If you are looking to buy your first home, here are some tips to help get your finances in order and minimize the stress of the home buying process.
1.) Reduce Your Debt-to-Income Ratio
Your debt-to-income ratio is the amount you owe across all accounts each month divided by your gross monthly income (your income before taxes). The lower your debt-to-income ratio, the more likely you are to be approved for a loan. Your debt-to-income ratio is a quick calculation that you or your lender can do to get an idea of your financial situation. For example, if you owe $800 in debt payments each month and your monthly income before taxes is $4,000, your debt-to-income ratio would be 20%.
A low ratio shows mortgage lenders that your budget can comfortably accommodate a new home loan. You can reduce your debt-to-income ratio by paying off smaller accounts and reducing unnecessary spending as much as possible in the months leading up to your mortgage loan application. Keep in mind that pre-qualifying for a mortgage allows you to see how much of a loan you would likely be approved for before you start looking at homes.
2.) Obtain a Copy of Your Credit Report
Your credit score and credit report are instrumental in the mortgage application process and one of the deciding factors in whether your application is approved, and if so, for how much. The Fair Credit Reporting Act (FCRA) allows all consumers to receive one free copy of their credit report each year. You can obtain a copy from any of the three agencies that maintain consumer records, which are Equifax, Experian, and TransUnion. You should obtain a copy of your credit report as soon as you know you will eventually apply for a mortgage. Be sure to contact the credit reporting agency immediately if you notice any discrepancies in your credit report. Under the FCRA, agencies have 30 days to respond to your request.
Knowing your credit score will be extremely useful when it comes time to shop for the best mortgage rates. A score of 780 to 850 will likely qualify you for the lowest rates available, while a score of 680 to 779 puts you in the “above average” to “very good” range. If you have a “below average” score, you should focus on improving it before you submit your mortgage application. Your application could still be approved with a low credit score, but you will most likely pay a higher interest rate than you would with a better score.
3.) Document Your Income and How You Earn It
Before you begin looking for a mortgage, keep in mind that your lender will need to verify your sources of income. Mortgage lenders are also concerned with whether you have a had a steady source of income over the past several years. Keep in mind that if you are self-employed, paid by commission, or have irregular sources of income, you may need to demonstrate a history of sufficient income over a longer period of time.
When applying for a mortgage, you should gather the following financial documents for your mortgage lender:
- Pay stubs if traditionally employed
- Profit and loss and/or income statement if self-employed
- Tax returns for the past two to three years
- Bank statements for the past 12 months
- Explanation of all deposits made within the last 60 days if they did not come from work
In some cases, your mortgage lender may reach out to your employer for verification as well.
4.) Have Cash on Hand
The general rule of thumb is that your monthly mortgage payment, along with taxes and insurance, should not exceed 28% your annual income. You should use a mortgage calculator to help determine how much you could realistically afford to spend on a house. Mortgage lenders prefer that applicants have emergency cash set aside in a retirement account or savings account in case of job loss, illness, or other situations that may prevent them from steadily earning income. You should also have sufficient funds on hand to make a down payment on your new home. Traditional mortgage loans require the borrower to put down 20% of the purchase price, but there are no-down payment and low-down payment mortgage loans available for qualified borrowers as well.
Being prepared for the mortgage process can help reduce stress and can help improve your chances of being qualified for a loan. Plus, in today’s challenging housing market, having all of your documents prepared ahead of time can help speed up the pre-qualification process and make you a more attractive buyer in the event of multiple offers on the same home.
If you are ready to begin the mortgage process, or if you’re just looking for initial guidance, BankFive’s dedicated mortgage originators can help! Schedule a consultation or get pre-qualified online today.