For most people, buying a house means a lovely house payment due every month ,aka the mortgage. But most of us don’t seem to know exactly what goes into actually getting one. You have to qualify and that in itself can be quite daunting and can require advanced and careful planning on your part. Don’t walk into such a pivotal moment without having done your research and preparing yourself for what lies ahead.
1. Your Credit Score
It’s not just a number, its the number. This three digit, seemingly innocuous, number holds the key to what kind of loan you will be able to get or if you will be able to get one at all. Lenders want to know how risky it will be to loan you money, the better your score, the better you look and your chances are high on getting a great loan. If your credit score is lower, it will make it more difficult to be approved.
Before meeting with a mortgage lender, Beverly Harzog, consumer finance analyst and credit card expert at U.S. News & World Report, recommends obtaining your credit report. You’re entitled to a free copy of your credit report at AnnualCreditReport.com. The report does not include your score—for that, you’ll have to pay a small fee—still, taking a look your report will give you a general idea of how you’re doing by laying out any issues such as late or missing payments.
So, how do you know if your credit score is good enough? The most widely used credit score is the FICO score. A perfect score is 850. However, generally a score of 760 or higher is considered excellent, meaning it will help you qualify for the best interest rate and loan terms, says Richard Redmond, mortgage broker at All California Mortgage in Larkspur and author of “Mortgages: The Insider’s Guide.”
A good credit score is 700 to 759; a fair score is 650 to 699. If you have multiple problems (e.g., late credit card payments, unpaid medical bills), your score could be under 650, in which case you’ll likely get turned down for a conventional home loan—and will need to work on your credit in order to get approved (unless you qualify for a Federal Housing Administration loan, which requires only a 580 minimum credit score).
2. Your Down Payment
How much is needed for a decent down payment on a house? In a recent NerdWallet study, 44% of respondents said they believe you need to put 20% (or more) down to buy a home. So, if you do the math, you’d have to plunk down $50,000 on a $250,000 house. And the higher the home price, the more that down payment shoots up.
Now for some good news. The 20% figure is common, but it’s not the end all be all of down payments.Although it is considered the gold standard because when you put 20% down, you won’t have to pay PMI (private mortgage insurance), which can add several hundred dollars a month to your house payments. Another plus of putting down 20% is that’s usually the magic number you need to get a better interest rate.
Not everyone can put down that big chunk of a change though and looking at such big numbers can be disheartening. Fear not, there are many lenders who will allow you to put down less cash. And there are many loan products that you might qualify for that demand less money down. FHA loans require as little as 3.5% down. The U.S. Department of Veterans Affairs loan program grants active or retired military personnel the opportunity to buy a home with a $0 down payment and no mortgage insurance premium. Same with USDA loans (federally backed by the U.S. Department of Agriculture Rural Development).
Another option worth checking into is qualifying for down payment assistance. Did you know that there are 2,290 programs across the country that offer financial assistance, kicking in an average of $17,766, according to one study. (You can find programs in your area on the National Council of State Housing Agencies website.)
In some cases, however, you will have to put more than 20% down to qualify for a mortgage. A jumbo loan is a mortgage that’s above the limits for government-sponsored loans. In most parts of the country, this means loans over $417,000; in areas where the cost of living is extremely high (e.g., Manhattan and San Francisco), it jumps to $625,000. Since these bigger loans require the lender to take on more risk, jumbo loans will usually require home buyers to have a bigger down payment—up to 30% for some lenders.
3. What is your DTI ratio
The last thing you should know before applying for a mortgage is that to get approved, you will need a a reasonable debt-to-income ratio. This DTI number compares your unpaid debts (on student loans, credit cards, car loans, and more) with your income.
For example, if you make $6,000 a month but pay $500 to debts, you’d divide $500 by $6,000 to get a DTI ratio of 0.083, or 8.3%. However, that’s your DTI ratio without a monthly mortgage payment. If you factor in a monthly mortgage payment of, say, $1,000 per month, your DTI ratio increases to 25%.
Lenders like this number to be low, because evidence from studies of mortgage loans shows that borrowers with a higher DTI ratio are more likely to run into trouble making monthly payments, according to the Consumer Financial Protection Bureau.
“For a conventional loan, most mortgage lenders require a borrower’s DTI to be no more than 36% (although some lenders will accept up to 43%),” says Ray Rodriguez, regional mortgage sales manager at TD Bank.
If you’re higher than the 36% ceiling, there are ways that you can lower your DTI. The most simple way would be to apply for a smaller mortgage—this means you’ll have to lower your price range. Or, if you’re not willing to budge on price, you can lower your DTI by paying off a large part of your debts in a singular payment.
Now that you’ve armed yourself with the right knowledge about the home loan application process, get out there and find your dream home. And you know who to call for help.
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