How To Prepare Your Finances So You Look Attractive to Lenders: 4 Tips For First-Time Homebuyers
Getting ready to buy your first house can be a daunting task. Between saving for a down payment, securing a mortgage, and closing a deal, there’s a lot that goes into the home buying process.
The new year is the perfect time to take your finances by the reins and prepare to close on the house of your dreams. If you’re looking to purchase a home this year, it’s important to have your finances in line so you’re ready to take on the costs and look good to mortgage lenders.
Establish a Budget
Before considering your options, figure out how much home you can actually afford. Some first-time homebuyers make the mistake of basing their overall budget on the amount of their mortgage without taking into account ongoing maintenance expenses. But if you live outside of your means, it’ll be difficult to save or even cover your existing bills. Typically, you don’t want your monthly mortgage payment to exceed 30 percent of your gross monthly income.
To determine your actual spending limits, you’ll need more than a pre-approval on your mortgage. Knowing your debt-to-income ratio can also help you determine how much you’re able to spend. You can calculate this ratio by summing up your monthly expenses and dividing the total by your gross income. You’ll want a debt-to-income ratio of 36 percent or lower to increase your chances of loan approval. However, if you’re above this threshold, you can lower your ratio by increasing your monthly payments on current debts, avoiding taking on additional debt, and postponing major purchases on credit.
Check Your Credit Score
Qualifying for a mortgage requires you to have a good credit score as lenders often pull your score for preapproval. Before applying for any loans, be sure to check your credit for any errors, such as duplicate debt listings or incorrect account balances, which could negatively impact your chances of approval. In addition, if you have a lower score, you can improve your credit by paying bills on time, paying off outstanding debt, and avoiding opening new credit accounts.
Tip: Keep in mind that if you are co-buying a home, mortgage lenders will take both buyers’ credit scores into account, so you should both aim for the highest score possible.
Aside from improving your chances of securing a mortgage loan, having a good credit score can also increase your chances of qualifying for a personal or home equity loan should you choose to renovate or are in need of funds in the future. With higher credit, you’re also able to avoid security deposits on utilities and reap cost savings in the long run. Remember, it can take months or even years to improve your score, so it’s best to start sooner rather than later.
Save For a Down Payment
Saving for a down payment can seem near impossible, especially when most mortgages require you to pay at least 3 percent of your home’s value upfront. If you haven’t already, you can start saving for a down payment by cutting out unnecessary expenses. Skipping a summer vacation, cooking at home, cancelling cable television services, and selling items you no longer use are all ways you can save for a down payment faster.
While a 10 to 20 percent down payment may seem like a hefty price to pay, there are many benefits to fronting a higher down payment. For instance, you’ll ensure a lower monthly mortgage payment and secure more equity in your home right off the bat. In addition, if you’re able to put down more than 20 percent of your home’s purchase price, you’ll also avoid paying for private mortgage insurance (PMI), which protects lenders should you miss loan payments.
Organize Your Documents
In order to apply for a mortgage loan, you’ll need to get your financial documents in order. Lenders use your financial history to determine your creditworthiness and approve you for mortgages. While the required documents will vary by lender, you should take time to clear financial clutter and make sure you have the following documents on-hand:
- Tax Returns: Lenders will review your tax returns to ensure your income is consistent with your reported earnings.
- Credit History: Lenders will use your credit history to evaluate you as a lender. You may need to prepare a written statement for any blemishes in your report.
- Proof of Income: Lenders will ask to see recent pay stubs, your W-2, or other proof of income to verify your current earnings.
- Rental History: Lenders will ask for proof that you have a track record of paying rent on time. Or, they may ask for a note from a former landlord to confirm your creditworthiness.
- Bank Statements: Lenders will read over your bank statements to ensure you have reserve cash in your account for mortgage payments.
Buying your first home is no small task, so you don’t want to make any wrong decisions. For guidance through the process, contact a trusted real estate agent who can steer you in the right direction. A seasoned agent will be able to help you make the best financial decisions so you can find a home that satisfies both your lifestyle and budget.