One way to gauge if you are financially ready to buy a home is to ask yourself the following four questions:
1. Is My Credit in Good Shape?
Before lenders approve a home loan, they will analyze your ability to repay it. To make this determination, lenders will obtain your credit report from one or more credit reporting agencies. The credit report shows how much you owe, to whom, if you make payments on time and how much credit you have applied for.
In addition, lenders will look at your credit score, which is a number that is calculated based on the information in your credit reports. Think of the number as a snapshot of your credit risk at that point in time.
What Credit Scores Mean
If you have poor credit and a low credit score, lenders may evaluate you as a higher risk for not repaying the loan. As a result, they may charge you a higher interest rate or possibly turn down your loan application altogether.
You can avoid surprises by getting a copy of your credit report from the three main credit reporting agencies before you apply for a home loan. If there are mistakes on the reports, get them corrected immediately. The three agencies are:
You can also obtain your credit reports for free from AnnualCreditReport.com. By law, consumers are entitled to one free credit report from each agency every 12 months. It’s also helpful to check your credit scores at this time. There are resources that allow you to check your credit scores for free, including Credit.com.
If you have less than perfect credit, be prepared to explain to the lender why. If you have no credit accounts, show the lender your cancelled checks and other documents to prove that you pay your rent, phone bills or utility bills on time. You also might decide to delay buying a house until you’ve improved your credit or established a credit history. The following steps can help you improve your credit over time:
- Pay your bills on time.
- Reduce your debt by paying off your credit cards.
- Only apply for the credit you really need.
2. Do I Have a Steady Job History?
A steady job gives lenders more confidence that you can repay a home loan. If you have been working continuously for two years or more, even if not in the same job, you are considered to have steady employment. Be prepared to explain to the lender if there are reasons why you have not been employed continuously, such as an illness or just finishing school or military service.
3. Can I Afford to Make Monthly Mortgage Payments?
The answer to this question depends on how much you earn and how much other debt you have. As a general rule of thumb, a lender will want your monthly mortgage payment to total no more than 29% of your monthly gross income (that’s your monthly income before taxes and other paycheck deductions are taken out). Add other long-term debt, such as car and student loans, and most experts say that the total should take no more than 36 to 41% of your monthly gross income.
4. Have I Saved Enough for a Down Payment?
In the past, down payments that equaled 20% of the purchase price were typical. Today, however, qualified borrowers who have good credit, but limited savings, can purchase homes with five, three, or even zero percent down — but the less you put down, the higher your mortgage payment.
You also will need money for closing costs to cover items like appraisals, loan origination fees, processing fees and so on. In addition, in return for an interest rate below prevailing rates, you may be charged “points” by the lender. One point equals 1% of your loan, and that amount is due at the time of closing. Online calculators can help you estimate your closing costs. Also know that you may be able to negotiate with the seller to pay certain closing costs.
“Grading” Your Answers
If you can’t answer “yes” to each of these four questions, don’t get discouraged. Simply give yourself a little more time to get ready financially to buy your home. In addition, check into federal and local home buying programs that specialize in working with people with limited financial resources.
This post was provided by Credit.com partner The Financial Planning Association.
More on Mortgages and Homebuying: