usually takes 30 to 45 days.
How interest rates work and what affects yours
An interest rate is the percentage of the loan amount that the bank charges you as the cost of borrowing. A $300,000 loan at 6 percent interest costs you more money over time than the same loan at 5 percent. The difference compounds over 30 years.
Your interest rate depends on four things: the current market rate (which changes daily based on economic conditions), your credit score (higher scores get lower rates), your down payment size (larger down payments get lower rates), and the loan term (15-year loans usually have lower rates than 30-year loans). You cannot control the market rate, but you can improve your credit score before explore, save for a larger down payment, and choose how long you want to take to pay back the loan.
Banks also offer fixed-rate and adjustable-rate loans. A fixed-rate loan keeps the same interest rate for the entire 15 or 30 years. An adjustable-rate loan starts with a lower rate for 3 to 7 years, then adjusts upward based on market conditions. Fixed-rate loans are more predictable. Adjustable-rate loans are riskier because your payment can jump thousands of dollars per year after the initial period ends.
Working with a mortgage broker versus going directly to a bank
You can get a home loan directly from a bank, a credit union, or a mortgage broker. A mortgage broker is a middleman who shops multiple lenders on your behalf and earns a commission when you close. Brokers can be useful because they know which lenders have the best rates for your specific situation — someone with a 580 credit score might get a better deal from a lender that specializes in lower scores than from a mainstream bank.
However, a broker does not work for you. They work for the lender who pays them. They have an incentive to close the loan, not to make sure you understand what you are signing. You are responsible for reading every document, asking questions about anything you do not understand, and walking away if the terms do not make sense. A broker cannot force you to take a loan you do not want, but they can make it feel like you should hurry.
Whether you use a broker or go directly to a bank, shop at least three lenders. Interest rates and closing costs vary, and a difference of 0.5 percent on the interest rate saves you tens of thousands of dollars over 30 years. Ask each lender for a Loan Estimate — a standardized form that shows the interest rate, monthly payment, closing costs, and all fees. Compare the Loan Estimates side by side.
What happens if you are turned down or offered a worse deal
If a bank turns you down, ask why. The reasons usually fall into three categories: credit score too low, income too low or unstable, or debt-to-income ratio too high. Each has a different path forward.
If your credit score is the problem, you can wait and rebuild it before explore again. Paying down credit card balances and making all payments on time for six months to a year can raise your score 50 to 100 points. If your income is the problem, you can wait until you have been at your current job longer, or you can add a co-borrower with income — a spouse, parent, or partner — whose income counts toward the process. If your debt-to-income ratio is too high, you can pay down existing debts before explore, which frees up room in your monthly budget for a mortgage payment.
If you are approved but offered a higher interest rate than you expected, the reason is usually your credit score or down payment size. You can ask the bank to lock in the rate for 30 to 60 days while you work on your credit score, or you can shop other lenders. You can also increase your down payment to reduce the loan amount and the interest rate.
Frequently Asked Questions
What is the difference between a 15-year and 30-year loan?
A 15-year loan has a higher monthly payment but costs less in total interest. A 30-year loan has a lower monthly payment but costs more in total interest because you are paying interest for twice as long. Choose based on what monthly payment you can afford and how long you plan to stay in the house.
Can I get a home loan if I have bad credit?
Yes, but you will pay a higher interest rate and may need a larger down payment. Some lenders specialize in borrowers with credit scores below 620. The tradeoff is that your monthly payment will be higher. You can also wait and rebuild your credit before explore to get a better rate.
What is a co-signer and when do I need one?
A co-signer is someone who promises to pay the loan if you do not. Banks sometimes require a co-signer if your income is too low or your credit is too weak. The co-signer's income and credit are examined just like yours, and they are legally responsible for the debt if you default.
Can I lock in an interest rate before I find a house?
Yes, during preapproval most banks will lock your rate for 30 to 60 days. This protects you if interest rates rise while you are house hunting. If rates fall, you can usually renegotiate. Ask the bank what their rate lock policy is and whether there are any fees.
What happens if I cannot make a payment?
Contact your lender when ready. Many banks offer forbearance — a temporary pause or reduction in payments — if you are facing a hardship. The longer you wait, the fewer options you have. Missing payments damages your credit and can lead to foreclosure, where the bank takes back the house.