By Tracy Scott
Are you ready to buy your first home? For many would-be home buyers, the answer falls somewhere between “I don’t know” and “Maybe.” Responding with a firm “Yes” is difficult.
Have you selected a neighborhood? Is it located in a good school district? Does the area have low crime rates? These and other critical questions need to be answered. But there are four key areas that should command your focus if you plan on buying a home soon:
- Credit health;
- Debt load;
- Down payment and closing costs; and
- Homeownership expenses.
Focus on these four areas on the path to homeownership and you could be saying “Yes, I’m ready to buy my first home!” in as little as 12 months.
Boost Your Credit Score
Credit scores are calculated using information contained in your credit history report. Higher credit scores result in mortgage loans with the most favorable interest rates and terms. Your prior history with credit, as reflected in your credit history report, is used to assess the risk of extending you additional credit. Poor credit can nix your eligibility for no or low down payment home loans, limit the amount you can borrow, or simply result in a loan denial.
Stay on track to homeownership within the next 12 months by confirming the current state of your credit health and trying to improve it by:
- Bringing any past due or delinquent accounts current. Commit to making on-time payments to your creditors since even one late payment can lower your credit score.
- Paying down debts since the closer you are to your credit limits, the lower your credit score. Lenders look at your credit utilization ratio to determine if you might be a high risk borrower. Applicants with accounts close to their credit limits appear to be relying too much on credit. Keep account balances low or pay them in full.
Order free copies of your credit history report from AnnualCreditReport.com as soon as possible. Ensure the information listed in each report is correct. File a dispute with each major credit bureau if incorrect data is found. Dispute procedures are available on each bureau’s website.
Reduce Your Debt Load
The debt you carry over each month not only impacts your credit score, but also your debt to income (DTI) ratio. This ratio is used by lenders to determine if your income can support an additional debt obligation. DTI calculations may use your monthly or annual income and compare it to your minimum debt payments or your overall debt balance to arrive at a percentage. Each lender has their own requirements related to DTI cutoffs. But, most prefer to approve borrowers with DTIs of less than 36 percent. Estimating your DTI is simple.
For illustrative purposes, let’s calculate Helen’s DTI using her monthly income.
Helen Homeowner has a gross monthly income of $5,000. Her car loan and credit cards require $2,000 in minimum payments each month. Her DTI is 40 percent.
Helen can increase her income or reduce her debt obligations to improve her DTI.
The lower your DTI the more home you might be able to afford. Use the next 12 months to lower your personal DTI.
Save for a Down Payment and Closing Costs
Putting money aside for a down payment and closing costs should begin early and occur often. The property and type of mortgage loan program you use will determine how much of a down payment you’ll need. Use a mortgage calculator to estimate how different mortgage loan amounts and monthly payments fit within your budget.
When you identify a loan amount that makes sense for your financial situation, examine homes in your price range and plan to save up to 20% of the asking price in a designated savings account. This will give you a ball park down payment figure. You might need more or less depending on the actual cost of the specific home you choose.
You may be eligible for zero, 5%, or 20% down programs and you won’t know until you apply. But don’t wait to start saving. Extra funds saved for a down payment that are not used can always be transferred into an emergency fund savings account. Keep in mind that even if you opt for a zero-down loan program, you must still pay closing costs which can run 2% to 7% of the home sales price.
Actual down payment and closing costs figures will be finalized and provided to you shortly before you sit down at the closing table. Remember that after your offer to purchase the home is accepted, it can take several months to complete the real estate transaction. Meanwhile, you should receive estimated closing figures. Use that time to gather additional funds, if necessary.
Research Homeownership Expenses
The cost of homeownership extends beyond the monthly mortgage payment. It’s important to gather estimates of these costs to determine how they fit within your budget. Researching these expenses early allows time to shop around for the best prices. Waiting until closing may result in simply choosing the default option suggested by your home builder or realtor, which might be the most expensive option. Examples of additional costs might include:
- Homeowners Insurance – A type of insurance that covers losses related to the structure, property and assets in the home.
- Security system installation and monthly monitoring.
- Homeowners Association (HOA) fees – Some neighborhoods require the payment of HOA fees by its residents to cover the costs of maintaining clean and operational amenities along with seasonal landscaping.
- Remember that other monthly bills might increase based on the utility services available in your new neighborhood, e.g., electric versus gas.
Planning for your first home purchase is smart. Taking the time to prepare for that purchase is even smarter. If you’re already prepared to buy a home, learn more about Generations Mortgages at MyGenFCU.org/Mortgage. (And if not, we’ll see you next year!)