Unless you have enough cash to buy a home outright, acquiring a home requires finding a lender who thinks you’re a safe bet. This means it’s time to get your finances in order.
Affording a home includes both short-term and long-term costs. Lenders can confirm that you have enough money for a down payment, but what they really want to know is whether you can be depended upon to repay the loan in the years to come. So, in addition to tallying your current cash balance, lenders will do a deep dive into your financial history.
The best thing you can do before you start perusing homes for sale is to get pre-approved for a loan. This will do two things: it will save you time and make you a more attractive buyer. Once you’ve been preapproved, you won’t waste time looking at homes you cannot afford. And when it comes time to make an offer, the seller won’t have to worry about whether you’re qualified, putting your offer above buyers whose ability to buy the house may be in question.
Just so you know, in our area people often spend about 35 percent of their gross income on housing (principal, interest, tax, and insurance).
Proving Your Worth
To prove that you can currently afford the home you’re seeking—and that you’re likely to be able to continue to afford this home, lenders will ask to see the following information.
- Proof of verifiable income (w-2 and tax returns)
- Employment history
- Employment verification (and assurances from your current employer that you’re likely to remain employed for the foreseeable future)
- Proof of cash for your down payment and closing costs
- Recent banking activity
- Credit report to evaluate how much debt you already have
- Credit score
If your income is all under the table, getting a conventional loan will be nigh impossible.
A History of Debt Can Be Good
Lenders want to figure out your debt-to-income ratio (DTI)—that is, your monthly debt stacked against your gross monthly income. Part of how they do this is to compare how much you owe to how much available credit you have.
As strange as this sounds, from a lender’s point of view, it’s actually better to have a long history of borrowing and paying the money back than it is to have saved up and then spent your savings.
Lenders love it when you have plenty of available credit, so don’t close that credit card with a zero balance, and if you can afford to, keep your credit card balances low while you’re getting approved for a loan by reducing purchases or sending payments before they are due.
Choosing the Right Loan
A good place to start when considering a home loan is to determine how much you can reasonably afford in monthly payments. Lower down-payment loans usually come with higher monthly payments, either because of the private mortgage insurance requirement, a higher interest rate, or both. So, if you can make a higher down payment, you’ll usually have lower monthly payments.
There are five major categories for home loans.
Conventional – These usually require 20 percent down and a minimum credit score 620. The terms for these loans are among the most favorable. You can get a fixed-rate or variable-rate conventional loan.
Jumbo – These loans exceed the “conforming loan limit” for your geographic area. These larger loans tend to be a little more expensive with higher loan fees up front or a higher interest rate. They are more expensive because the originating broker cannot sell the loan to Fannie Mae or Freddie Mac.
Fixed Rate – A fixed-rate loan means the interest rate is the same for the life of the loan.
Adjustable Rate – An adjustable-rate loan means the interest adjusts as the market changes. If rates go up, your loan’s interest rate goes up and vice versa. These loans often have maximum rate changes allowed for a given year and over the life of the loan.
Step-rate – These loans have a planned schedule of when the interest rate will change. The rate is negotiated ahead of time and not affected by market conditions. This arrangement is common with seller financing situation.
The long and short of it is that you should ask your Realtor for a list of local lenders so you can get pre-approved before you start house hunting.
If you have questions about property management or real estate, please contact me at rselzer@selzerrealty.com or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery.
Dick Selzer is a real estate broker who has been in the business for more than 45 years.