Buying a house is a very smart financial move. Instead of paying rent every month, you can build equity in a piece of property that is your own. Very few people are lucky enough to buy a house outright. Instead, they need to get a mortgage. The process of getting approved for this type of loan can seem overwhelming. Therefore, it’s a good idea to get help from a professional when you are navigating the process.
1.) Get to Know Your Credit Score
The first question any potential loan officer is going to ask you is about your credit score. How high or low your score is will determine what types of mortgages and interest rates you qualify for. Anything that can be done to improve your score should be started before you begin the home-buying process.
It’s important to check your report from all three credit agencies. The first thing you will want to do is dispute any false information on them. Although a bit of a pain, this is one of the easiest ways to improve your credit. If you have unknowingly been the victim of identity theft, your credit may be much lower than you are aware.
Things such as several missed or late payments can ding your score significantly. Make sure you are on top of your bills and monitor your credit report for changes. You may need to put off buying a house until you have cleaned up your credit a bit. A conventional loan often requires a credit score of 680. FHA loans have lower requirements, but a better score can get you a better rate.
2.) Save Up Some Cash
There are two reasons you will want to start building up your cash flow before starting your home-buying adventure.
You need a down payment
The days where you could buy a house with no money down are pretty much over, especially if you don’t have a perfect credit score. You’ll need to have cash (or a check) on hand in order to be approved for a loan. How much money you’ll need will vary. For a conventional loan, the number is usually between 5 to 20 percent. Don’t worry if saving for a down payment sounds stressful. FHA loans will allow you to put down as little as 3.5 percent. Both VA loans and Rural Development loans still require no down payment, making them a great option if you’re interested in purchasing a new home.
You need money in the bank
Several lenders are hesitant about giving a loan to someone who will wipe out their savings with their down payment. Depending on the company and type of loan, you may need to have anywhere from the equivalent of one to two and a half loan payments in your bank account to be considered for a home-loan.
If that isn’t enough, remember there are “hidden” expenses that come with this process. Although not usually required, it is a good idea to get a house inspection done. This can cost anywhere from $200 to $600+, depending on where you live and the size of the house. There are also closing costs, an appraisal, title costs, etc. that are due at the time of closing.
3.) Stay at Your Job
Lenders like to see that you have job stability before lending you large amounts of money. Staying at the same job for many years shows them that you have the ability to maintain a steady income and are reliable.
The other reason to stay at your job through the loan-application process is that any changes to your financial situation can sink the deal. Even if you have been pre-approved and are days away from closing on your dream piece of real estate, quitting or losing your job will likely change that. Your application was pre-approved based on your income and expenses, so it makes sense that lenders get nervous when that changes.
Do not think you can sneak information like that by a lender, either. They will check with your employer as well as pull your credit score again in the final hours before closing.
4.) Avoid Getting New Debt and Pay Down Current Debt
Your credit is another area where you will not want to rock the boat. Being pre-approved for a loan for your new house can be very exciting, but try not to celebrate too much. Many people make the mistake of going out and buying all-new furniture to fill up their new house, not realizing that adding a new line of credit and using most of it is killing their credit score. As previously mentioned, the lending company will pull your credit again towards the end of the process. They can change their mind about your approval at any point up until you get the “clear to close,” and in some cases even up until you sign the papers.
Paying off debt is a good move for your financial health in the future as well. Owning a home may be more expensive than you realize, and eliminating debt beforehand can help you have the extra resources you need. Once you have closed on your new place and have a better understanding of what your new bills will be, go ahead and get that new living room set. Put off purchasing or leasing a new car while going through the home-buying process as well.
5.) Choose the Right Loan Type
Learning as much as possible about the options available to you is a good way of finding the loan you are most likely to be approved for. Generally speaking, you can choose between conventional, FHA, VA, and RD loans. A mortgage expert can help you determine if there are other options available to you and which one is the best choice.
A conventional loan will likely have the best interest rate but can be the most difficult to qualify for. VA loans are a great way to get veterans into new homes. These have the advantages of both no down payment and no PMI. An RD loan, or rural development loan, can be used on certain types of houses. Usually, these are houses that are located outside of any city’s limits.
If you are a first-time home-buyer, be sure to investigate any programs out there designed to help you. Some are programs aimed to help people with down payment funds, while others aim to help educate first-time buyers. Often, people that successfully complete these educational courses can get a better interest rate on their loan. Be sure to check your local government’s websites for more information about these types of programs. They operate at a state, county, and city level.
You are also probably aware that there are 15-year and 30-year home-loans. While the payments on a 15-year one will be much higher, you end up paying far less interest over the life of the loan.
6.) Have Your Documents Ready
Many people are taken by surprise when they hear what types of documentation they will need to even apply for a loan. In order to appear as a well-prepared potential buyer, it’s a good idea to gather as much information and papers as you can before you go in. The documents you need will largely depend on your financial and tax history.
Although this list can change depending on the company you are working with and the type of loan you are seeking, here is a good idea of what you can expect to need:
- Paycheck stubs (usually the last three months, although this can vary)
- W2’s from your current employer, as well as previous employers if you have not been at your current job long
- Bank statements, both checking and savings if you have it
- Tax returns for the previous two years
The lender may be willing to help you obtain the following documents but it will be helpful if you already have:
- Your credit report
- Proof that you pay your rent on time
- A list of assets
- A list of debts (usually similar to what is on your credit report)
If you have received gift funds for a down payment, you will need a letter from the person who gave them to you. This letter will need to explain that they do not expect this money to be paid back so that it does not count against you as an outstanding debt. If you have been divorced or declared bankruptcy, you may be asked to provide the paperwork from that.
7.) Buy a House You Can Afford
Now, this may seem obvious, but many people get caught up in what their lenders think they can afford, not what they actually can afford. Although the number crunching done by lenders is meant to determine how much of a monthly payment you can handle, it does not take into account things like utility bills. Also, if you are moving significantly further away from your job, you will have to consider the cost of gas.
Many loans will allow the buyer to have a debt-to-income of up to 41 percent. That may not be in your best interest, however, depending on your lifestyle. Many experts agree that you do not want to have a debt-to-income of more than 36 percent.
Also, keep in mind that the number you are pre-approved for may be different than the loan you are ultimately approved for. If you try to buy real estate that sits right at your maximum loan, any slight changes to your finances may end up getting the loan denied.
The house you choose can be just as important as your finances in getting your loan approved. Many loans have strict requirements for the type of property they can be used for. Almost any home-loan will require the house to have a permanent foundation. If it is a modular home, it will need to have been built in a certain time frame.
You do not want to be hasty when deciding on which house you want to buy. In order for it to be financially worth it, you will likely need to live there for a minimum of seven years. That being said, in a competitive market, you will need to be able to move quickly when the right house becomes available.
Once you have chosen your house, you will have to appraise for the amount of your loan. This is how the lender secures the loan and has a way to recoup their losses if you cannot make your payments. That’s why it’s important to work with a professional that will help you decide on a reasonable offer for a house.