If you’re planning in the spring to buy your first house, you already may be feeling a bit overwhelmed about what can often be a complicated and convoluted process. ¶ The good news is that you have plenty of time to learn the myriad steps to buying a home and getting prepared for the endeavor. ¶ Many experts say that — even before finding a real estate agent — the first things you should do are to get your finances together and to find a lender who can get you prequalified and advise you on how much house you can buy.
Scott Davis, a senior loan officer at McLean Mortgage in Fairfax, says buyers should never start searching for a home without speaking first with a lender. This will help you avoid falling in love with a home you can’t afford. Plus, a lender can advise you on how to prepare for a mortgage application.
“Applying for a mortgage is actually counterintuitive,” Davis says. “Things that might be good for you financially can actually hurt your chances of getting a mortgage approved. For instance, some people think it’s really smart to take all their cash and pay off their debt, then close their current credit card accounts and open a zero interest card. The problem is, you won’t have enough cash reserves for a deposit, a down payment and an emergency fund. You’ve also dropped your credit score from 800 to 600 if those closed credit cards had a good payment history. Now your score is based on a history of about 30 days.”
Even before you contact a lender, there are a few steps you should take as far in advance as possible before making an offer on a home, including checking your credit, developing a budget, saving money and getting your cash in place.
Steven Cohen, vice president at First Place Bank in Rockville, says prospective borrowers should request their own credit report to check for errors. A 2012 Federal Trade Commission study found that 20 percent of all consumer credit reports have mistakes. You can get a free copy of your credit reports annually from AnnualCreditReport.com. You don’t have to get all the credit reports at once; you can request one from Equifax, TransUnion and Experian at different times of the year to keep on top of your credit profile. You can also pay a small fee to get your credit score.
“You should make sure that everything is reported correctly, such as any late payments that you actually made on time or a debt that you don’t actually owe,” says Craig Olson, vice president of mortgage operations at Pentagon Federal Credit Union in Omaha. “I had an account that showed up twice.”
Cohen recommends that each credit card account have a balance of less than 50 percent of the limit. He says it’s better to have two or three accounts with smaller balances than one card with a high balance. Your credit score will be higher if you limit your credit card balance to less than 25 percent of the limit.
Olson says first-time buyers often come to him without an idea of their own budget. He recommends sitting down for a few minutes at your computer or with pen and paper to draw up a quick plan that shows your income and expenses.
“You can find calculators online that can help you estimate what your payment will be under different scenarios,” Olson says. “You can use those numbers as a starting point and figure out your own comfort level with different payments.”
Depending on the loan program you choose, you’ll need at least 3.5 to 5 percent or more for a down payment, plus you may need cash for closing costs unless you can negotiate to have the seller pay those fees. You should have been saving for a down payment, but there are some other options for cash, such as a gift or borrowing from your retirement account if you’re employer allows it.
“Some people may be depending on gift money from their parents, but you need to get an idea of how much to expect,” Cohen says. “Someone may think they’re getting $20,000 when the parents are thinking $2,500.”
Davis says that Federal Housing Administration loans allow for the entire down payment to come from gift funds, but conventional loans require borrowers to have at least 5 percent of their own funds for the down payment.
“If you’re receiving a gift or moving funds from one account to another, you should put the funds into an account at least 60 days before you apply for a mortgage,” Davis says. “Lenders are required to look at two months of bank statements during the application process, so any money placed in your account earlier than that becomes your money and you don’t have to provide a source for the funds.”
Olson says that while you’re consolidating your funds, you should begin to gather the paperwork you’ll need for a loan application, including:
●Two most recent W-2 forms.
●Two most recent pay stubs.
●Two months of bank statements.
●Two months of investment/retirement account statements.
●Two years of tax returns.
Once your paperwork is in order, then you can meet with a lender to discuss your loan options. If you’ve already identified a real estate agent to work with on your home purchase, he or she can suggest several reliable lenders. You can also ask trusted friends and colleagues for recommendations and then interview two or three lenders.
“Interviewing a lender should be a lot like a job interview,” Davis says. “I think it’s important to have a face-to-face meeting because you need to find someone you can trust and form a relationship with. You can ask if they’ve worked with a lot of first-time buyers, but I think it’s more important to find someone you can trust to work with you regardless of your price range. You want to work with someone who’s driven by building a relationship, not by earning a commission.”
