An important early step in the home-buying process is to make sure you can actually afford to buy.
If you’re in the market to buy a home, you may have already started shopping for properties online. Perhaps you’ve driven by some houses “just to look” and even attended a few open houses. Well, hold your horses: You’ve already missed a crucial first step in the home-buying process.
“You need to meet with a lender before you dive in to your home search,” says Peggy Yee, a supervising broker at Frankly Realtors in Vienna, VA. Granted, sitting down to take a look at your finances — and sift through pages of paperwork — isn’t the most exciting part of the home-buying process, but doing this work upfront can help you get your finances in check — and enables you to quickly put in an offer on a home.
By meeting with a lender, you’ll be able to learn about different types of loans, ask questions, and, most important, determine your buying power. After all, without knowing what you can afford, you may be wasting time looking at homes that are outside your price range. Looking for a lender in your area? Quickly find one on Trulia.
To get a sense of your budget, use Trulia’s Home Mortgage Affordability calculator. Then, if you’re serious about buying a home, take these steps through the financing process.
Know what type of property you want to buy
Before meeting with a lender, think about what type of property you’re looking for. Are you in the market for a single-family house? Townhouse? Condominium? By choosing to buy a condo or property in a homeowners’ association, you typically get the benefit of having your association fees cover the home’s exterior maintenance and repair costs, which can decrease your month-to-month expenses. For instance, you also don’t have to hire landscapers. However, mortgages for condos and townhomes usually have higher interest rates than loans for single-family homes; expect to pay an extra 0.125% to 0.25%.
If you’re having trouble deciding, grab a sheet of paper and jot down the pros and cons for each type of property — it’ll be easier to assess what it is you want when you have the criteria in front of you, rather than just ideas floating in your head.
Find a reliable lender
When you shop for a car, some dealerships are better than others; the same goes for mortgage lenders. Get recommendations from your home-buying friends and family or your real estate agent. Or you may want to consider a mortgage broker. A crucial note: You’re not obligated to use the first lender you meet with — even if you get a preapproval letter from them. “You should always meet with multiple lenders and compare interest rates,” says Indianapolis, IN, real estate agent Christine Dossman.
Get started early
Aim to meet with a lender three to six months before you start seriously looking at properties and get pre-approved for a loan. To get pre-approved, you’ll typically need to provide the lender with a substantial amount of paperwork, including bank statements, pay stubs, W-2 forms, 1099 forms, and tax returns. The lender then reviews these documents and pulls your credit score before determining your buying power. If the lender decides to offer you pre-approval, you’ll receive an estimate that spells out the amount that you would likely qualify for. The mortgage will still need to go through official underwriting after you sign a purchase agreement on a house.
Once you have a pre-approval letter in hand, you’re in the position to seriously start window-shopping and make an offer on a property. By looking at properties without getting pre-approved, you’re setting yourself up for disappointment. For example, if you come across your dream home at the same time as a buyer who has already been pre-approved, your offer could be last to the table and you could very well miss out.
Compile the necessary paperwork
When you meet with a lender to get pre-approved, you’ll typically need to provide a number of documents, such as recent bank statements, pay stubs, W-2 forms, 1099 forms, and tax returns from the past two years. Prepare yourself: These may take a substantial amount of time to gather depending on how organized you are. You’ll also need to show proof of where your down payment money is coming from. If the cash is from a gift, you’ll most likely have to pay taxes on the money, but there are some exclusions. (Check the IRS guidelines here.)
Prepare to whip your credit into shape
A lender is going to look at several factors when assessing your ability to pay a loan on time each month; your credit score is one of them. Five aspects impact your score, each varying in importance: payment history (35%), credit utilization ratio (30%), length of credit history (15%), credit mix (10%), and new credit (10%).
Borrowers with high credit scores (760 to 850) typically qualify for the best interest rates. If your credit score is just shy of 700, getting it over the 700 point could help you nab a substantially lower rate. Have a credit score below 620? You may still get approved for a mortgage, but you’re probably better off nursing your credit first and then buying.
You’re entitled to an annual free copy of your credit report from each of the three major credit bureaus: Equifax, Experian, and TransUnion. Unfortunately, “many homebuyers have no idea what shape their credit is in,” says Staci Titsworth, a regional manager at PNC Mortgage in Pittsburgh, PA. If you haven’t checked your credit report recently (or ever), you may be surprised what you find: One in four Americans said they spotted errors on their credit reports, according to a 2013 Federal Trade Commission survey.
By meeting with a lender three to six months before digging into your home search, you’ll be able to assess your credit and have time to make any necessary repairs. If you haven’t yet, you can use Trulia to quickly find a lender in your area.
Determine your down payment
Cash is king in the home-buying game. In other words, the more you can bring to the table upfront, the more attractive (and stable) you may appear to a lender. You may have heard that it’s best to make a 20% down payment. In many cases, by putting down 20%, you eliminate the need for private mortgage insurance (PMI), which can be expensive depending on the type of loan you use. You can also negotiate for a lower interest rate and, in competitive markets, putting down 20% can give you an edge over buyers who don’t, whom sellers may view as a riskier option. Making a 20% down payment can also help you snag a lower interest rate, thus decreasing your monthly payment and how much you’ll pay in interest over the life of the loan.
Evaluate your budget
Lenders want reassurance that you’ll be able to make your mortgage payments on time in addition to all of your other financial obligations. To do this, they determine your debt-to-income ratio. First, they’ll look at your front-end ratio — your monthly housing payment (including insurance, interest, taxes, and PMI, if applicable) divided by your monthly income. The general rule of thumb is to keep this at or below 28%.
Next, the lender will look at your back-end ratio, which shows how much of your monthly income goes to service your existing debt (e.g., car loans, student loans, credit card payments). This is your total monthly debt payments divided by your monthly household income. The general rule of thumb is to keep your back-end ratio at or below 36%.
While landing above these suggested ratios won’t necessarily end your journey to homeownership, it can worsen your loan terms.
Shop around for the best deal
Meet with at least three lenders to explore your financing options and compare interest rates. To make sure you’re getting an apples-to-apples comparison, ask each lender for a loan estimate, which breaks down all the fees for you. Some fees are non-negotiable, such as the origination fee, which is typically 1% of the total value of the loan. However, you may have some negotiating power in terms of the interest rate.
Since mortgage rates can change daily, you should shop around within a short time. If you receive a loan estimate from one lender on Monday and then wait a few days to get an estimate from another lender, the second lender might be able to offer a better deal than the first one did simply because the market changed since Monday.
If one lender offers a lower interest rate, revisit the other loan officers and see if they’ll offer to beat the rate. “If they can’t beat it, they may be willing to match it,” says Sylvia Gutierrez, a loan officer in South Florida and author of Mortgage Matters: Demystifying the Loan Approval Maze.
Still mulling over whether you want to buy a home now or wait a few years? Consider that interest rates on a 30-year fixed mortgage recently fell to 3.57%, the lowest mark in three years, according to Freddie Mac.
… But don’t consider only interest rates
The best mortgage lender isn’t necessarily the one that offers the lowest interest rate, says Todd Sheinin, mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD.
You need to find someone you feel comfortable with, since you’ll be working closely together over the course of your home search. This is more of a “gut check,” says Sheinin, where you need to ask yourself whether you trust the lender. To make an accurate assessment, you should meet with each lender in person rather than trying to gauge their personalities by phone or email.
Ask these questions to effectively evaluate prospective loan officers:
- How many years of experience do you have?
- What types of loan programs do you offer? (Some lenders are not approved for specialized loans, like Department of Veterans Affairs loans or Federal Housing Administration loans.)
- How many clients are you currently working with?
- Will you be available during nights and weekends if I have pressing questions?
- How long will it take to process my loan application?
- What precautions do you take to keep my personal information secure?
- What sets you apart from other lenders?
Assemble your team
To ensure your loan gets approved by your settlement date, your mortgage lender and your real estate agent will need to collaborate throughout the home-buying process. If they’ve worked together in the past, they probably know each other’s communication style, but if they’ve never met, you want to make sure they connect and get on the same page before you start viewing properties.
You’ll also need to select a title company. The title company is primarily responsible for verifying that the title to the property is legitimate so that you can be sure you’re becoming the rightful owner of the property. The title company is also typically responsible for maintaining an escrow account and overseeing the closing.
If you’ve never worked with a title company before, first ask your real estate agent or mortgage lender for recommendations. Do your homework by checking with the Better Business Bureau to see whether the company has any complaints against it.
Just like when you’re searching for a lender, you should shop around to find the best deal. Since some title companies try to tack on unnecessary fees, ask your real estate agent or a real estate attorney to review the offers. If you purchase an owner’s title insurance policy, make sure you get one with as few exclusions as possible and that covers the full purchase price of the home.