7 Tips to Prepare Your Finances for a Home Loan
Buying a house for the first time is exciting, but it is also a learning experience. If you're wondering how to get a home loan, there are many things you can do to prepare now so that you'll be ready when the opportunity comes.
Just follow these nine tips to set you up for mortgage success in the current real estate market.
1. Know Your Credit Score
One of the first things you need before getting a home loan is your credit score.
You are entitled to one free credit report each year from each of the major credit bureaus: Equifax, Experian, and TransUnion. This report includes your credit score, but you should also use it to check what's on your credit report and whether it is affecting your credit negatively or positively.
You'll also want to make sure there isn't anything on your report that shouldn't be there. Unfortunately, fraud does happen, and it's better to know sooner rather than later so you can dispute it and get it removed.
Banks and other lending institutions care so much about your credit score because is it shows how well you manage your money and your debt. Banks take a risk when they lend money, especially when they're a large amount involved, like with a home mortgage.
If you have a good credit score, it lets banks know they can trust you to repay your debt, which is why it's a big factor in whether or not you'll be approved for buying a house.
Additionally, credit will also affect what interest rate you'll be able to get on your mortgage. A low credit rate combined with a low debt-to-income ratio and sufficient income will help you get approved for better interest rate (and maybe even a higher loan amount).
Even small differences in your interest rate can add up when it's stretched out of a 30-year mortgage. Basically, having a good credit score can end up saving you thousands of dollars.
Here's an example: Let's say Jane has a credit score around 680, which raises her monthly payment by $40 compared to someone with a higher score. That extra $40 a month becomes an extra $480 per year. And after 30 years, Jane has paid an extra $14,400.
While a 680 isn't a bad score, the truth is that scores above 700 will help you get better rates, and anything over 720 is considered excellent credit.
As for what credit score is too low, many lenders believe it's too risky to lend to someone with a score below 620. If you're score is in that range, it could be difficult for you to get approved for a conventional loan.
However, there are other alternatives that may work if you have a lower credit score, like an FHA loan. So don't worry—you can give our team at Elevate Mortgage a call to find out what your options might be.
2. Explore Different Options
There are lots of different options when it comes to purchasing a mortgage. Some will probably work better for your situation than others, which is why you want to explore what they are before committing.
Some of the different mortgage options include:
- 30-year fixed rate mortgages
- 15-year fixed rate mortgages
- 7/1 adjustable rate mortgages
- Jumbo loans
- FHA loans
And many more!
In addition to the options for various loan types, there are also a lot of options when it comes to choosing a lender and getting approved for a mortgage.
Even though we always hope someone chooses us, we still encourage every homebuyer to shop around to ensure they get the best deal.
In addition, it's important to know that just because one lender declined your application doesn't mean you should give up. Different lenders have different requirements for credit and income, so while you may not meet one lenders qualifications, you could meet another's.
3. Save for Your Down Payment
Preparing to purchase a house by saving up for a down payment can save you a lot of money both upfront and over the life of your loan.
Most home loans require a down payment on the mortgage that is anywhere from 3%–20% of the total purchase price. So, if you want to purchase a $250,000 home your down payment would be anywhere from $7,500–$50,000.
However, for lower percentage down payments, it's important to know that you might have to pay some kind of mortgage insurance, usually either private mortgage insurance (PMI) or mortgage insurance premium (MIP). This can make both your monthly mortgage payment and the total amount you end up paying over the life of the loan much more expensive.
Finally, though there are some home loan options with a 0% down payment, it's still a good idea to save up and pay one if you can, because of you'll still save lots of money in long-term interest payments.
Basically, the more money you put down up front, regardless of what the required down payment is, the more you'll save on the loan.
However, saving up that kind of cash can be tricky. If you struggle with savings, one tip is to treat it like an automatic payment each month where you put a designated amount into an untouchable savings fund.
4. Get Rid of Debt
This is solid advice in general, but when you're buying a house, excess debt can actually hurt your chances of getting approved. The less debt you have, the better it looks on your credit report and to potential lenders.
In addition, lenders almost all look at your debt-to-income ratio, and if it's too high, it may limit what you are approved for or cause your application to be denied.
So pay down that debt before you apply, and save any major purchases—like a car loan or appliance and furniture charges on your credit card—until after you've closed on your mortgage.
Lenders can, and often do, pull your credit a second time before closing, just to double check that you're good to go, so don't give them a reason to turn you down at the last minute.
5. Get Pre-Approved
The best possible way to start your home search is by getting pre-approved for your mortgage.
This lets you know what your limit, as well as the potential terms, are when you start looking at homes and helps you veer clear of homes you can't afford.
To speed up your pre-approval application, you'll need to supply some documents for the lender. Most banks require your most recent W2, two most recent pay stubs, last two years of taxes, and any current bank or brokerage statements.
Once you get the pre-approval, make sure you keep a copy of it for your records. And, if you don't get approved, don't worry. Just start working on your credit and keep saving money. Get a plan together on how to improve your position so that you can try again in the future.
6. Determine Your Budget
Just because a lender approves you for a certain amount does not mean that home is within your budget. Lenders don't know the intricacies of your budget or how much you like to save and invest each month.
So, before you go house hunting, it's up to you to really take a look at your finances and figure out what you can actually afford to pay each month. Then, once you know that, you can figure out what home prices will fit into that budget.
Financial planners, like Dave Ramsey, often recommend keeping your monthly housing budget to no more than one-fourth of your total monthly income. If you are interested in calculating your monthly payments, there are several mortgage calculators you can use.
7. Don't Quit Your Day Job
Lenders want to see that you have a consistent and stable job history, usually for at least the last two years. So if you're thinking about switching career fields, and you are wanting to buy a home in the next couple of years, you might want to wait before quitting.
Your job represents your ability to pay back the mortgage, which is why changes in employment can can make lenders nervous. Even just changing career fields, without gaps in employment, can be problematic because lenders might see it as you not having a clear career plan.
Realize Your Dream of Homeownership by Being Prepared
Following these steps to buying a house will help you on your way to homeownership. So, whether you're considering buying a house now or in the future, if you follow our advice, you can make sure you're ready.