So, are you ready to buy a home and don't know where to start? Buying and financing the purchase of a home is one of the most important financial decisions in anyone's life. It is probably the most important purchase you have ever made. So making good decisions is essential because once signed, it's a done deal. How do you know if you are making smart decisions? The best thing to do is to educate yourself and use common sense in the decision making process. Weigh desires against needs and focus on logical rather than emotional choices.
Budget
There’s nothing fun about crunching your budget numbers, but if you can’t afford the expenses of a new home then perhaps its best to wait until your financial picture improves. Budget items to consider:
Down payment
Most lenders require anywhere from 5% to 20% of the purchase price as a down payment. If you don’t have 20% to put toward the purchase, a lender may require you to have Private Mortgage Insurance (PMI – default insurance) which will add to your monthly payment. Or they may require a 15% second mortgage, which still means you need 5% to close the loan. There are loan programs that offer low or no down payment options such as FHA, VA, or USDA loans. If you don’t have at least 5%, do your homework on other loan programs and determine if you are eligible.
What Can You Afford
A Mortgage expense isn’t just the monthly principal and interest payment, because there are additional expenses associated with homeownership. Lenders will include the property taxes and insurance into your monthly payment when evaluating your ability to make the mortgage payment. These figures are included whether you have an escrow account set up to pay your taxes and insurance or not.
In addition to property expenses, you should evaluate whether or not you can afford the utilities. If the house is larger than your previous dwelling will it cost more to heat or cool? These are factors to adjust for in your budget.
Lastly, can you afford home repairs? You should have enough money saved up to cover any costly home repairs. There should be enough savings room in your budget to account for periodic home improvements to keep a home up to date. Eventually, a roof will need to be re-shingled, or windows will need to be replaced. Will your budget allow for you to keep up with repair and maintenance of the property? If not the home could fall into disrepair, and you could potentially lose money when you try to sell.
How a Lender determines what you can afford
Lenders determine whether or not you can afford a mortgage payment by calculating a debt to income (DTI) ratio. A higher DTI could mean your loan poses a higher risk which might mean you get a higher rate.
Debt to Income Calculation
Add up the minimum monthly payments on ALL debt (car payments, installment loans, credit card, deferred student loans 1% of balance). Also, include the new mortgage principal and interest payment plus the monthly figure for taxes and insurance.
Income is your monthly gross pay before any deductions.
DTI = (total debt / income) * 100
35% or less is considered optimal, 36% to 49% could use some work, and 50% or higher mean you probably won’t be approved.
Get Your Financial House In Order
If your budget and Debt to Income ratio look good, then the next step is to get your financial house in order. Pull a free annual credit report from all three of the credit bureaus and review your reports. Make sure all the items on your report have been reported correctly. Pay close attention to any past dues or collections. If any items are incorrect, you will want to dispute those items and clear up your credit before applying for a mortgage loan. Or if they are correct, you want to get delinquencies up to date or pay off collections.
You can request your credit score if you’re not sure what it is or if you’re concerned it might be too low. A score of 640 is typically the minimum excepted credit score for most mortgage loans. If you have a score on the lower end of the spectrum, expect to pay more in interest at a higher rate.
You should determine if your score needs to improve. You can pay off or pay down any unsecured debt; especially credit cards. As for late payment histories, unfortunately, the only remedy is time. You must make consistent on-time payments over an extended period of time to raise the credit score.
Prepare to Apply
If all your ducks are in a row, you can prepare for that application process. Its best to get as much of your financial paperwork together and ready as possible. Any number of issues can throw a mortgage application off the rails (i.e., title issues, collateral concerns, inspection issues). If you are prepared with the things you know are customary you can avoid any unnecessary hiccups in the process.
Documentation
Get all the request documentation promptly. A lender can’t close your loan without the proper documentation, and a failure to provide information promptly could cause closing delays.
Income: Last two pay stubs showing the pay period and YTD earnings, plus last years W-2’s
Tax Returns: At least the last year, two years for self-employed borrowers and three years for FHA.
Asset Statements: Bank statements for any savings or checking accounts; plus any 401k; funds from closing including down payment must be traceable in an account for at least 90 days (that means no stashed cash it must be deposited in an account)
Sales Contract: once you have signed a sales contract for your dream home, forward it to your lender so that the process can move forward
If you are getting a home inspection, make sure to schedule and complete in the allotted time frame.
You must obtain homeowners insurance before closing and provide proof to the lending officer. You will need to pay for the first year of insurance upfront before closing. So if you plan on shopping around, do so promptly and don’t wait until the last minute.
Once you have your house picked out, documentation in order and you know your financial picture is sound and you can afford all expenses, it’s time to apply for that loan. Call your bank to schedule an application appointment or apply online. There may be additional documentation required so be patient and prompt with the process. The application process can be tedious and stressful, but it’s worth it in the end.