To buy your first home, you likely will need a mortgage. In fact, before you even start looking at houses, you should look into your mortgage prospects.
If you have good credit, a healthy income and money in the bank, you’ll be able to secure mortgage preapproval quickly and proceed straight to the homebuying process. But if you have less-than-stellar credit, are self-employed or have little cash to bring to the table, you’ll want to start the process way before you look at houses – maybe more than a year before.
“You have to get a copy of your credit report,” says Don Frommeyer, chief executive officer of the National Association of Mortgage Professionals and a mortgage broker in Indianapolis. “You have to know what’s in there.”
The free credit report you can get annually, while it helps you identify problems, won’t show you the same credit score your mortgage officer will see. “The score is invariably higher than what you get when someone in the mortgage company runs it,” says Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage” and a mortgage broker in the San Francisco Bay Area.
That makes meeting with a mortgage officer (or two or three) at the start of the process crucial. In competitive markets, agents won’t even show homes to buyers without mortgage preapproval.
Be prepared to produce documents, and lots of them, starting with several years of tax returns and many months of bank statements. Lenders will want proof of your income, and they will want to know about all your debts. They also will want to know the source of any big deposits. If your parents give you money for a down payment, they will need to write a letter documenting that.
The other thing you’ll need, besides documents, is money – and lots of it. You’ll need money for your down payment, closing costs and more than a year’s worth of taxes and insurance payments, for a start. Lenders will also want to see that you have adequate reserves in case you lose your job or the furnace breaks down.
“What happens if you have to buy a new furnace?” Frommeyer says. “There are always added costs when you buy a house.”
Financial experts disagree over how much money you need for a down payment. While 20 percent is often considered a rule of thumb, you can buy a house with as little as 3.5 percent down with a Federal Housing Administration mortgage, 5 percent with a conventional mortgage or nothing down with a VA loan available to military veterans.
But the less you pay down, the bigger your monthly payment will be. Plus, if our down payment is less than 20 percent of the purchase price, you’ll have to pay private mortgage insurance or the FHA equivalent, known as mortgage insurance premium.
The PMI can add about $92 a month, for example, to $475 principal and interest payments on a $96,500 loan to buy a $100,000 house. With 20 percent down, the principal and interest payment on that house is only $373 a month, at 4.25 percent. FHA mortgages also require an upfront MIP payment equal to 1.75 percent of the purchase price.
You may also get a lower interest rate with a higher down payment. “The less you put down, the more expensive the mortgage insurance is and the higher the interest rate,” Fleming says.
Here are 12 things to know before getting your first mortgage:
Meet with a mortgage officer before looking at homes. This will help you determine whether you have credit problems that need to be solved first. It will also let you know how much house you can afford before you begin your search.
Pay off as much debt as you can first. This will help keep what’s known as your debt-to-income ratio down. Lenders look at your income and all your debts – student loans, car payments, credit card debt – to determine how much you can afford to borrow. If your total debt, with the new house payment, would be more than 43 percent of your income, you’re unlikely to get the loan. Some lenders may want a lower ratio.
Develop good credit habits way before you plan to buy. Missing payments on student loans or habitually paying your bills late will lower your credit score and make borrowing for a home impossible or more expensive. Once a bill goes into collections, it can take months or years to recover from the damage.
Consider consolidating or refinancing student loans. If you can’t pay off student loans before you buy a home, investigate whether you can lower your payments. You’ll have to decide whether it makes sense to stretch student loan payments over more years to buy a home sooner.
Show a solid work history. If you’ve just finished graduate school in engineering and gotten your first engineering job, a lender may not care that you don’t have two years of work history. But if you’ve just left graduate school and gone to work at Starbucks, you’ll have a hard time getting a mortgage until you’ve had that job for two years. That goes for part-time jobs, too. However, taking a part-time job on the side and using the money to pay down debt or add to your cash reserves may be helpful even if the lender isn’t willing to consider that income.
Be prepared to document everything. You’ll need tax returns, bank statements, brokerage statements and documents to verify the source of any money you plan to use. The lender will also verify your employment and income, once at the beginning of the process and again a day or two before closing.
Don’t buy anything on credit or apply for any credit while your loan is pending. You may be tempted to buy new furniture for your new home and put it on a credit card. Or, perhaps you realize you’ll have enough cash left for a down payment on a new car. “Once we start this process, don’t spend a dime that you don’t have, don’t put anything on credit cards, don’t apply for any credit,” Fleming warns. Otherwise, you may jeopardize the deal.
Talk to several lenders or mortgage brokers. Not all lenders offer the same loans, so it makes sense to shop around. Be careful that you’re comparing apples to apples. All lenders let you choose whether you’d like to pay more upfront, in the form of “points,” to get a lower interest rate. If a lender offers you a “no closing costs” loan, find out where you’re being charged extra to compensate for that.
Shop for closing agents. The actual closing costs, such as document preparation, legal fees and title insurance, vary considerably. In a state where those costs are high, you can save several thousand dollars on the transaction by choosing a different closing agent. Ask both your real estate agent and mortgage officer for recommendations, as well as friends and family.
Make sure you have enough cash to cover all your costs. In addition to closing costs charged by the lender and the closing agent, you’ll need to pay for a home inspection, an appraisal, a survey and city, county or state transfer taxes. Not only that, most lenders ask for at least a year’s worth of homeowners insurance and property taxes upfront.
If you’re self-employed, prepare to jump through more hoops. People who own small businesses often can’t qualify for a mortgage until they’ve been in business two years, though exceptions are likely for professionals, such as doctors, who leave a staff position and become self-employed in the same field. Most self-employed professionals write off enough expenses on their taxes to make their adjusted gross income much lower than their actual income. The lender will consider that lower number your income.
The house may also have to qualify. If you’re getting an FHA mortgage, the house has to meet certain standards. Lenders may also set standards for home conditions for conventional mortgages. Plus, the house has to be insurable.