When you’re planning to buy a home, there can seem like so much to think about. Where do you want to live? What kind of mortgage should you get? Will you even get approved?
Here are the steps you can take to make sure you’re in the best possible position to start looking for that new home.
1. Check Your Credit and Address Any Issues
Your credit report will be a determining factor in whether you qualify for a mortgage and what loan terms you are offered. Start by getting copies of your credit report from the three major credit reporting agencies at annualcreditreport.com. You are entitled to one free copy each year using this site. You may find other sites that offer free credit reports, but they are usually tied to a subscription you will need to pay for.
Check over the reports to make sure that all the information is current and correct. If you find errors, annualcreditreport.com will walk you through the process of disputing them.
If you have negative information on your report that is correct, it may affect your ability to qualify for the best loan rates and terms, so do what you can to improve your credit while you are waiting to start looking for a home. For example, if you have late payments, make sure that you are making payments on time going forward. If those payments were because of extenuating circumstances, such as job loss, you can work with potential lenders to ensure that they understand the anomaly, but making payments on time now that you’re back on your feet will be very important.
Another potential red flag could be a high debt-to-income ratio (or DTI). You can calculate this yourself to get a rough idea of what your DTI is by adding up the minimum monthly payments on your debts (student loans, rent, auto loans, and so on) then dividing this number by your monthly income.
For example, if your rent and loan payments total $1,500 each month and your monthly income is $5,000, your DTI is 30%. If your DTI is higher than 40%, consider paying off debt to lower the ratio. Your lender can help you make a more precise DTI calculation and let you know where your ratio should be to qualify for various loan programs.
2. See How Much You Can Afford
Your DTI calculation can also be helpful in figuring out how much home you can afford. Look at how much homes cost in the areas where you want to buy, then calculate what the mortgage payment might be (your lender can help with this too, as can a trusted real estate agent). Also be sure to budget for estimated property taxes and homeowners insurance premiums, as those will be included in the escrow portion of your monthly payment.
You may consider getting pre-approved for a mortgage at this point to see how much you qualify to borrow, but your calculations may show that you will want to shop for a home that costs less than the mortgage amount of your pre-approval.
3. Plan Your Down Payment
How much have you saved for a down payment? The more you have set aside, the more options you are likely to have for your mortgage. But if you don’t have 20% of the typical home price in your area, don’t despair. Many loan programs require lower down payments or even no down payment in some cases (such as if you are a Military Veteran).
You will also need to pay closing costs, which are typically 3%–6% of the purchase price, at the time of the sale. Some loan programs have lower costs, so work with your lender to choose the best option for your financial situation.
You can use gifts from family and friends, cash savings, and/or other investments to cover your down payment and closing costs. Just be ready to disclose the sources of the funds you plan to use when applying for a mortgage.
Once you’ve reviewed your credit, figured out how much you can afford, and planned for your down payment, you are ready to start looking for that dream house. With a pre-approval from your local Homeowners Licensed Mortgage Professional in your pocket, your shopping experience should be a smooth one – especially if you’ve followed these three preparation steps.