Starting out in the housing market can be intimidating for anyone. Ever since the housing market crashed in 2007, the road to recovery has been rather uneven.
This includes buyers being held back due to increasingly stricter standards for lending. Things in the housing market have been changing and showing small signs of improvement.
For starters, banks are less strict about the minimum requirements, and lenders are offering mortgages and down payments at lower rates than before. This may just be a good time to consider jumping into the market.
With the housing market heating up and consumers all ready to buy a home, it is time to begin preparing for the road that lies ahead of you.
Understanding the Importance of a Good Credit Score
Credit health is one of the most important factors that will decide the interest you will end up paying on your mortgage.
In fact, its impact is so significant that the difference could be in the range of thousands of dollars, based on nothing but your credit score. Let us give you a small example to make this a little clearer.
Let us take $178,500, just as a completely random price, as the amount in question.
Pretend that two people each own a $178,500 home and both want a 30-year fixed mortgage. They are paying the same amount for their down payment.
The difference between these people is their credit scores. One person has a low score of 620, while the other has a higher score of 760.
In almost every case, the one with a poor credit score will end up paying more, even a 3.5 and 5 percent interest rate difference could mean $59,000 or more over a mortgage’s lifetime.
Thus, this should be an indication of why having a good credit score before you take on a mortgage is an important factor.
So what can you do to ensure that your credit is in good shape before you jump into the mortgage market? Here is a short guide to help you in doing just that.
#1. Monitor and analyze your credit history
- With your credit score being such a crucial aspect of the final approval, it is important to have a good idea of how your score is going to affect you.
- Keep a tab on your score well in advance - this will help you to have an accurate estimate of the rate that you can expect. If your credit score is good, it will help you get approval.
- Also, take this opportunity to find out areas where your credit history could use improvement, and take steps to make sure the improvement takes place.
#2. Report errors and inconsistencies.
- A study by the Federal Trade Commission stated that 1 out of every 4 consumers had errors in their credit reports that were significantly affecting their scores.
- It also revealed that 5% of consumers found errors that would have led them to pay significantly higher amounts for mortgages and loans.
Do not let any such errors on your report make you pay more than you should. Make sure you pull and carefully check the three reports, disputing any errors that would affect your score, such as wrong credit limit(s) or an incorrect account.
While the dispute process may not lead to instant results, investing time and effort may be worth it in the long run.
#3. Pay off any outstanding dues.
- Similarly, lenders and underwriters of your mortgage will need some certainty that you are a trustable buyer who will be able to make payments on time.
- This means that having any delinquent accounts or outstanding discrepancies on your credit report may hurt your chances. Before applying, try to clear any such accounts that are hurting your score.
If that is not possible, make sure that the impact of late payments is being minimized.
- You can do this by burying it with years of payments that have been made on time.
#4. Decrease the percentage of your income that goes into paying debts
- Your debt-to-income ratio is the part of your income that goes into paying debts. This is a significant factor that your underwriter will take into consideration.
- This will help evaluate what credit risk you pose, and the amount of debt that you can safely handle. Studies have indicated that people with high value ratios are going to find it harder to make regular monthly payments.
Lenders may not be able to trust you with their money if you are already using a large part of your income to pay off other debts.
Lowering this ratio needs you to do either of the two things. Decrease your debt payments or increase your total income. While the latter may seem tough to do, there are quite a few options to consider.
A little increase in your income could lower this ratio substantially.
#5. Beware of applying for credit.
- You want your credit score as high as possible when applying for a mortgage.
Thus you should try to avoid getting more credit, especially when your underwriter is making a decision on your mortgage.
- Every credit application you fill out during this time could lead to an inquiry that would significantly decrease your score.
- That is why it is important to consider the impact of each application you fill out for seeking credit during this period.
The one thing you should keep in mind is that improving your credit score will not happen overnight - it is something that could take quite some time.
It is essential that you begin keeping your credit score in check the moment you start thinking of buying your home. By keeping your credit score at a good level, you will not have to worry about paying extra interest on your house.
Keeping Your Credit Clean Before Purchasing a Home
When it comes to your credit and purchasing a home, you must be extremely careful with how you handle your money. One wrong move and you can wave goodbye to your new home.
