The amount of credit you’re using relative to your available credit limit, or your credit utilization ratio, can sink a credit score.
You’ve decided to go for it. Buying a home can be thrilling and nerve-wracking at the same time, especially for a first-time homebuyer. It’s difficult to know exactly what to expect. The learning curve can be steep, but most of the issues can be resolved by doing a little financial homework at the outset.
Take these five steps to make the process go more smoothly.
1. Check your credit report
The homebuyer’s credit score is among the most important factors in qualifying for a loan these days.
“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, formerly a mortgage planner with McKinley Carter Wealth Services in Wheeling, W.Va.
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To get a sense of where your credit stands, go to AnnualCreditReport.com to get your free credit report from each of the three credit bureaus.
Scour the reports for mistakes, unpaid accounts or collection accounts.
Just because you pay everything on time every month doesn’t mean your credit is stellar, however. The amount of credit you’re using relative to your available credit limit, or your credit utilization ratio, can sink a credit score.
The lower the utilization rate, the higher your score will be. Ideally, first-time homebuyers would have a lot of credit available, with less than a third of it used.
Repairing damaged credit takes time — and money, if you owe more than lenders would prefer to see relative to your income. Begin the process at least six months before shopping for a home.
How do you spend your money? Do you have piles of money left over every month, or are you on a shoestring budget?
A first-time homebuyer should have a good idea of what is owed and what is coming in. If you don’t know, track your spending for several months.
You should understand a little bit about monthly cash flow,” says Winesburg.
Additionally, buyers 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 professionals, such as the self-employed or straight-commission salesperson, may have a more difficult time getting a loan these days than others. Gone are the days of the no-doc loan, thanks to the abuses of the go-go days.
A stated-income loan was available to non-W-2 wage earners in previous years, but today’s standards are much more stringent.
According to Winesburg, the self-employed or independent contractor will need a solid two years’ earnings history to show.
3. Organize documents
When applying for mortgages, homebuyers must document their income and taxes.
Typically, mortgage lenders will request two recent pay stubs, the previous two years’ W-2s, tax returns and the last two months of bank statements — every page, 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, Calif.
Buying a home can take a long time, but knowing what you need and where to find it can save time when you’re ready.
4. Qualify yourself
Ideally, first-time homebuyers would know how much they can afford to spend before the mortgage lender tells them how much they qualify for.
By calculating their debt-to-income ratio and factoring in a down payment, buyers should have a good idea of what they can afford, both upfront and monthly, when it comes to their home.
Though there’s not a fixed debt-to-income ratio that lenders require, the old standard dictates that no more than 28 percent of your gross monthly income be devoted to housing costs. This percentage is called the front-end ratio.
The back-end ratio shows what portion of income covers all monthly debt obligations. Lenders prefer the back-end ratio to be 36 percent or less, but some borrowers get approved 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. Your down payment
It takes effort to scrape together the down payment.
There are programs that can assist buyers with qualifying incomes and situations.
“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,” says Winesburg.
“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, speak with 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 about the process and other steps first-time homebuyers should take.