A house could be the biggest purchase you will ever make, and the process of shopping for a home and obtaining a mortgage can be overwhelming. However, there are steps you can take to make the process more manageable and the purchase more attainable.
1. Know Your Credit History and Score
A high credit score helps you not only get approved for a mortgage. It also improves the terms available. Here is a breakdown of the five major components that make up your credit score.
- Payment History – Reported payments account for 35% of your total credit score. Late payments will affect your score negatively, so it’s important to consistently make payments on time.
- Credit Utilization – How much of your credit is in use makes up 30% of your score. If you reach the credit limit on your credit cards, it lowers your credit score. Do your best to start paying down credit card balances to free up your credit.
- Length of Credit History – How long you have been using credit and making payments as well as the amount of time each of your credit accounts have been open is 15% of your total credit score. If you’re trying to clean up your credit, closing accounts may not necessarily be the answer. It may be best to pay off accounts and keep them open to maintain long standing accounts.
- New Credit – Be cautious when opening new credit accounts, which accounts for 10% of your score. Opening too many new accounts in a relatively short period of time could hurt your score.
- Credit Mix – The remaining 10% of your score relies on the variety of credit accounts you have. Having a mix of revolving credit accounts, such as credit cards, and installment loans, including auto loans and student loans, with positive payment histories show that you can manage different types of credit and will increase your score.
Remember, the higher your credit score as a potential buyer, the lower the risk to a potential lender.
2. How Much Can and Should You Spend?
When reviewing mortgage applications, lenders pay close attention to your debt-to-income ratio (DTI). DTI shows how much of your monthly gross income – your income before taxes or other deductions are taken out – goes to monthly debt payments. Many lenders prefer that your total monthly debt payments, which include housing payments, auto loan payments, student loan payments, and minimum credit card payments, not exceed 40% of your gross monthly income. Some lenders prefer a DTI of 36% or less. Others may accept a higher ratio.
3. Save, Save, Save
Having savings makes it easier to purchase a home. Saving can be hard given the challenges many first-time home buyers face with high housing costs and student loan debt, but most lenders require a down payment, and you will likely be responsible for closing costs. You will also want to have money available once you complete the purchase for maintenance or repairs in your new home. So let’s look at the possibilities.
4. Start Organizing Documents
When you apply for a mortgage, most lenders will want one or two months of paystubs, two years of tax filings, three to six months of bank account statements, information about any retirement savings, and other documentation specific to your financial situation, such as explanations of any recent large deposits or withdrawals from your bank account. It can be overwhelming to pull together so much information in a short timeframe, so start early. By getting these documents in order at the beginning of your house hunting journey, you give yourself time to ensure you have all of the documents the lender requires.
When you’re ready to buy a house, understanding the costs and benefits, researching your credit and housing options, and building your savings are the best first steps toward owning your first home. In next month’s article, we’ll take a look at the next step in the home buying process: applying for a mortgage.