A lender can help you wade through the options for various loan programs and then use your paperwork and loan application to preapprove you for a loan.
“Some lenders offer a ‘prequalification’ for a loan, which can be a good starting point for learning about the mortgage process,” Cohen says. “A prequalification is based on your verbal statements about your income and assets and an estimate of your credit score. A loan preapproval, which many Realtors require before they’ll work with a buyer, means that the lender has verified your credit, your employment, your income and assets, and determined how much you can borrow based on that information.”
The preapproval letter can be used as part of your offer when you’re ready to buy a home to prove that you can afford the property. Cohen says a preapproval letter is generally valid for three months and can be renewed with a quick update of your credit profile.
“There are a lot of factors that go into a loan approval,” Davis says, “which is why every prospective buyer should consult with a lender to see where they stand.”
Many first-time buyers opt for FHA financing, because this program requires a down payment of only 3.5 percent. While the FHA says borrowers must have a credit score of 580 or higher to qualify for a low-down-payment loan, most lenders require a minimum credit score of 620 or 640 or above, Cohen says.
“FHA loans are less popular now, though, because they carry heavy mortgage insurance that lasts for the life of the loan if you make the minimum down payment,” Cohen says.
Cohen says that a down payment of 20 percent is ideal because you won’t have to pay private mortgage insurance (PMI) and you’ll pay the lowest interest rates, particularly if you have good credit. He says borrowers with a credit score of 740 and above pay the lowest interest rates for conventional financing. Most conventional lenders offer loans with a down payment of 5 percent, although there are some special loan programs available with a lower down payment. Veterans Administration loans, available to veterans, do not require a down payment.
In addition to your credit score, an important element of your loan qualification is your debt-to-income ratio.
The federal government’s new “qualified mortgage” rule, aimed at toughening standards to prevent another foreclosure crisis, “requires a maximum debt-to-income ratio of 43 percent,” Cohen says. “If you make $120,000 a year, your gross income would be $10,000 per month, so your maximum payments for your housing plus the minimum payment on all other debt, such as your car, credit cards and student loans, would have to be $4,300 or less.”
In addition to consulting a lender, most first-time buyers can benefit from taking a home buyer education class that helps them establish a budget and prepare for homeownership. The Consumer Financial Protection Bureau offers a list of government-approved housing counselors that offer free programs; state and local governments also offer home buyer education.
The District, Maryland and Virginia offer home buyer assistance for down payment funds or low-cost loans, provided the buyers meet specific criteria. Some programs are limited by income or exclusively for first-time buyers.
A strong understanding of your finances is an important first step on the path to homeownership.
Michele Lerner is a freelance writer.
Here are definitions of several terms you will encounter as you confer with
Adjustable-rate mortgage (ARM): A mortgage loan with an interest rate that periodically changes.
Annual percentage rate (APR): The yearly interest rate paid on a loan. Federal law requires that this rate is disclosed as part of the truth-in-lending documents.
Conventional mortgage: A mortgage offered by a lender that will probably be bought on the secondary loan market by Fannie Mae or Freddie Mac; these loans have an upper limit of $625,500.
Federal Housing Administration (FHA): A government agency that offers low-down-payment loans along with housing information.
Fixed-rate mortgage: A mortgage loan in which the interest rate remains the same for the entire length of the loan.
Good faith estimate: An estimate of the entire cost of buying a home, including all down payment, interest payments and closing costs associated with a loan; to be provided by the lender within three days of a loan application.
Jumbo loan: A mortgage loan above $625,500; these loans sometimes carry a higher interest rate and require a higher down payment and higher credit score than smaller loans.
Loan origination fee: A fee charged by the lender for administering and processing the loan; also sometimes called a “point” and is equal to 1 percent of the loan amount.
Mortgage insurance: Insurance that protects the lender against loss if the borrower defaults on the loan.
Points: A fee charged by the lender equal to 1 percent of the loan amount; points can be paid at the closing to lower the interest rate on a loan.
Preapproval: A qualification for a mortgage by a lender based on proof of your income, assets and credit score that states the maximum loan that you can qualify for; final loan approval also requires an appraisal on the property, which demonstrates that the value of the property is more than the loan amount.
Prequalification: An estimate of your ability to qualify for a loan given by a lender based on your credit worthiness, income and assets but without a complete proof of all assets.