But first things first, this will likely be the biggest financial transaction of your life so it’s important to understand the home buying process.
Chances are that you will need to get a mortgage to finance the purchase of your desired home, which means you will need to work with a lender who will loan you the amount you need to buy a home. Here are a few tips to increase your chances of getting a loan.
Step 1 – Your Credit Score
You’ve heard about the importance of a good credit score when it comes to everything from purchasing a cell phone, a car, and even your cable. Buying a home is no different. Lenders check your credit score to understand how big of a risk you are.
In other words, a higher score means you are a lower risk individual and more likely to pay back the loan, while a lower score means the opposite.
A low score doesn’t necessarily mean that you will not get a loan; it simply means that the terms of the loan, namely the higher interest rate, will be less favorable than the interest rates offered to individuals with higher credit scores.
What’s a good score? A perfect score is 850, and less than 1% of the population has a perfect score so don’t feel bad. If you’ve got a score above 700, you’ve got a good credit score.
A score between 650 and 699 is considered a fair score, while anything below 650 is considered challenging. Again, you can still qualify for certain loans, such as FHA loans (which require a minimum 580 score), but you’ll likely end up paying more money over the term of the loan.
So bottom line, check out your credit score for free on freecreditreport.com or any other free platform to get a sense of what your score is.
Step 2 – Your Income
This one is obvious and in my humble opinion, should be the most important (above your credit score). What’s the point of having a good credit score if you don’t have the income to pay for your purchase? But I digress.
Lenders want to see stable income. This means that you have had steady employment for ideally at least two years on the job. There are exceptions of course where you may change jobs every year or so, so long as there aren’t big gaps in employment.
If you’re self-employed, you’re considered a bigger risk. That is, unless, you have been self-employed for at least two years and your income is stable as proven by bank statements or tax returns.
Lenders use your income to calculate your debt to income ratio. This is simply your monthly debt obligations divided by your income.
For example, between your student debt, car loans, utilities, credit card, you may pay $600 per month. Let’s say, your monthly income is $5,000 month. Your debt to income ratio would therefore be 600 / 5,000 = 12%. This is good as it is below the recommended 36% debt to income ratio many lenders look for.
Now, add a potential monthly mortgage payment of $1,200 and your total debt obligations become 1,200 + 600 = 1,800. 1,800/5000 = 36%, which is excellent!
However, keep in mind that most lenders are fine with borrowers having a debt to income ratio of as high as 50%.
Enter these numbers in the home affordability calculator such as this one to see how much home you can afford.
Step 3 – Down Payment
This is probably the biggest barrier for home ownership. Saving up a large amount of money to put as a down payment for a home can be daunting for many.
Some say that you’ll want to put down 20% of the price of the home. Most buyers do NOT make a down payment of 20%.
A 20% down payment will also ensure that you don’t have to pay private mortgage insurance, which is an additional payment (usually between 0.3 and 1.5% of the total loan amount).
If you’re unable to put down 20%, most traditional lenders will be ok with a 5% down payment instead. You’ll still have to pay the PMI (private mortgage insurance) but given that interest rates are low, and that you will only have to put down half as much cash, it is well worth it for many potential home buyers.
After making your monthly payments, you will eventually have 20% equity in your home, and your PMI obligations will go away.
Still, there are other option for those who can’t or don’t want to fork over such a large down payment.
Depending on your state and income, there are plenty of down payment assistance programs available, that can be found via a quick Google search, on the Dept of Housing and Urban Development Website, or on Bank of America’s database of programs.
These loans are backed by the government and allow for borrowers to put down as little as 3.5%. There certain criteria that must be met to qualify for these loans so check the aforementioned HUD website.
If you’re a military veteran, thank you for your service! Veterans can qualify for VA loans that and the Dept of Veteran Affairs require no down payment at all.
Once you have figured out your credit, income, and loan options, you can speak with a lender to start the pre approval process.
A preapproval letter is basically a document from a lender that shows how much mortgage you can afford.
It shows realtors that you’re serious about buying a home. It’s not a formal loan that a lender has made to you, but it states that the lender is willing to lend you a certain amount in order to finance your home purchase.
With a pre approval letter, you’re ready to speak with one of our professional realtors to help you find the home of your dreams!