First-Time Homebuyer’s Guide: Part 3
Review your finances
Now that you’ve established why you want to buy a new home, it’s time to decide if you can buy a new home. Like the last step, this one requires you to be totally honest with yourself. Only you know how responsible you’ve been with money, and whether you can afford the expenses and shoulder the obligations of owning a home. Make sure to research these areas of your financial health before moving on to the next step.
Your past and present relationships with creditors and services determine your ability to borrow, plain and simple. You may not know your exact score, but you should already have a basic idea of how good it is without needing an official statement. If you’ve established a track record of late payments, defaults or bankruptcy, you’ll have a long upward climb before a lender trusts you to make mortgage payments. On the other hand, if you pay bills on time or ahead of time and you’ve done so for years, you’ll have a much better chance to be approved for a mortgage and have access to the best rates and products on the market.
Are you good at socking away funds? If yes, you’ve got a big leg up when it comes time to apply for a home loan. The amount of your down payment determines the rate and type of mortgage products available to you. When you’re a good saver and have the money ready to transfer, it shows lenders you have both the means and solid habits of a wise, responsible borrower. Current bank statements are part of the standard loan documentation, so when you’re living check-to-check without any savings to speak of, it’ll be tougher to find that perfect mortgage.
Your debt-to-income ratio is an important metric that mortgage lenders use to measure your risk as a borrower. In other words, your income won’t matter if you’re overburdened with debt, even if you make a lot of money. The “28/36” rule* states that no more than 28 percent of your gross monthly income should be spent on housing expenses (mortgage and insurance payments, property taxes, etc.) and no more than 36 percent should go to other debt servicing (car loan, credit cards, etc.). If you do a little math and find out you’re well within the 36 percent debt-to-income ratio, you can feel good about your prospects of home ownership.
Are you expecting a child? Do you have a parent or in-law who is sick or disabled? Do you have a child who’ll be going to college soon? Are you going back to college soon? All of these are relevant questions when assessing your future ability to pay the mortgage, property taxes, insurance premiums and so on. Even if you are enjoying current financial health, you need to account for probable expenses gathering on the horizon before you commit to buying a home.
When it comes to shining the best possible light on your financial situation for potential lenders, there are a number of “do’s and don’ts”. For instance, it’s a bad idea to buy expensive items on credit or incur any other debt leading up to and during the home loan process. Such transactions increase your debt-to-income ratio, which will send your mortgage interest rate in the wrong direction. Merely applying for credit is a bad idea. Though you might get a 10 percent discount for a retail purchase by signing up for a store card, it could cost you thousands down the road because of a higher mortgage interest rate. Conversely, it’s advantageous to have “seasoned” assets in your portfolio, that is, established debt items you’ve proven you can pay on a monthly basis. This demonstrates responsible fiscal behavior lenders want to see when deciding to offer you a loan.
In next week’s First-Time Homebuyer’s Guide…
Part 4: How much can you afford?