Its 2010! A New Year and a New OPPORTUNITY to determine what kind of real estate investment works best for you! You resolved to make a new start to purchase property and become part of the 70% of American households that are homeowners.
Homeownership definitely has its advantages. It is an opportunity to build wealth through home equity and appreciation; it provides tax benefits and it makes you the final decision maker and “ruler of the castle” for the property you live in. This STEPS TO HOME OWNERSHIP series will provide some information that will help you determine if now is the time for you to purchase a home or stay a renter.
Step One: Finances – Show me the Money!To purchase a home you need cash or a mortgage loan. Cash can be sitting in your bank account, in a line of credit, or in a financial security that can be liquidated or borrowed against. As a potential buyer you can also borrow money from financial institutions or private investors to fund the purchase of the property. Given all the recent defaults in the mortgage market, lenders are now being more responsible to potential buyers by sticking to more consistent standards in qualifying potential home buyers and disclosing costs associated with getting a loan to purchase a home.
The three key things considered by the lender in the loan approval process are: 1) the credit score; 2) the monthly debt-to-income ratio; and 3) cash on hand or access to cash to pay costs associated with the purchase of the home. *
1. Credit Score - Many people do not have a clue of their true credit score. To purchase a home, or even to rent, a credit report is required. The lender will ask you to provide your social security number so they can pull your credit report as the beginning step in your home purchase process. If you are not seriously looking for a home and just want to know your score, you can request a free credit report once a year with no impact to your score. Unlike consumer credit inquiries, you can have your credit pulled by a financial institution multiple times in a 30 day period while you are shopping for a home loan and it will not affect your credit score.
Most lenders are looking for a credit score of at least 620 or above. If your score is below 620, it is an opportunity to see what items on your credit report require your attention to bring your score up. There are numerous free and paid credit counseling agencies that can assist in this area.
For most lenders, the credit score is the initial criteria used to determine if you will be able to move forward in the loan approval process to finance the purchase of a home.
2. Debt-to-income ratio – After the lender has pulled your credit and determined they can begin the loan process for you, they will require a loan application and various documents to verify your income. This may include 3 months of pay stubs, your last 2 years W-4s, and a list of your current credit obligations. This information is reviewed and one key area the lender is looking at is your debt-to-income ratio. Simply put it represents your monthly obligations as a percentage of your monthly income. There are many ways to approach this…but one way is taking the things that make up your mortgage payment, PITI= principal & interest, tax & insurance and dividing that by your income. If PITI/income is 45% or less, this leaves a little over half your monthly income to cover other expenses.
As a new home owner, you really don’t want to pay your monthly income for a mortgage and after other expenses, like food, water, gas/oil, electricity, phone, transportation (car note & gas), cable, internet, and entertainment….you have ZERO funds left over for things like travel, entertainment and yes emergencies. You may love the idea of owning your home, but if this percentage is too high, under current guidelines, the lender will not be able to lend you the money if your ratios are too tight.
On the flip side, the lender may approve you for a loan based on basic recurring expenses and income, but there may be other expenses like entertainment & travel which are not readily reflected.
Don’t leave it all to the lender. Preparing a budget is a good step to make sure you have considered all the expenses that are important to your lifestyle when deciding the affordability factor for your new home.
3. Cash Needed to Purchase - A minimum of $2000 cash on hand is a good estimate of upfront funds to get started. These funds cover your deposit, given at the time of contract signing (please note that the deposit can range from $1000 to 10% of the purchase price); the cost of your home inspection; and the cost of your lender appraisal of the home. Let’s call these upfront costs.
Add to that your down payment. For the three most common loans expect a minimum of 0% of the purchase price for a VA loan; 3.5% for an FHA loan; and from 5%-20% for a conventional loan.
And lastly you will need money for closing costs which may include one year’s worth of home insurance, at least 3 months of taxes, title insurance, and lender fees. This can add up to 3% to 6% of the cost of the home. Your lender should provide you with a “Good Faith Estimate” of the costs to purchase a home. This estimate should be updated once you select a specific property and you know the exact taxes, insurance and title information related to the property you selected.
Finances play a key role in the purchase of a new property. The lender is the professional who will review your financial information and talk with you in detail about your purchase options, including the type of loan and the interest rate for the loan. The lender will be able to answer all the questions about your loan. The lender will also provide a preapproval letter and ultimately a loan commitment letter to your realtor. This letter lets your realtor know that you are ready to begin looking for homes in the price range determined by you and the lender.
For more information: I am your one stop shop to exploring your financing options!
Clara Lyons
I turn real estate dreams into reality – One home at a time!
856-264-1058
ClaraSellsHomes@gmail.com
*The figures quoted in this blog are estimates. The info presented is a snapshot of some factors used by lenders and is not intended to represent all the factors taken into consideration in the loan approval/credit rating process. There are a range of loan options and programs. Each financial institution reserves the right to establish financial guidelines and credit worthiness.