There are many factors that come into play when it comes to keeping your credit clean before purchasing a home. You must pay serious attention to these factors during this process.
It's important to keep in mind that after you apply for a loan, or do anything which involves your credit score and report directly, all of the information is then documented in your current credit report.
In the case of purchasing a new home through an application for a mortgage, it's best to wait before taking out any credit cards, or applying for car loans. If it’s impossible to wait, make sure you speak to your loan officer or mortgage broker for some advice. You do not want to risk losing your home loan.
Messing with your Income Ratio
Were you aware that messing with your income ratio when purchasing a home can negatively affect the process? If not, then there are things you will need to know.
For example, if you are attempting to take out a home loan, but are also purchasing a new car, your lender will evaluate all of your debt-to-income ratios, and make a decision based on that information. Your ratio represents the amount you are spending on debt payments, per month.
On a typical basis, mortgage lenders generally prefer a ratio to be no higher than 36 percent. If a separate loan comes up during the screening process of a home loan, such as a car loan, your mortgage lender will probably get in touch with you to go over it.
This car loan will affect your debt-to-income ratio and you may not be approved for the home loan.
Your Credit Report and Why It Matters
As previously stated, every loan you apply for, credit card you pay for, or anything in general that involves your credit, will show up on your documented credit report.
Lenders will look into your reports to see whether or not they should grant your loan.
For example, if you are in debt and applying for too many loans, your report will be negative and any lender that is reviewing your loan request will see it.
Paying your Loan in Cash?
If you would rather use the cash route to pay a loan, then lenders will not be able to see it on your credit report.
This means that since you did not take out a loan for the purchase, your credit report will not have the debt documented on it.
For example, if you plan on buying a car and want to apply for a mortgage at the same time, you can pay for the new car in cash. Then your mortgage lender will not be able to see any changes on your credit score or report.
Although, your mortgage lender will be able to look into your bank account to view any account balances you have open.
So it is risky to use a savings account to purchase anything large, such as a car, while trying to have a loan approved.
Totaling your Monthly Costs Compared to your Monthly Income
Follow the steps below to total your monthly costs compared to your monthly income:
- Record all of your gross pay for each month, before any deductions for your insurance, taxes, or anything applicable.
- Multiply the number you come up with by .28, which equals 28%.
The amount that you come up with for the second point is the amount the majority of mortgage lenders will use as a guideline when it comes to your housing costs.
This will include property, homeowner’s insurance, interest, principal, etc.
Tips to be Prepared
When it comes to taking out a home loan with a mortgage broker, you are going to need to be prepared.
This means you will need to produce many documents, beginning with tax returns from years before.
Lenders will also want to see monthly bank statements, as well as proof of your income and all debts you may have. It’s also a good idea to have sources for any big ongoing deposits you may have.
If you have any family or friends making a down payment for you, it is important to have a written letter to document such information for your lender.
You will need quite a bit of money for things such as the down payment, closing costs, at least a year's worth of taxes and insurance payments.
It is also recommended that you have extra cash because mortgage lenders will want to ensure that you have an adequate reserve.
This is just in case something in the home breaks and needs to be replaced, or if you lose your job and need money to make payments while you look for new employment. Multiple financial experts have agreed the general rule of thumb for a down payment is around 20%, but you are able to do it with as little as 3.5%.
However, this is only in the case of Federal Housing.
Administration mortgages are different. A conventional mortgage with a VA loan, which is available to veterans of the military, is only around 5%.
You should keep in mind that if you are paying less on the down payment, you will be paying more on the monthly payments.
This also includes the private mortgage insurance you will need to pay, which is known as the mortgage insurance premium. The mortgage insurance premium only applies if your down payment is less than an average 20%.
Be Ready for Anything
In conclusion, it's never a good idea to take out more than one loan at a time, especially if you are in the process of applying for a mortgage loan.
If you need to purchase something big while applying for a mortgage loan, such as a car, always try to use cash to avoid negatively affecting your credit score. Also, be ready with all of the documents that your mortgage lender will need. This ensures that the process will be as smooth as possible in the end.
