Some Financial Insights For First-Time Homebuyers
Unless you have just won the lottery, inherited a large sum, or your start-up business took off like a rocket, you probably cannot afford to pay for your first home with cash. The fact is, most first-time home-buyers – as well as many second and third-time home-buyers – need to obtain financing in order to purchase a house.
So when you are tired of renting and get the itch to actually buy your first home, the question that is sure to be at the front of your mind is: Can I really afford to buy a house?
Your answer will be determined by understanding what financial institutions look for in determining whether and how much they are willing to loan for a home. Once you get your financial house in order, you can go about seeking a loan pre-qualification from a lender, and start home-shopping.
Understanding Your Home Purchase Financial Profile
A home loan will probably be the largest debt you will ever take on, and that means mortgage lenders are going to be very careful in evaluating your creditworthiness in regard to a home loan. There are several things that a lender will require you to provide, so your first step will be to gather documentation to substantiate your financial situation. Let’s take a look at these items.
Your household income is the first important factor. To substantiate your income, you will have to provide more than just pay stubs. Lenders want to see that your employment has been relatively steady over a period of time. If you have only had your current job for a month or two, a lender is going to dig pretty deeply into your overall earning history and capacity. But if you have had your current job for a few years, your income numbers will likely be accepted.
Your overall debt and debt-to-income ratio are also important. If you have credit card loans, automobile loans, student loans, or other debt, a lender will look at the total debt number to evaluate whether you are overextended, and also determine the cash outflow needed to service these debts monthly. This outflow number is put against your gross monthly income number to calculate a debt-to-income ratio. While every lender is a little different, few lenders will offer to finance if your debt-to-income is higher than 43%. In other words, your overall monthly debt payments (including the home loan payment) will need to be less than 43% of your gross monthly income in order to obtain approval for a mortgage loan. The lower the ratio, the better.
Your credit report is another indicator that lenders evaluate. The three major credit reporting bureaus track your debt and debt payments, and give you a score based on how promptly you pay your debts, how much debt you carry compared to how much credit you are offered, and the length of your credit history. A lender will want to see scores that reflect at least a “Good” credit rating. “Very Good” and “Excellent” ratings are, of course, preferred. Credit bureaus are legally required to let you see your credit report, and it will be wise to review them to make sure they are accurate before you apply for a loan.
If you gather these numbers together and they don’t look too promising, it may be wise to “fix” your financial situation before sitting down with a lender. Some options may be to transfer or consolidate credit card debt to a card with a lower interest rate and lower payments to improve your debt-to-income ratio; wait a short while for a raise that you anticipate to materialize, or wait a few months so that you have a longer employment history, or pay off some of your debt. Believe it or not, reorganizing your finances specifically to appeal to a mortgage lender can have a large impact on your ability to obtain the home loan that you want.
Designated Cash Savings for Your Down-Payment
The other important factor in purchasing a home is how much you have available for a down payment. The greater the percentage of the home price you are able to put down, the easier it will be to get a loan since lenders prefer to limit their exposure in case of default.
Ideally, you want to be able to put down at least 10% but many lenders will work with 5% or even 3%. If you qualify for a VA or USDA loan, you may be able to get into a house with 0% to 3% down.
But putting a low amount down comes with a cost: your monthly mortgage payment will be higher, and private mortgage insurance (PMI) is usually required when a buyer has less than 20% equity–a cost that gets added to your monthly mortgage bill.
Before you embark on your home-buying quest, figure out how much you can put down as a down payment. The funds can come from your savings, but there are other ways of gathering funds. Often, parents are willing to gift funds for a down payment, or you can opt to use retirement funds. However, if you use a 401(k), be aware that you will pay a penalty as well as taxes on any amount you withdraw. For IRAs, first-time home-buyers may withdraw up to $10,000 from their accounts for a down payment without penalty, but they will have to pay taxes. You will need to calculate whether the liability is worth the investment; it may be that the home’s increase in value or the money you save on mortgage payments will more than makeup for the taxes and penalties.
If you feel as though the financial side of the home buying process is daunting, the Prime Real Estate Group can help. You aren’t the first person to have questions about the process, and our Mortgage Loan Originator can help you navigate your way to buying your first home. Contact us today at Prime Real Estate Group to learn more.