1. Down Payment
As a general rule of thumb, the bigger the down payment, the smaller the loan payment. With cost of housing in today’s market however, a 20% down payment is a tough hurdle for many consumers. There are many loan programs out there designed to help first time home buyers, which allow you to put down as little as 3% to 5% down for the purchase of the home. Keep in mind that with a down payment of less than 20% down, your mortgage will come with Private Mortgage Insurance (PMI). This is insurance required by the lender to help cover their risk. PMI automatically drops off your mortgage at 80% loan to value ratio.
2. Credit Score
There are loans that will allow borrowers to purchase a home with a credit score as low as 620. But the most competitive rates are offered with a credit score of 720 and above. It may be worth it to wait until you raise your credit score before you purchase. It’s best to have a mortgage loan officer to run the numbers to see what the difference in total amount paid would be over the life of the loan. Or you can find a mortgage calculator online and get a rough idea and start from there.
3. Closing Costs
Not only will you have to have a down payment, but you will be required to pay closing costs. Closing costs can include:
· Application Fee
· Attorney Fees
· Closing Fee
· Credit Reporting Fee
· Escrow Funds
· Discount Points
· Private Mortgage Insurance (PMI) or FHA Mortgage Insurance
· Flood Certification
· Homeowners Association Transfer fee / HOA Fee (reserves)
· Homeowners insurance
· Loan Origination Fee
· Lender’s Title Insurance
· Prepaid Daily Interest Charge
· Property Taxes
· Rate Lock Fee
· Recording Fee
· Title Search Fee
· Transfer Taxes
· Underwriting Fee
Depending on your area and what type of loan you have you could see some or all of these fees listed plus maybe a few that aren’t.
Ultimately, closing costs can amount to an additional 2% to 6% funds needed on hand to bring to closing. This amount is called Cash to Close. On a $500,000 purchase transaction, for the sake of simple math, which can amount to roughly anywhere from $15,000 to $30,000 dollars. On top of your deposit.
4. Know what you can afford
It’s a good idea to have a mortgage payment that remains within 25% to 28% of your gross monthly income. This should include the principal, interest, taxes and insurance and (if applicable) homeowners association dues.
Keep in mind that it’s also highly recommended, that as a homeowner, you save roughly 1% of the purchase price of your home for maintenance costs. In our $500,000 purchase price scenario that equates to $5000 a year or $417 a month. The question becomes can you save that amount plus pay your mortgage and other debts?
There are other factors to consider like your Debt-to-Income Ratio (DTI and what your overall Loan to Value (LTV) will be when you combine all the previously mentioned factors. Ultimately, when you feel that you’re ready to start shopping for a house it’s important to consult with a lender first to see what you can be pre-approved for. Barring that, your lender should collaborate with you to establish a clear mortgage ready plan to help solidify your steps towards homeownership.
5. Know your DTI
Three factors that really help define how much of a loan you may qualify for. One is your credit score. Another is your monthly gross income and the third is your debt. The las two in conjunction with one another are known as your Debt-to-Income Ratio (DTI).
To figure out your overall projected DTI add up all your monthly financial obligations. Items such as car loans or leases, credit cards, alimony and/or child support and student loans.
Payments such as cell phone, your current rent as well as utilities such as the water, electric and garbage bill are not counted as debt, therefore should not be counted in your DTI.
Take your total monthly debt and divide it by your monthly gross income (pre-tax). The subsequent percentage is your overall projected DTI.
Most lenders want your debt-to-income ratio to be no more than 36 percent, but some lenders or loan products may require a lower percentage to qualify. If your DTI is high, work with your lender to develop a clear Mortgage Ready Plan. Aside from increasing your income, which can consist of paying down some credit cards or reducing other monthly debts. If you manage to pay down any revolving debt down to zero, be careful not to close those accounts. Doing so will actually lower your credit score.
As an aside it’s encouraged to take advantage of your yearly free credit report and deal with any disputes prior to ever looking for a home. Removing disputes will lower your credit rating, yet many lenders will want them removed as a conditional approval for a home loan. Having disputes removed will lower your score and can often do so enough to disqualify you for the loan. It’s best to have those removed prior to shopping for a home and let your credit score recover. Depending on your DTI, it may also be advisable to work with a credit repair specialist. If you do utilize one find one that works on being paid on a per item basis vs a monthly service fee.
6. Talk to a lender
Realtors will not show you houses without your being a pre-approved and a pre-approval letter on hand. You won’t know how much your pre-approved for, or how to get there without discussing what options are available to you without talking to lender. Talking to a lender will give you an idea of where you stand.
During your meeting with a loan officer, your loan application will be created in which a good loan officer will help to determine the amount you will qualify for based on your qualifying factors and once you’re pre-approved you’ll be able to develop a clear and ready mortgage plan as well as answer questions important to you such as:
How much can we afford?
What price range should I be looking into?
What neighborhoods does my price range fall into?
What features would I like to include in my home?
Now you’re ready to talk to a realtor and start finding the home best suited for you.