How to prepare for buying a home

Long before you start driving around neighborhoods looking at houses with sale signs on the lawn, or searching online for your ideal home in that great school district, there are a few things to consider in order to prepare yourself for the home buying adventure to come. It’s tempting to start looking at houses before you have even thought of how much house your budget can sustain, or how much of a mortgage you will be able to afford, but the time you spend considering these things will be time well spent.

What can you afford?

A good indicator of how much mortgage payment you can afford is the amount you are currently spending on rent. Some first time home buyers want to pay less on their mortgage than they currently pay for rent, but consider that the tax benefits of claiming for your interest payments on your tax return could put some money back in your pocket. There’s nothing to claim if you are renting. If you are considering moving into a larger space than you currently occupy, you may want to avoid high credit card balances and large car notes. Both of these items affect the ratio of your debt to income, a factor lenders use to decide what, if any, mortgage you can qualify for.

Rule of thumb one then, is to keep your credit card balances and the resultant payments low. Rule number two is avoid buying a shiny new car before you buy your home as this can have a major effect on your debt to income ratio.

How much down payment will you need?

Depending on the price of your intended home purchase, you may need to stash away a sizeable lump sum to get into your first home. A FHA loan will allow you to buy your home with a 3.5% down payment, so for a house costing $150,000 you would need $5,250. But don’t despair. If you have a 401k you will likely be allowed to borrow funds against it to use for your down payment. And for first time home buyers with agreeable relatives, you are allowed to use gift funds as part of your down payment. While you are saving, it’s also a good idea to open a separate bank account to stash your funds as a lender will require you to substantiate the source of your deposits, in order to assure the department of homeland security you have not been trying to launder money through the home buying process.

In some cases, with a high enough credit score, you may be able to qualify for a conventional mortgage with as little as five percent down, using a combination of first and second mortgages. That could save you paying mortgage insurance premium (MIP) on a FHA loan.

What about your credit score?

Fortunately, there are mortgage programs available that start with credit scores below 600. You may have strong income, a hefty down payment and the desire to own your own home but your credit score could hold you back. A good idea is to have an expert look at your credit report to determine what inaccuracies are harming your score and what items you could pay off to boost it. Do this early in the home buying decision process to get your score comfortably above 600. One of the biggest bangs for your buck in raising your credit score is to ensure that the outstanding balance on your credit cards do not exceed 30% of the allowable limit.

I pay cash so I don’t use credit

Well it’s nice that you are responsible with your budgeting, but that’s also a double-edged sword. Lenders will require that you have at least two open lines of credit on your credit report. And what does that prove? It shows that you have the ability to follow up on your payments and are used to paying a bill regularly and on time. And two open lines of credit could be some things as simple as a secured credit card that you use for buying gas, and a store card from a big box retailer, or a (if you insist) car note.

So while it’s nice to be careful spenders and avoid the potentially risky business of having credit cards lying around in your wallet or purse, it’s useful to show that you can handle regular payments, which is a good indicator of how you will handle a mortgage payment.

Adding a co-signer

Anyone who joins you on your mortgage note as a co-signer has to meet the same standards of qualification as you do. They must have a credit score above 600, two open lines of credit and verifiable income. Happily, you can use gift funds as part of a down payment as long as you can provide evidence of the source of the funds and an assurance that it’s not expected to be paid back. Now is a good time to call your well-heeled relatives and humbly explain to them that you need help with buying a home.

Documentation you will need

It’s a good idea to locate and file the following items in a single location, as you will need them for the qualification process:

• Two years of tax returns – all pages
• Two years of W2s
• Copy of your drivers license and social security card
• Your two most current paychecks
• Bank statements

Home buying is not a painless process but it is also not as complicated as it may seem. A bit of preparation can make it go a lot smoother than expected and the willingness to ask questions of an expert mortgage professional can save you a lot of worry in the long run.

photo courtesy of Alan Cleaver, Creative Common License 2.0, modified from the original 427x640 to 320x568.