First-time Homebuyers – where to begin
Becoming familiar with the varied steps and requirements of the home-buying process will help you feel much more confident with your big decision.
Get your finances in order
By this point you should already have a spending plan in place, if not, you’ll need one to see if a mortgage is even a possibility. Honestly evaluate your monthly financial obligations. Can you easily manage your total monthly debts? Are you able to cover all of your credit cards, car loans, insurance, utilities, and other financial obligations? Now, what would that spending plan look like with an added mortgage payment?
Most experts recommend you pay your unsecured debt down as much as possible; a reasonable debt-to-income ratio will keep your monthly budget in check, and it will show lenders that you can borrow responsibly.
Lenders will look at your monthly gross income and weigh it against how much you would have to pay each month in principal, interest, taxes and insurance. If the mortgage payment doesn’t consume more than 28 percent of your gross income, the lender will likely make the loan. If you have a significant amount of savings and/or an investment portfolio, lenders will generally lend more. You can also qualify for a larger loan if you have relatives willing to loan you money.
Set aside savings
If you haven’t already started a savings account, now would be a good time. Take a hard look where your money is currently going. Where can you cut back? You’re going to have to make some sacrifices in order to afford your new home. In addition to your anticipated mortgage payment, you will also need to come up with money for a down payment, property taxes, closing costs and possible mortgage insurance. Unexpected repairs or other emergencies could also set you back substantially if you are not prepared. Owning a home is not cheap; the more cash you have stashed the better.
Check Your Credit
Lenders need to evaluate your credit-worthiness (what kind of risk you will be to them) before they’ll lend you money. They’ll look at your credit report to verify your payment habits and other financial information. You want to be sure this information is accurate. Your credit score also plays a large role in the approval process and is used to determine what interest rate you qualify for. Before you apply for pre-approval, take a look at your credit report and correct any inaccuracies immediately.
Refrain from using credit to buy anything big in the months before applying for a loan. You want to keep your debt and credit balances low. Be sure you wait until the funding is complete and you are in the home before using credit to make any major purchases. A common mistake made by many potential home buyers is thinking that just because they have been pre-qualified or even pre-approved they are okay to start making major purchases, like a car or furniture. Applications are constantly reeavaluated until they are completely funded. If any changes occur in your debt to income ratio or your payment obligations, the application could be denied.
Collect your financial information
As part of the application process, you will be required to provide your lender with several documents. Be sure to have them ready as they will play a role in determining how much you can afford to spend on a home.
- Tax returns for the last 2 years.
- W2s for the last 2 years.
- Paychecks for the last 30 days.
- Employer information for the last 2 years.
- Three months of statements for all asset accounts (savings, checking, CDs, IRA, 401K).
- List of outstanding debts.
- Verification of child support or alimony payments for the last 12 months, if applicable.
Prepare For the Down Payment
As mentioned above, you will need to be prepared with a down payment. The ideal down payment is 20 percent of the total cost of your home. A 20 percent down payment makes it so the original loan is smaller and you have instant equity in your home. Another major advantage is you can avoid private mortgage insurance (PMI). PMI exists to protect lenders when borrowers default. If you can’t come up with 20 percent, you can still qualify for a mortgage, you’ll just have to add PMI to your monthly principal and interest payments. You won’t have to pay PMI forever, and can usually cancel once you earn 20 percent equity in your home.
General Guidelines to Keep in Mind
Wondering what kind of monthly mortgage payment you can afford? Here are a few general rules that will give you an idea of what you are facing. Most lenders agree that your total housing costs should not total more than 28 percent of your gross monthly income. “Total housing costs” include mortgage payments, insurances, property taxes, and homeowner’s fees. Your gross monthly income includes your primary job plus any overtime, disability, social security, child support, a part-time job, unemployment; virtually any money coming in each month. For instance, if you make $3,000 each month, before taxes, your monthly housing costs should not total more than approximately $840.
Another guideline most lenders consider is, in addition to your monthly housing costs, any other long term debt (car payments, student loans, large credit card balances) should not total more than approximately 36 percent of your gross monthly income. So if your gross monthly income is $3,000, and your housing costs total $750, your monthly car payment, student loan payment, and credit card payments should not total more than $330.
For a general idea of your buying power, you can multiply your gross annual household income by 2.5. This means that if your gross annual income is $50,000, you may be able to qualify for a $125,000 loan. Of course your credit and employment history can affect that number, but it is a good rule of thumb to keep in mind as you eyeball your general price range. You can visit a mortgage lender for a more exact figure.