The spring home-selling season is nearly here. If you’re ready to buy a new home, you’re probably itching to tour new condos, Victorians and Cape Cods. But before you head off to even your first showing? You need to make some smart financial moves to remove as much stress as possible from the mortgage-lending process.
Here, then, are four moves you absolutely need to do to prepare for this spring’s home-buying season.
Determine how much home you can afford
You don't want to waste your time looking at homes that cost $300,000 if you can only afford one with a price tag of $200,000. Those less expensive homes won't look quite as nice after you've toured ones that are out of your price range.
That's why Umesh Patel, a mortgage loan officer at Jax Federal Credit Union in Jacksonville, Florida, recommends that you calculate how much of a monthly mortgage payment you can afford before you schedule any home visits.
Patel uses this formula: Multiply your annual gross income -- your income before taxes are taken out -- and multiply it by 28 to 31 percent. Then divide the result by 12. That is the estimated mortgage payment you can afford each month.
Here's an example: Say you and your spouse make $90,000 a year before taxes. Multiplying that by 31 percent leaves you with $27,900. Dividing that by 12 gives you about $2,325. That's the maximum mortgage payment you should take on each month.
"This formula is not set in stone, but it is a good guideline for estimating what you can comfortably and reasonably afford," Patel said.
Build that credit score
Katie Ross, education and development manager for American Consumer Credit Counseling in Auburndale, Massachusetts, says that consumers should also order their credit reports and credit scores before they go house hunting.
Lenders today rely on your three-digit credit score to determine if you qualify for a mortgage and at what mortgage interest rate. Lenders today consider FICO credit scores of 740 or higher to be particularly strong ones. Have a FICO score under 640? You'll struggle to get approved for a loan.
Ordering your credit score isn't free. You'll generally have to pay about $15 to either of the three national credit bureaus -- Experian, Equifax and TransUnion -- to get one of yours. Ordering your credit reports from these bureaus, though, is free. You can order one credit report from each of the bureaus at no charge once a year. You can order these reports from AnnualCreditReport.com.
Your credit report is different from your credit score. Your reports list basic financial information about you, but also lists any late or missed payments, financial missteps such as past bankruptcies and the amount of money you owe on your credit cards. Ross says that you should study your reports carefully. If you find any incorrect information, correct it with the offending credit bureau.
"Know your credit score, it is the first thing a bank will look at when determining whether they will grant you a mortgage," Ross said. "If you find that your score is lower than it should be to purchase a house, take some time to improve it so that by the time you are looking to buy a house, it's at the appropriate level.
That last point is important. It is possible to improve your FICO credit score. Paying all your bills on time each month and reducing as much of your credit-card debt as possible are good places to start. But doing this takes time. There is no fast way to boost your score. If your score will consign you to a high interest rate? It might make sense to wait until you can improve it before buying a house.
Getting pre-qualified is easy. You simply call a lender, tell that lender how much money you make and how much you owe, and the lender tells you how big of a mortgage it is willing to give you.
Pre-approval, though, actually takes some work. To earn a mortgage pre-approval, you have to send your lender copies of such financial documents as your paycheck stubs, taxes and bank statements. Your lender will then use these documents to verify that you are telling the truth about your income. Your lender will also run your credit. Armed with this information, your lender will provide you with a written pre-approval lender stating that it is willing to give you a mortgage. The letter will state how big of a loan the lender will give you.
Ty J. Young, chief executive officer of Ty J. Young, Inc., a national wealth-management firm based in Atlanta, said that not only does a pre-approval letter tell you how much of a home you can afford -- you can't buy a $250,000 home if lenders will only give you $180,000 in mortgage dollars -- it makes you a more attractive buyer to sellers. If you and other buyers are all making offers on the same home, sellers are more likely to accept an offer from buyers already pre-approved for a loan.
"Make sure to get a pre-approval letter in hand before starting the process," Young said. "It puts you in a stronger negotiating position to get a lower purchase price."
Build up your savings
Paying for a home is expensive. You’ll need a down payment, of course. That can vary, but you can expect to pay at least 3 percent to 10 percent for a down payment for an FHA or conventional loan. For a home costing $200,000, that down payment of 10 percent comes out to $20,000, while one of 5 percent is still an intimidating $10,000.
If you can put 20 percent down, you'll avoid the cost of mortgage insurance, an ongoing fee which runs about one-half to 1 percent of your loan amount per year.
You’ll also have to pay for the closing costs of your new mortgage. That will vary, too, but you can usually expect to pay about 2 percent to 5 percent of your mortgage amount in closing costs.
So, yes, you will have to build up your savings. In fact, most lenders want you to have enough money saved in your bank account to cover at least two months of mortgage payments.
You can rely on gift funds from family members to cover your down payment, if you have particularly generous relatives. These relatives, though, will have to provide a written letter stating that the money they are giving you is a gift and not a loan that you have to pay back.
And these costs aren’t the only ones you should consider when determining how much money you need to save.
Paul Cones, president of CourthouseDirect.com, a Houston-based company that provides public and property records for the real estate industry, said that too many buyers forget to take into account costs that can vary by community, everything from property taxes to utility bills to homeowner association fees.
"While you may have everything else in place for the home purchase, there are plenty of other expenses associated with owning a home that may put potential homes out of your budget," Cones said.
Cones recommends that home shoppers look at the property records for homes in the areas in which they'd like to settle. They can then get a better idea of how much the property taxes and other local fees might cost them, he said.