A growing family may lead you to buy a new home, which can be the biggest purchase you’ve made to date.
Am I Ready to Own a Home?
This is a question that a lot of first-time home buyers ask themselves. While there may never be the “perfect” time to buy a home, there are some honest discussions you should have with yourself, your spouse, or your family before taking the first step towards home ownership.
Are My Finances In Order?
Purchasing a home is probably the largest debt you’ll ever take on. Whether you make plans to repay your new home in 15 or 30 years, your mortgage is likely to be the largest payment you make each month and will use up the biggest portion of your income. So, if you’re carrying a high amount of debt already, this might not be the time to add a mortgage payment to your monthly expenses. Before you purchase a new home, make the effort to pay off any high-interest credit card or personal loan debt. Additionally, you can work on minimizing the balance on any student loans or auto loans.
Is My Income Reliable?
Owning a home is a long-term commitment. So it’s important to realize what you can afford now, but also what you can afford years from now. Do you anticipate any career changes that will significantly affect your income? If you have plans to start your own business or become a stay-at-home parent, then you need to figure whether you can still make your mortgage payments and cover other home expenses when your financial situation changes.
Do I have a Down Payment?
If you’ve been able to budget and save up for a down payment, it’s a good financial indicator that you’re ready for home ownership. Making a down payment is good financial sense because you’ll end up borrowing less money and paying less interest on your loan.
For most conventional home loans, lenders prefer that you make a 20% down payment (20% of the purchase price of your new home). If your down payment is less than 20%, you’ll be required to carry and pay for mortgage insurance until you’ve built a certain amount of equity in your home.
Am I Seeing the Big Picture?
You’ve done the calculations and feel pretty confident with how much money you can put towards your monthly mortgage payments. You’re set, right? Not necessarily. There is a lot more that goes into owning a home than just paying off your mortgage. You’ll need to ensure that you can handle the additional expenses that are associated with your home.
Make sure you adjust your budget to accommodate payments you’ll need to make towards your homeowners insurance, property taxes, homeowner’s association (if applicable), and utilities which include water, sewer, and garbage.
Am I Ready to Handle Emergencies?
If you’ve been renting up until now, you know the ease of calling your landlord or property manager when you’re faced with a broken AC, lack of hot water, or a leaking roof. Not to mention summer landscaping and winter snow removal being taken care of without much thought. When you’re a homeowner, these types of repairs and maintenance now fall on your shoulders.
Even with a home inspection before purchase, emergencies will arise and need to be handled. Before making the first step to a buying a home, you should have an emergency savings fund to cover unexpected costs, as well as the know-how and willingness to put a little elbow grease into fixing things on your own.
Key Numbers You Should Know
There are two important numbers that every potential home buyer should know by heart when beginning the process of purchasing a new home. They are key financial numbers that lenders will review when deciding if they will approve your loan application or not. These are your credit score and debt-to-income ratio.
Simply put, your credit score is a reflection of your credit worthiness. Anytime you apply for a loan, in this case a mortgage, your credit score will be reviewed. It’s a major factor in whether a lender is willing to work with you and what interest rate you will be charged on your loan. You can access your credit score once a year, for free, from any of these crediting reporting bureaus – Equifax, Experian, or Trans Union.
Your credit score is calculated based on the following criteria: Do you make loan or line of credit payments on time? How much outstanding debt do you have? How much credit do you have available? How much are you using? Are debt or bill collectors collecting on money you owe? Are there any liens, judgments, or bankruptcies in your name?
Credit scores of 650-800+ are considered either Fair, Good, Very Good, or Excellent. If your credit score is rated as Excellent, Very Good, or Good, you will have more mortgage options available to you. You’ll receive the best interest rates and repayment plans, as well as lower fees. If your credit score is lower, you’ll have to do a little more to show you’re a worthy borrower because you represent a higher risk of non-payment or default. You will be charged higher interest rates and may be asked to provide a larger down payment or collateral.
Your debt-to-income (DTI) ratio expresses how much of your monthly income is dedicated to paying off your debt. You can figure out your DTI by adding your recurring monthly debt and dividing it by your total monthly gross income. Multiply by 100 to see the number as a percentage.
In the home-buying process, your DTI helps mortgage lenders determine if you’ll be able to manage your monthly repayment. Additionally, lenders don’t want to see that housing expenses make up too large of a percentage of your total debt. A DTI around 36% is considered favorable by lenders, and lenders prefer that no more than 28% of your total monthly debt go towards your housing expenses.
What’s important to keep in mind is that your income is not the most crucial factor in a favorable debt-to-income ratio. It’s possible to have a small income and still have a favorable ratio. At the same time, you can have a very large income and carry a poor ratio. It’s more about what you spend than what you earn.
Should I Be Pre-Qualified or Pre-Approved?
BOTH! These terms shouldn’t be used interchangeably. They are different and play different roles in the home buying process.
