If you think the questions you should ask yourself before you start viewing homes are about square footage, neighborhoods, amenities, or commute times, think again. Once you’ve decided that you’re ready to buy a home, the first questions you need to be able to answer are all about money.
That’s right, unless you’re flush with cash or just received a huge inheritance, you need to know how you’ll finance your new home long before you start looking. While a mortgage lender will be able to give you specific details, you can figure out if you’re truly ready before you start filling out paperwork.
Here are four questions you need to ask yourself before you start looking for homes to buy.
What is My Credit Score?
Why do you need to ask this question? Because it’s the first one a lender is going to ask. Your credit score is based on five factors in a convoluted algorithm that only a few people really understand, but here are the basics:
- Your payment history accounts for 35 percent of your score. This is why late payments are such a big deal.
- The amount of debt you owe makes up 30 percent. It’s a good idea to pay off as much debt as possible before getting a home loan.
- The length of your credit history is 15 percent of the total score. Longer is better, especially if you’ve got a good payment history.
- Your mix of debt accounts for 10 percent. Is all your debt credit cards or do you have a student loan or auto loan, too?
- New credit makes up 10 percent of your score. A lot of new credit is a red flag to lenders especially if it’s all credit cards. They may wonder if you have enough cash to pay for basic necessities, let alone a house.
All of these factors make up your overall credit score. The higher your score, the easier it is to get a mortgage at the best interest rate available. Lower scores may disqualify you completely or you may be offered a ridiculously high-interest rate.
- Great credit: 760 - 850
- Good credit: 700 - 760
- Okay, but not good credit: 620 - 700
- Poor credit: 620 and lower
Before you buy a home, you need to know what your credit score is and work to raise it if it’s not above 700. You can check your credit report for free once a year at AnnualCreditReport.com. It won’t give you a score, but you can make sure you’re on the right track and look for any errors that could hurt your score.
How Much Down Payment Can I Afford?
The common wisdom of needing 20 percent down to buy a home isn’t exactly accurate. There are plenty of good reasons to put down that much or more when you buy. Your mortgage will be lower. You’ll have more equity walking in. You won’t have to pay private mortgage insurance (PMI). But not everyone can afford to save that much for a down payment.
Many lenders offer mortgages with lower down payment options. They offer three, five, and even zero percent down depending on your income level, status as a buyer (first time or not), and other factors like thcredit score. Depending on your situation, you could qualify for an FHA loan or if you’re military (retired or active duty), VA loans are an option. Both of these government-backed mortgages let you buy a home with low or no down payments.
What is My Debt-to-Income Ratio?
While this is probably never a question you thought you’d need to ask yourself, it’s important to have an idea of what it is. Lenders will definitely check this number when deciding if you qualify for a home mortgage. Your debt-to-income ratio is your total monthly amount of current debts (not including housing) - loans, credit cards, etc. - divided by your total monthly income. A good ratio is 36 percent or less. A higher ratio won’t automatically disqualify you from a mortgage, but it doesn’t help either.
Another number lenders look at is your housing cost ratio. This number should be at 28 percent or less. Your total monthly housing costs (mortgage, insurance, interest, taxes, and PMI) divided by your monthly income gives you this number. A home will be out of your price range if it costs more than 28 percent of your monthly income.
How Will I Pay for My House?
Once a lender decides you’re a good credit risk, they’re going to want to know how you’ll pay your mortgage each month. During the loan process, you’ll be asked for a lot of information to verify your current income as well as any assets you may have - investments, stocks, bonds, other property, etc. You have to show that even if things get tough financially you can pay your home loan.
It’s also important to have more than your closing costs saved in the bank. A lender who thinks that buying a home will wipe out your savings isn’t going to make the loan. If you’ve only got what you need to buy the house and get through the closing, keep saving and then talk to a lender. Your chances will be much higher of getting an approval if you’ve got more money in the bank than you need.
Deciding on neighborhoods, flooring, wall colors, and even how you’ll re-do the patio may be fun, but before you get that far in your hunt for a dream home, you’ve got some serious work to do. If you can answer these questions with ease, you’ll be well on your way to buying your next home. If not, keep saving and paying down your debt. Talk to a lender to see if they have any programs that can help you. Once you’ve got your finances sorted, you’ll be well on your way to homeownership.
Did your homework on your finances and you’re ready to buy? Let’s talk!