7 Steps to Prepare for the Home Buying Process
When it comes to applying for a mortgage, times have changed since the financial crisis of 2008. Today, the mortgage application process may take longer, and depending on your financial situation, there may be more requirements for you to fulfill. Here are seven steps you can take now to better prepare for applying for a mortgage and home ownership.
1. Know your credit score: The higher your credit score, the stronger your opportunity to obtain the mortgage loan that you want. Your credit history and credit score are important, because both can affect the interest rate and loan amount that you’re eligible for. It’s a good idea to obtain your credit report about six months prior to applying for a mortgage. That will allow you to not only check for any inaccuracies in the report, but also will give you some time to begin raising a lower credit score than you’d like.
2. Create a realistic household budget: How big of a monthly mortgage payment can you comfortably afford? The best way to know is to determine what your total monthly budget is. Include all of your fixed expenses (such as utilities and credit card payments), and be sure to allow some room for entertainment (an occasional dinner out or movie is a great reward for smart and responsible budgeting).
When you’re calculating your maximum mortgage payment, remember to include homeowner’s insurance and property taxes. Above all, keep in mind that no matter how big of a mortgage you might be preapproved for, that doesn’t mean you have to take on that much debt. Choose the home, and the mortgage, that you’re most comfortable with. Overextending yourself is no fun—and could be a financial issue down the road.
3. Understand your “debt-to-income” ratio: Your mortgage lender will pay close attention to how big your mortgage payment is in relation to your other debt. This is called the “debt-to-income” ratio. And while the debt-to-income requirements can vary from lender to lender, a common rule of thumb is make sure your mortgage payment is no more than 25% to 30% of your total monthly debt.
4. Accumulate enough cash for a down payment: Most conventional mortgages require that you have at least 20% of the home’s purchase price available as a down payment. However, government-backed loans from the FHA require far less—just 3.5%. And a VA mortgage requires no down payment at all. Mortgages with low down payment requirements may also require private mortgage insurance, which increases your monthly payments and overall cost of obtaining your mortgage.
5. Prove that you have enough income: Your mortgage lender will require proof that you earn enough income to make your monthly mortgage payments. So you may be asked for pay stubs, tax returns, W-2s or other documentation.
6. Keep a cash cushion in the bank: If you like to keep money in the bank “for a rainy day,” that’s good. Because that’s exactly what mortgage lenders like to see: that you plan ahead for unexpected expenses. Ideally, you’d have as much as six months of your typical monthly expenses tucked away in a savings account.
7. Get preapproved before you start home shopping: Imagine starting your home search with the confidence of a cash buyer, because you know exactly how much money you can borrow. It also demonstrates to home sellers that you’re a serious buyer. So ask your mortgage lender about getting preapproved for a maximum loan amount. Keep in mind that preapproval doesn’t mean you’re guaranteed to obtain a loan for that amount. You’ll still have to complete the loan process before getting final approval.