So, you’re thinking about buying your first home. Congratulations! Before we pull out the champagne and celebrate, you will have to get over the most annoying part of the house-buying process, which is getting a mortgage. Here are the 6 most important steps to take before you apply to get a mortgage.
1. Get Your Financial Life Together
Sure, maybe you’ve gotten this "adulting" thing down. You’re paying your bills on time, doing laundry, and cooking more than just frozen pizza; but, do you know your credit score and income-to-debt ratio? Before you start crying on the inside (or the outside), take a deep breath, and do the following tasks:
A. Get Your Credit Score
If you sign up for Credit Sesame, you can get a free credit score within a matter of minutes. It also shows you how much debt you have overall, and what categories of debt you have. (Credit cards, student loans, car loans, etc.) This is very important information to know. The higher your credit score, the more banks will be willing to work with you, and the lower your interest rates will be. So it's very important to know where you stand, and Credit Sesame can help you with suggestions tailored to your specific situation on how to improve your credit score.
B. Keep Your Pay-stubs
This one may seem obvious, but a bank is going to need your proof of income before they give you a mortgage. When you are getting ready to buy a home, grab a folder and start gathering all of the necessary paperwork. You will need at least several months of pay-stubs, as well as proof of how long you have been working at your job. If you have your original employment contract handy, it can’t hurt to grab that, as well. If you have income from any other sources outside of your job like alimony or gains that you’re earning from investments in the stock market, it’s important to bring proof of that as well.
C. Keep Your Bank Statements
Unless you opted in for paper-free banking, you probably get your statements mailed to you each month. It’s important to always keep your bank statements, so make sure you begin keeping them in a folder as soon as they arrive. If you lost your physical copies, don’t panic. You can go to online banking, where the PDF of your statement is saved, and you can print it from home. If you don’t have access to a printer, you can walk into your bank and ask for a new copy. Lenders want to know exactly how much money you have in the bank, and how much you make. While it’s technically not part of the process, they will also take a peek at your spending habits. You should be saving money for your new house anyway, but it may be a good idea to cut back on embarrassing spending habits you may have in the months leading up to applying for a mortgage.
D. Get Your Tax Returns
Banks want to see the past two years of your tax returns, because they want to see how much money you make consistently over a long period of time. You should always keep your tax information, but just in case you lost the paperwork, it’s okay. The IRS allows you to request a transcript from previous years. However, keep in mind that it takes a few weeks to show up, so make sure you have that paperwork on-hand now before you shop for a mortgage.
2. Stay Stable
You want to give the bank the impression that you are a reliable person, and you won’t flake out on your mortgage when times get tough. This means that it’s a good idea to stay at your current residence for at least a year or more. If they see that you having a habit of breaking your lease every 6 months, or if you have any history of eviction, that is a huge red flag. If an eviction is on your record, they will dig deep into your past. They may even call your former landlord to get their side of the story. Staying at your job for at least 2 years is also a must, because it shows that you are loyal. If you're thinking about changing jobs, wait until after you secure your mortgage.
3. Estimate Your Costs Beforehand
Before you apply for a mortgage, you can do a quick calculation at home so you at least know a ballpark of the number you can expect. After the economic crisis of 2008, over 10 million families lost their homes to foreclosures. One of the main reasons why people lost their homes was because the banks gave out mortgages that people could not actually afford. In 2010, laws were put in place to make sure a mortgage lender cannot lend you a mortgage that costs more than 35% of your income. After that point, they also take a look at your other debt obligations like credit cards, student loans, and car loans. Remember, if you’re married, or if you are buying a house together with your partner, your gross income gets combined.
Even though you can borrow up to 35% of your income, a quick rule of thumb to make sure you don’t get yourself in financial trouble is that your mortgage should never take up any more than 28% of your monthly income. So, if you make $50,000 a year, you’re bringing in roughly $4,166 a month. That means your mortgage (or rent!) should never go above $1,166.
You should also make an estimate with your whole financial situation in mind. First, let’s calculate the maximum mortgage amount of 35% of a $50,000 salary. That’s $17,500.
If you paid $17,500 a year on your mortgage, that’s $1,458 a month. Already, you can see that’s a lot more than the recommended 28%.
Now, Let’s assume you have $200 in student loans, and $200 in credit card bills. That automatically takes away $400 from what you can afford. Now, you’re down to $1,058 a month.
With this remaining $1,058 a month, you need to be able to pay your mortgage, property taxes, and homeowner's insurance. This amount will change depending on which state you live in, so be sure to do that research as well. Overall, your debt-to-income ratio should never go above 35%.
4. Know Your Options
It’s important to know how much financing you qualify for before you go house shopping. If you are afraid that your income may not be high enough to qualify for a mortgage, there are plenty of options out there for you. You should never apply to just one mortgage company or bank. You will never know if there is a better option out there for you until you shop around. Your rates will change dramatically depending on your credit score, and the amount of money you have saved as a down payment. Getting pre-approved for a mortgage allows you to know your budget up-front, so that you can begin the house hunting process knowing exactly how much you can and cannot afford.
5. Find a Broker
When you call a real estate company to get a tour of a house, you are usually talking to an agent, and their boss is a broker. Sometimes, brokers work independently and show houses as well, but it’s important to know the distinction. Both agents and brokers making money on commission, meaning that they want you to buy your dream house just as much as you do. If you have an absolute dream home in mind, but you’re afraid a bank will deny you, it’s worth talking to a broker. You may have to pay a fee to get their advice, but you can learn a lot from them about the home buying process in your particular area. They can look at your financial situation and help steer you in the right direction.
6. The Underwriting and Closing Process
If you actually get approved on a mortgage, congratulations! However, there is a lot of paperwork that goes on while you are officially buying the house. It needs to get inspected, the deed or "title" of the house needs to be transferred, etc. A lot of this process is handled by your real estate broker or even a lawyer, if you choose to hire one. Keep in mind that this all costs a few thousand dollars for all of these fees, and they change depending on your location and the price of your home.
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