It’s a new year and a great time to set some goals. A time to really think about what you’d like to accomplish for yourself and your family. You decide it’s finally time to work toward your goal of homeownership. But are you in a financial position to even buy a house? What are lenders looking for from you once you apply for a mortgage? Well, wonder no more. We’ve got 4 steps needed before dipping your toes into the homebuying market. Let’s get started:
ASSESS YOUR INCOME
Your lender isn't only interested in knowing how much money you make. They'll also want to review your job history (typically for the past two years) to ensure that your income is consistent and steady. In doing so, your lender will ask to see your proof of steady employment by way of recent paystubs and W-2s. They may also ask for your last 2- or 3-years income tax returns. Showing your income stability will allow the lender to assess your creditworthiness and your ability to make regular payments.
REVIEW YOUR CREDIT REPORT
Your credit report and credit score will demonstrate to your lender how well you handle your current credit commitments. To better understand your credit score, you must obtain credit reports from each of the three credit reporting bureaus (Experian, TransUnion, and Equifax). Fortunately, there is no charge to do this one time each year. Should you wish to pull it more than once a year, by law, the credit reporting agency can not charge you more than $13.00 to do so. The Consumer Financial Protection Bureau provides instructions on how to obtain a copy of your credit report here. To learn more about how your credit score affects your mortgage interest rate, check out this article from CNBC.
REVIEW YOUR DEBT-TO-INCOME RATIO (DTI)
Another financial tool used by mortgage lenders to assess your loan application is the DTI. Your DTI tells your lender how much of your monthly income goes to debt, which helps them determine how much mortgage debt you can take on.
The debt-to-income ratio (DTI) is computed by multiplying your monthly debt by your gross monthly income. If your monthly debts (credit card minimum payments, loan payments, and so on) total $2,000 and your gross monthly income is $6,000, your DTI is $2,000/$6,000, or 33%. Your DTI will be calculated by your lender using the debts listed on your credit report.
It's a good idea to check your DTI before applying for a loan. To qualify for a mortgage, you'll need a DTI of 50% or less in most circumstances, however, this amount varies depending on your lender, loan type, and other criteria.
If you're trying to improve your debt-to-income ratio or learn how to utilize credit sensibly, here are a few things to think about:
Don't take on any new debt.
According to the Consumer Financial Protection Bureau, "avoiding debt might help you enhance your financial well-being." Because your DTI ratio is determined by the amount of debt you have compared to your income, adding additional debt without increasing your income will raise your DTI ratio. As a result, it's a good idea to apply for only the credit you require to avoid taking on additional debt.
Pay off any outstanding debts.
Debt repayment can be accomplished in a variety of ways including debt consolidation. Before you make any decisions, consult with a certified financial advisor to devise a debt management strategy that is right for you. Your employer or retirement plan administrator may be able to provide you with some financial planning services.
Make a larger payment than the bare minimum.
When possible, the Consumer Financial Protection Bureau recommends paying more than the minimum payment on your credit cards. This could help you pay off your credit card debt faster and save money on interest. It can also help you improve your credit usage ratio, which is a key element in determining your credit ratings.
Make a spending plan.
Making and sticking to a budget, according to the Consumer Financial Protection Bureau, is a vital step toward bringing your debt under control. They even give you a budget.
PREPARE LIQUID ASSETS
Liquid assets are the monies needed during the homebuying process. You should prepare to have this money before dipping your toes into the homebuying market, especially since it is still moving at such a fast rate. You don’t want to get to the point where you’ve found a house that fits your needs perfectly and then realize you don’t have the liquid assets to finalize the deal. Let’s break these assets down:
More often than not, you’ll need to put down some money toward the home you’ve chosen to purchase. The amount of money you'll need for a down payment is determined by the sort of loan you take out and the quantity of money you borrow. You can purchase a property with as little as a 3% down payment (though there are benefits to putting down more).
As part of your due diligence—your responsibility in learning as much about a home you’ve placed an offer on—you’re going to want to get a home inspection. The cost for this falls on the homebuyer and is typically priced per square foot. You may not know of a home inspector and may want to use one your real estate agent recommends. Or you may get recommendations from friends and colleagues. Either way, make sure you do some research on the home inspector. Does he or she have any certifications? While certifications do not imply a guarantee, it may indicate a certain level of professionalism and training. Does he or she have any reviews online (i.e. Google, Yelp, Facebook)? Reviews often provide insight into the inspector’s knowledge and experience.
Closing costs are money paid to the lender and other third parties for the creation of the loan. Years ago, the responsibility of closing costs could be negotiated. But in our current, very hot market, closing costs more than likely fall on the homebuyer.
The amount you'll pay in closing fees can vary depending on where you live and the type of loan you have. It's a good idea to budget for 3 percent to 6% of your home's value in closing fees. Part of your closing costs may be rolled into your mortgage or covered by the seller utilizing seller concessions in some cases.
While this article is not meant to cover every homebuyer’s scenario, it is a good place to start. For some, it may take years to financially prepare to buy a house, and that’s okay. Everyone is on their own journey with their own set of unique circumstances. If homeownership is a dream of yours, take the time to get to know your financial worthiness and set some goals. If necessary, clean up your credit, pay down some debt, and work on your debt-to-income ratio. This may mean finding a better-paying job. But whatever is necessary, learn what that is now, so you can set your goal to live the American dream.