First-time homebuyers: Financing your purchase

Unless you have loads of cash, you'll need to take out a mortgage for your first home

(MoneyWatch) COMMENTARY There's more to buying a home than just touring some houses, finding the perfect fit and signing on the dotted line. What many first-time home buyers don't realize is that lining up financing should ideally happen before you ever make an offer - and preferably before you start searching for a home.

Today more than ever, sellers are wary of accepting offers contingent on financing. Since lending restrictions are so tight, many sellers are worried that potential buyers won't get financing and the contract will fall through. To make your offer stronger - and have an idea of what you can realistically afford - get preapproved for a mortgage.

Unlike prequalification, you'll need to apply for a loan in order to get preapproved. On your application, your lender will ask you to disclose the assets and debt you have. You'll also need to prove it, so be sure to bring documentation.

Having the following information can speed up the process and help your chances of getting preapproved for a mortgage: Copies of all bank statements for the last three months; copies of all account statements, including stock brokerage accounts; the most recent pay stub for you and your spouse or partner; W-2 forms for the past two years and a gift letter if part of the money is a gift from a friend or relative.

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If you're self-employed, know that it will likely be more difficult for you to get a mortgage. Lenders see 1099 contract employees as temporary, even if you've been with the same company for many years. You'll need to show stable income, so bring the last two years of your tax returns and a profit-and-loss statement for the year to date.

Both self- and traditionally-employed individuals will need to provide tax returns, but the lender will also ask all applicants to sign a form which permits the company to pull its own copies of the returns directly from the IRS to avoid fraud.

The lender will look at how much cash you have on hand. Generally, they will want to see at least a month's worth of expenses which include the mortgage payment, taxes and insurance. Lenders will also look at your credit score and history, and look through all your accounts for red flags like large, unexplained cash withdrawals or deposits.

Once you have all your documentation together, you'll need to make some decisions about the mortgage you want to apply for:

Loan terms. Are you risk-averse or do you believe the higher the risk, the more potential for reward? If you prefer stability, a fixed-rate loan is probably your best choice. The length of the loan term is up to you, but knowing what you'll pay each month for the entire term is generally the way to go. These days, the vast majority of loans approved are 15-year or 30-year fixed-rate mortgages.

If you don't plan to stay in the home very long and don't mind a little risk, you might apply for an adjustable-rate mortgage (ARM). You benefit if rates go down, but run the risk of skyrocketing monthly payments if the ARM adjusts to a higher rate.

Being preapproved for a mortgage could mean the difference between your offer being accepted or rejected

Interest rate. In most cases, the lender will ask you if you want to float the rate or lock it in. This means choosing between locking in at the current rate or gambling on the rate going lower before you close on the loan. Some lenders might allow you to lock in with a free float-down option, which means you'll have the opportunity to lock in at a lower rate if a drop occurs. This doesn't come without drawbacks - that new low rate could go up one-quarter to one-half a point.

Rate lock period. You can't lock in a low rate for a year while you search for a house, so getting preapproved should only happen when you're ready to buy something. Lenders will usually hold a rate for 30, 45 or 60 days, and once it expires you'll need to re-apply for a loan. You should base the length of the lock on your projected closing date, but make sure your lender can close within the timeframe you choose. If you want to close in 30 days but your lender can't make it happen, choose a longer timeline.

This is also true if you're hoping to close quickly. If this is the case, make sure your lender can approve your mortgage and lock a rate in a short time frame. Make sure you give your lender everything they need in order to expedite the process.

If you're buying new construction and will have to wait months -- or years -- to close, wait until you're 60 or 90 days out from closing to look at interest rates and lock in.

Points. Each point represents one percent of the loan amount and the more points you pay, the lower your interest rate. Points are paid in cash. If you are a first-time homebuyer who is lucky enough to have the money on hand to pay points (many don't), you should - it can save you thousands of dollars over the life of the loan. Points are also tax-deductible during the year of closing.

If you don't have cash on hand to pay points, you do have the option of paying for them over the life of the loan. This does increase your monthly payment, so it's not an ideal scenario.

Your lender is required to give you a Good Faith Estimate no later than three days after you apply for a mortgage. This document will lay out all the costs associated with the mortgage, so be sure to review it thoroughly before committing to the loan. Keep in mind that some costs may still be confusing, so ask your lender questions until you understand exactly what the cost means.

Visit CBS MoneyWatch again on Friday for more tips for first-time homebuyers.

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    Ilyce R. Glink is an award-winning, nationally-syndicated columnist, best-selling book author and founder of Best Money Moves, an employee benefit program that helps reduce financial stress. She also owns, where readers can find real estate and personal finance resources.