You’ve decided to go for it while mortgage rates are still at attractive lows.
Buying a house can be thrilling — and nerve-wracking — for a first-time buyer. The learning curve is steep, but doing a little financial homework will help you navigate the process.
Take these five steps to make your homebuying experience go smoothly.
1. Check your credit
The homebuyer’s credit score is one of the most important factors in qualifying for a loan.
“In addition, the standards are higher in terms of what score you need and how it affects the cost of the loan,” says Mike Winesburg, a former mortgage planner and wealth adviser in Wheeling, West Virginia.
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Just because you pay your bills on time every month doesn’t mean you have excellent credit. The amount of credit you’re using compared with your available credit limit, known as your credit utilization ratio, can hurt or help your overall credit score.
The lower the utilization rate, the higher your score. Ideally, first-time homebuyers should have a lot of credit available, with less than a third of it used.
But if you owe more compared with your income than lenders like to see, your credit may need work. Start tidying up your credit at least six months before you start shopping for a house.
2. Evaluate assets and liabilities
So you don’t owe too much money and your payments are up to date. But how do you spend your money? Do you have a lot left over every month, or are you on a shoestring budget?
A first-time homebuyer should have a solid idea of what is owed and what is coming in.
“You should understand a little bit about monthly cash flow,” Winesburg says. “If I were a first-time homebuyer and I wanted to do everything right, I would probably try to track my spending for a couple of months to see where my money was going.”
Buyers also should have an idea of how lenders will view their income, and that requires becoming familiar with the basics of mortgage lending. For instance, some workers who are self-employed or work on straight commission may have a harder time getting a loan than others.
The self-employed or independent contractor will need a solid two years’ earnings history to show a lender, Winesburg says.
3. Organize documents
When applying for a mortgage, homebuyers must have proof of income and taxes.
Mortgage lenders typically request two recent pay stubs, W-2s from the previous two years, tax returns and bank statements from the past two months. They want every page of the statements, even the blank ones.
“Why it has to be every single last page, I don’t know. But that is what they want to see. I think they look for nonsufficient funds or odd money in or out,” says Floyd Walters, owner of BWA Mortgage in La Canada Flintridge, California.
Knowing which documents you need and where to find them can save time.
4. Qualify yourself
As a first-time homebuyer, you should know already how much you can afford to spend before the mortgage lender tells you how much you qualify for. Bankrate’s “How much house can I afford?” calculator will help.
By calculating debt-to-income ratio and factoring in a down payment, you will have a good idea of what you can afford, both upfront and monthly.
A standard rule for lenders is that monthly housing expenses should consume no more than 28 percent of your gross income. This percentage is called the front-end ratio.
The back-end ratio includes all debts, including housing expenses, credit cards, car loan, etc. This ratio should be 36 percent or less, but some borrowers get mortgage approval with back-end ratios of 45 percent or higher.
“Find out what you can afford and then you can back into everything else. We know the money you have available to put down, we know the monthly payment and we can solve (the equation) for the third variable, and that is the home price,” Winesburg says.
5. Figure out your down payment
It takes effort to scrape together the down payment. There are programs that can offer financial assistance to help buyers qualify.
“I’ve helped arrange assistance loans for $10,000, which are interest- and payment-free, and forgivable after five years. Although considered a loan, they’re more like grants. Other programs can provide up to $40,000 interest-free,” Winesburg says.
“Each state is different, but most of this money comes from the HOME Investment Partnership Program, which is a federal block grant to create affordable housing,” he says.
Finally, talk to mortgage lenders when you’re starting the process. Check with friends, co-workers and neighbors to find out which lenders they enjoyed working with and ask them questions about the process and what other steps first-time homebuyers should take.