Assessing Your Finances
Once you think it may be a good idea to purchase a home, it is now time to assess your finances.
The first thing to do is go to www.annualcreditreport.com . Do not use any other site but this one. This is the site set up by the three credit bureaus for your one free credit report a year.
After pulling your report, check for accuracy. More often then not, there are mistakes that could be affecting your credit score. If you believe something is in error work on getting that remove. A good mortgage banker can also help you with this process.
A 20 point difference in credit score can make a huge difference in your interest rate or loan programs available to you. Again a good mortgage banker can help you do little things that can significantly affect your credit score. It takes some time so this is an important first step.
Qualifying for a Mortgage
Now it’s time to look at your qualifying ratios.
Top End (housing ratio)/Bottom End (total debt)
You have your top end ratio which is your housing expense. Your housing expense includes, principal, interest, taxes, insurance, private mortgage insurance and condo fees.
Then, your bottom end ratio is your total debt, including housing ratio and minimum monthly payment on your consumer debt, including credit cards, car payments and student loans.
The government suggests ratios of 28/36 which is fairly conservative. Most loan programs will go up to about a 40-45% debt to income (bottom end) ratio.
The following worksheet will help give you a rough idea of what size mortgage you may qualify for. Nothing beats a proper pre-approval from a mortgage banker but this will give you some rough idea of what you may be able to afford.
To calculate the principal and interest of a loan find an online mortgage calculator to get a principal and interest payment. PMI or Private Mortgage Insurance is tricky. You usually have to get PMI for the bank if you put less than 20% down. For rough qualifying purpose figure your PMI at about .75% of your monthly principal and interest payment, if you are putting less than 20% down.
|Gross Monthly Income (pre tax)|
|Car Loans -monthly payment|
|Credit Cards -min. monthly payment|
|Student Loans- monthly payment|
|Any other monthly installment payments|
|Total Monthly Debt|
|Estimated Monthly Housing Debt|
|Total Housing Expense- add lin 4a-4d|
|6. Total Housing Payment Ratio – your total housing payment should be no higher than 28-40% of your gross income. Divide line 5 by line 1.|
|Total Monthly Debt- Total line 5 and line 3|
|8. Total Debt Ratio- divide line 7 by line 1. This should be no more than 40-45% of your gross monthly income.|
In this quick example, the ratios appear to be well within qualifying guidelines for a mortgage.
Remember you can probably qualify for more house than you may be comfortable with. At the end of the day, you need to come up with a purchase price you are comfortable with, just because a mortgage lender says you can afford certain payments, it does not mean yu have to be comfortable with it. It is your decision.
With a majority of the loans you will need a minimum down payment of 3-3.5%. That means if you want to purchase a $300,000 loan you will need a minimum of $9,000 for a down payment. You could put down more but that is the minimum amount you will need.
The size of your down payment will sometimes effect your interest rate, your monthly PMI payment and the loan programs that may be available to you.
Closing costs will vary from state to state. Typically in Massachusetts, they can run from $2500 to $6,000. Closing costs include such fees as:
- Recording fees
- Title insurance
- Legal fees
- Courier fees
- Title Rundown
- Escrows for insurance and city taxes
- And more……
When you sit down with your mortgage banker, find out what the cost will run you. If you are paying the closing costs yourself, you will need to have the closing costs on top of your down payment.
Tip: In today’s buyers market it is not unusual for, buyers to request that sellers pay the” buyers closing costs pre-paids and/or escrows” Ask your agent how that plays into your overall financial plans and negotiating strategy.
Reserve funds are cash on hand after paying your down payment and closing costs. The reserves required must equal the amount a home buyer pays in principal, interest, taxes and insurance for a period of months. The amount of reserve funds, required by a lender, is dependent on the loan program.
Reserve funds required can typically equal between 0-4 months. Reserve funds can also be money that is in a 401k or any liquid cash account.
Other Costs Associated with Purchasing a Home
Other costs associated with purchasing a home are home inspections and moving costs.
Documents Needed for Your Mortgage Broker
Here is a quick list of documents your mortgage broker will need. It is a good idea to have them ready for your first visit. This is a quick list, they may ask for more down the road.
- 1 month most recent paycheck stubs
- 2 months of your most recent statements including, checking savings retirement, stocks…. Include all pages not just the front page.
- Last 2 years tax returns including 1099’s and W2’s
Learn to keep these documents handy during the process paychecks and cash account statements may need to be updated several time through the process.
Top 5 Reasons Mortgage Financing Goes Awry
- Undocumented Cash Deposits- The mortgage underwriter needs a paper trail and an explanation for cash moving in and out of your accounts. One big mistake borrowers makes is assuming that a large sum of money given by a parent is no problem. While in general it is no problem it is important to source those funds.
- Change in Credit Profile- Do not open any new lines of credit, change jobs, buy a car while in the middle of the process. Every little change can effect your credit profile. A big mistake that home owners will make is they get excited and open a line of credit at home depot or the furniture store in anticipation of their new home. Wait until the home is purchased!
- Dealing with Credit Issues at the Last Minute- At the beginning of this chapter I told you to pull a free credit report. Start dealing with your credit issues now not 30 days before you put an offer on a property.
- Not Having a Proper Pre-approval- You need a good pre-approval where a mortgage banker reviews and verifies the information on your paychecks, statements and pulls a tri-merge credit report. A “pre-qualification” is where you call a broker up he asks you how much you make and how much money you have and asks how your good is your credit. He never verifies anything. You are running around thinking your good to go, you put in an offer than you find out that the overtime you get can’t be included in your monthly gross, or the $10,000 mom and dad gave you can’t be used toward your down payment. Take the time to get it done right before ever looking at a house!! Shopping Rate- Yes you want a competitive interest rate, but you need to also shop the quality of the mortgage lender and their ability to deliver on their word. I can’t tell you how many times, I have had buyers tell me they are all set with their mortgage then they call me in a panic with a problem after an offer. Then I step in with one of my mortgage brokers to straighten out the mess.
Your mortgage is one of the more complicated pieces to buying a home. Start the mortgage process before ever looking at a home and get educated so there are no surprises along the way. A good mortgage broker can save you a ton of time and aggravation.