How to prep financially before applying for a home loan

You need to prepare for plenty of milestones in your life. 

• Taking the training wheels off your first bike 
• Proposing to the love of your life
• Your wedding day 

So why does applying for a mortgage seem to be an afterthought for so many? 

We think it's because many people — typically renters who haven't bought their first home yet — happen upon an open house or see an online listing for a home for sale and get swept up in the “I've gotta have that house” frenzy. They rush to a local mortgage company and are kind of in shock when they realize that the process of applying for a mortgage is a lot more challenging than finding a home they'd like to live in.

It takes time — and a little math — to find your monthly payments comfort zone. Have you looked at your bank statements lately? Your credit report? Before rushing into things, maybe it's a good time to tidy things up a bit — financially speaking, of course.

HIT THE BRAKES

Let's slow down a little — around 3-6 months — and consider what it takes to be ready to buy a home. Here are eight tips you should follow before househunting in earnest or reaching out to a loan officer.

DETERMINE WHAT YOU CAN AFFORD

The saying “house rich and cash poor.” refers to homeowners who buy a roof over their heads that is — financially — WAY over their heads. Their income can barely make the monthly payments, more repairs are necessary than they bargained for, utility bills and taxes might be higher than expected. They own a house that is keeping them from enjoying their lives. Living like this is no way to be, and once you're in that mess, it's hard to extract yourself from it.

To avoid this scenario, take a hard look at how much you spend versus how much you earn. To determine where your money goes, create a budget by reviewing the last three months of your spending habits. Focus on things you must pay for each month — groceries, student loans, car payments, medications and commuting or internet costs — and exclude things like eating out, concerts, and vacations. 

To get the percentage of your income you'll need to put aside for necessary expenses — not including rent — take that number and divide it by how much money you make every month, before taxes. With that total in mind, you can use an online mortgage calculator to determine the price range of a home you can afford. Lenders suggest homebuyers cap their expenses and mortgage payment at less than 45% of income. 

SET A SAVINGS TARGET

Knowing how much you can comfortably offer on a home is the first step in calculating what you'll need to cover the down payment and closing costs. Remember, there are many home financing options out there that require low down payments, but the more you can put down at closing, the lower your monthly mortgage will be.

Keep in mind that in most cases, if you put down less than 20%, you may need to pay monthly mortgage insurance on top of your payment. Find out private mortgage insurance here. 

Once you decide on a down payment amount you think you can save, calculate how far away you are from hitting that target number. Then add in property taxes, homeowner's insurance, estimated closing costs, and other fees. Once again, you'll do well to talk to a loan officer to better understand what closing costs might be.

When you apply for a home loan, your lender will provide you with a detailed breakdown of all these figures, including approximate closing costs, in the form of a “loan estimate,” but you'll want to get an idea of what that number is now so you can start saving for it. Be smart about it: not having enough cash for a down payment and other expenses may cause some lenders to decline a loan application.

CONSIDER ALL THE INCIDENTALS

On the topic of saving, there are plenty of other expenses related to purchasing a home. Property inspections, pest inspection, moving expenses and appliances and repairs can all add up — all at the same time. You might want to create a separate bank account just for these expenses. Once you know how much you need to save — and have a better idea of how long that will take — you can estimate just how soon you can comfortably start shopping for a home. 

CHECK YOUR CREDIT

Every year, you can get a free credit report from each of the three main US-based credit bureaus: Experian, Equifax, and TransUnion. Better yet, go to your bank or annualcreditreport.com for a free annual credit report.

Looking up your credit won't give you the complete picture that mortgage lenders use when assessing your creditworthiness, but it gives you a glimpse of whether or not there is anything strange or worrisome on your report. If there's something that shouldn't be there – like a late fee or missed payment – you'll want to take care of it sooner rather than later, as an improved credit score will help you get a better interest rate. 

SAY NO TO CREDIT OFFERS

While we're discussing credit, it's a good time to point out how prospective homebuyers need to put the brakes on making big purchases or opening new lines of credit cards. Don't open any mail from credit card companies pitching a new card with great benefits. Skip the cashier offering 10% off a single purchase just by opening a charge account. New credit can lower your score for up to a year, which in turn will undoubtedly impact your plans for getting a mortgage at a great rate. 

WATCH THE PAPER TRAIL

Shuffling money back and forth between your checking, savings, and investment accounts is okay most of the time, but when you apply for a mortgage, it can create a paper trail nightmare. Try to curb this practice at least three months before applying.

PAY YOUR TAXES

Be sure that you've made all tax payments due for past tax years. Being on a tax payment plan — one where you pay off back taxes owed in smaller monthly payments – add to your debt burden when you're trying to qualify for a loan and are roundly frowned upon. Try to pay all your back taxes before even thinking of buying a home.

ASK FOR HELP

It's okay to receive cash as birthday or holiday gifts before applying for a mortgage, but if they are large sums, you'll want to disclose that these are not personal loans that you'll be expected to pay back after buying a home. Mortgage guidelines typically allow you to accept gifts funds from immediate family members but documenting the receipt of gift funds is very specific, so don't have gift funds transferred before speaking with a loan officer. They'll be able to tell you the gifting requirements based on the loan you may be offered.

LET'S GO

Getting your finances in tip-top condition well before you even shop for a home will help quell much of the stress associated with the mortgage loan process. If you're a prospective homebuyer with questions about home financing, please reach out to one of our local loan officers to discuss these tips and other essentials, like how much down payment you'll need or what happens at closing.