Congratulations! You’ve made a big decision and are ready to become a homeowner! Before you start looking at — and falling in love with — a house, find out how much you can afford. This involves talking with a bank (also called a lender) or mortgage broker, sharing some financial details and getting a letter with an amount they’re willing to lend to you. This article will walk you through the process but first, let’s clarify some jargon.
Bank vs. mortgage broker — If you’re looking for car insurance, there are dozens of choices. You can just pick one and sign up but how can you be sure you’re getting the best rate for your unique situation? Instead of just calling Aetna or Geico and paying whatever or getting a bunch of quotes, you may decide to use an insurance agent. The agent will compare rates and plans at different companies and negotiate the best situation for you. The insurance company pays the agent for the referral and everyone is happy.
With a mortgage, it works the same way. You can contact any bank or credit union to compare rates and plans or you can contact a mortgage broker who will do that work for you. There’s no wrong answer. If you decide to go directly to the banks, you should know that you can negotiate. If you liked a specific loan officer but their rate was a little higher, let them know you got a better deal from another lender. Odds are, they can meet or beat that interest rate.
Pre-qualification vs. Pre-approval — Although these terms are used interchangeably, they are not created equal. The pre-qualification or prequal is a good — but not necessary — first step. The lender will run your credit and use income and expense numbers that you provide to give you a ballpark of what they’d lend you. This is great for identifying anything negative on your credit report that you can fix before getting the loan. Normally, the figure they give you should be close to what they’ll actually lend.
The pre-approval is a much more involved process. The lender will require copies of tax returns, W2s, bank statements, and they’ll run your credit. If you have information on the house that you want to buy, they can factor in taxes, condo fees, etc. to give you a more accurate figure. When you’re ready to buy the property, a pre-approval letter carries more weight with the sellers’ agent than a prequal. It’s also more likely to identify any problems that could derail your ability to buy a house. Since you’d want to fix these issues ASAP, you might want to skip the prequal and get a pre-approval letter. Here’s some more info from Bank of America.
Seasoned Funds — Whether you’re working with a lender or broker, they both need to follow the same rules and guidelines. The money laundering regulation requires that any money used to buy real estate must be seasoned or be able to be sourced. What does that mean? Lenders will require that you show them your previous two months’ bank statements. For every deposit over $1000 on one of those bank statements, you will have to prove to the lender where you got the money.
For example, your parents know you’re house hunting so they give you $5,000. The money has to be in your bank account or the lender won’t let you use it toward the down payment, so you deposit it. The loan officer sees the $5,000 on your bank statement and asks you the source of the money. You tell them that your parents gave it to you. Your parents now have to write a letter saying they gave the money to you as a gift — not a loan that needs to be paid back. Now the bank needs to see where your parents got the money. They’ll request bank statements from your parents showing the money coming out of their account. Messy, right? Avoid all of this by putting any money that you plan to use — whether it’s under the mattress, a gift, or whatever — into your account right now and not applying for a mortgage for at least two months. As long as the deposit shows up on the bank statement before the ones you give to the bank, you’re golden. Here’s more info from Doughroller.net.
Now that we’ve got the jargon out of the way, here are a few things to consider before you talk to a lender or broker:
- How much do you want? It’s a good idea to first figure out how much you’re comfortable spending per month on your housing and then talk to a lender and see what they’re willing to lend. If you skip this step, you could find yourself with a mortgage that keeps you awake at night. You may also find the opposite — that you feel you can afford more based on what you’ve been saving. If this happens, talk to the lender and see if there are some changes you can make that will get you approved for a higher loan amount.
- Do you look good on paper? I’m self-employed. Because I have a good accountant, I have a ton of tax deductions. That’s great for me at tax time but not so great when getting a loan. If a lot of your income doesn’t end up on your tax return, you may have trouble qualifying for the loan that you know you can afford. Some people in this situation will file amended tax returns for the past two years to increase their income or get a co-borrower.
- What’s your DTI? Your debt-to-income ratio has a lot to do with the loan you can get. Banks look at your minimum monthly payment for all debt so paying off a loan early can really help. Add up the minimum monthly payments for all of your credit cards, car loans, student loans, etc. The DTI guideline is 36% including your mortgage so the higher your personal debt, the smaller the mortgage.
- How’s your credit? Low credit scores can affect your ability to get a loan or force you into a higher-interest program. Request your credit report and see if there is anything that doesn’t look right. It takes at least few months to resolve issues and clean up errors so do this today. Once you decide to buy a house, stop applying for other types of credit — no more store credit cards, etc. Every time you apply for a new credit card, the query hits your credit report. Too many requests will lower your score. Also avoid making any major purchases. I had a client whose loan request was rejected because he decided to buy a purebred dog for $7,000 after putting in an offer on a condo. Be aware that most lenders don’t use FICO, so the score they use will likely be different than what you see online. Here are some more tips from Experian.com.
The more you can do ahead of time to improve your credit worthiness, the better off you’ll be when you start interviewing lenders. Like all of the professionals who will form your home-buying team, both the loan officer or mortgage broker and the company behind them, are important. It’s a long-term relationship so you should trust the person, believe that they know their stuff and be comfortable with their communication style, how quickly they get back to you, etc. Don’t chose someone who you feel doesn’t respect your or who condescends to you when you ask questions. All mortgage professionals are not created equal. Keep shopping until you find a good fit.
To help you find a reliable and efficient mortgage lender to assist you with the entire process, the editorial team at Money put different mortgage lenders to the test and laid out what they offer so you can start your home buying journey informed and ready to go.
A final note about fair housing. Even though this is the 21st century, there are still people out there who discriminate and do other bad things to good people. If you feel you’ve been treated unfairly or haven’t got the interest rate or the loan amount that you feel you deserve, report it. We can’t stop these practices if we don’t know they’re happening so please don’t suffer in silence— and remember, I’m here to help.
How about incorporating your finances into your goals for the new year? Get advice here.
Next week: HBU E04 - Credit Score
Did you miss Part 1?
Your rights under Fair Credit Reporting Act.