You can get pre-qualification from a lender by filling out a simple online form and providing some basic information on your income, debt, and assets. A pre-qualification letter details the mortgage amount you could qualify for. It’s a helpful tool in narrowing down which houses in which price range you can feel comfortable purchasing. However, a pre-qualification doesn’t mean that you are guaranteed to be approved for a mortgage loan.
During the mortgage pre-approval process, a lender will review your finances more thoroughly. To obtain a pre-approval, you’ll submit a formal mortgage application and your lender will review your financial documents and credit history. At this point, you’ll receive a letter with a specific mortgage amount, along with interest rates and terms.
What Mortgage Option is Best?
Fixed Rate Mortgage
With a fixed rate mortgage, your interest rate remains the same for the length of your loan. The benefit is that your mortgage payments remain the same every month. Additionally, your loan is immune to any interest rate hikes that may take place over the next 15 or 30 years. On the downside, you’re unable to take advantage of falling interest rates unless you go through the process of refinancing.
Adjustable Rate Mortgage (ARM)
An adjustable rate mortgage usually offers an initial lower interest rate and lower monthly payments than a fixed rate mortgage. However, after an agreed upon amount of time, the interest rate will increase or decrease to reflect your lender’s current rates and will continue to fluctuate based on market changes over the term of the mortgage. To protect you against rapid rate increases, most ARMs have an interest rate “cap” or “ceiling.” Additionally, some ARMs have a feature that allows you to convert into a fixed rate mortgage.
When deciding between a fixed rate or adjustable rate mortgage, talk through the following questions with your lender: How long do you plan on staying in your home? Are you comfortable with changing mortgage payments?
15- or 30-Year Term?
The most common repayment terms for a new mortgage are 15 years or 30 years. While there is certainly the temptation to have your home paid off sooner rather than later, there are advantages to each repayment term.
When you choose a 15-year mortgage, your monthly payments are higher but you pay less in interest over the course of your loan. Choosing a 30-year mortgage, you pay more for your house because you’re paying more interest, but your mortgage payments are significantly lower.
A 15-year mortgage, and the higher monthly payments that come with it, may be right for you as long as you are confident that you’ll maintain a consistent income and that you’ll have additional money available to build your retirement savings or save for your children’s education.
On the other hand, a 30-year mortgage allows you the advantage of making interest deductions on your taxes for years longer and pocket a little more of your earnings. You can also make additional payments on your 30-year mortgage, whether you use your tax refund to make one extra payment each year or you add an extra $100 to each monthly payment. Here you have both the benefits of a low monthly payment and saving on the amount of interest paid.
The Mortgage Loan Process
Review Your Credit Report
Before you begin your house hunt, review your credit report to ensure you're in good financial standing and to check for any errors. You are entitled to a free credit report from each of the three reporting bureaus on a yearly basis.
Provide LRRCU with top-level financial information, including income, debts, and assets. Pre-qualification gives you a good idea of the loan amount you can expect to receive. Use this information to determine the price range of homes you can comfortably afford.
As your home search gets more serious and you're ready to make an offer on a new home, reach out to a LRRCU Loan Officer for a pre-approval. We will now do a more formal check into your financial history and determine the loan type, loan amount, interest rate, and loan terms available to you. A pre-approval makes you a more attractive buyer.
Final Loan Application
Once your offer has been accepted, you can submit your final loan application. If your pre-approval is more than 90 days old, you'll need to resubmit your financial paperwork, along with additional supporting documents.
LRRCU will arrange for a home appraisal on your new home. A home appraisal will determine the property value of the home you want to buy. This will let us, as your mortgage lender, know if the value of the property is consistent with what you're paying for it.
LRRCU's team of underwriters will review your entire loan package to determine the risk associated with offering you a home loan. They will either approve, suspend, or decline your loan using three critera: credit reputation, capacity, and collateral.
Closing Documents & Funds
Once your loan is approved, your LRRCU Loan Officer will meet with you to sign all necessary paperwork to finalize your loan. We'll release the necessary documents needed for closing and your final funding.
What are Closing Costs?
Closing costs might be the biggest mystery of the entire home buying process. You’ve heard the term, but what exactly are they? Closing costs is a catch-all term for all the various fees you pay to your lender and other parties involved with the closing of your new home. On average, closing costs will represent 2-5% of the purchase price of your new home. They include an interest payment, insurance costs, various lender fees, title fees, attorney fees, and an escrow account payment.
Your lender is required by law to provide you with a Good Faith Estimate (GFE) of what your closing costs will be within three days of receiving your loan application. Then, within one day of your new home closing, your lender will provide you with a final outline of your closing costs. Some of these fees can change as much as 10% between the time you apply for a loan and close on your home. Compare the final to your original GFE and question any charges that have increased dramatically. You always have the option of walking away from your loan if you feel the closing costs presented to you are too high.
While the home buyer typically pays for closing costs, you can ask the seller to cover all or a portion of the closing costs when you submit an offer on a home.