Are You Financially Prepared to Buy Your New Home?
Are you financially prepared to buy your new home? There is a lot of emphasis put on the credit score when discussing financing qualifications. However, this is not your only concern in being financially qualified to buy.
Most loans will require a down payment (except for VA and USDA loans). Know, however, that although VA loans don’t require a downpayment they have a funding fee. You will want to compare the expected monthly payment of the VA loan to other mortgage options to see what works best for you. FHA loans require a minimum 3.5% for down payment. Conventional loans will require down payments ranging from as low as 3-5%. Of course, a higher down payment will reduce the anount of your monthly mortgage payment. Note that there may be down payment assistance programs available. In Illinois, the Illinois Housing Department Authority (IHDA) has some great programs available for downpayment. Your lender should be able to advise you on the availability of programs to assist with your down payment.
Closing costs for buyers include such expenses as attorney and appraisal fees, loan fees, title costs. It also includes prepaid items such as property taxes and insurance held in escrow. Expect this to be 2-3% of the purchase price depending upon the purchase price point as well as other factors. Often negotiations with the seller include asking that the seller either partially or completely pay for these costs. However, the seller is not obligated to agree to the request. Note also that a seller contribution to your closing costs reduce their net sales price received. This makes your offer less competitiive but if you need the funds in order to purchase, ask.
Lenders will require that your debt levels be limited to a certain percentage of your income. Debt to income for mortgages is calculated as total monthly revolving debt to monthly gross income. Total revolving debt includes housing costs (principal, interest, taxes and insurance) plus monthly payments for credit cards and loans. FHA raised it’s debt to income requirements in 2017 to 50%. The maximum debt-to- income ratio (DTI) for a conventional loan is generally 43%. However, exceptions can be made for DTIs as high as 50% with strong compensating factors like high credit scores and/or lots of cash reserves.
If you carry high credit card balances or have significant student loans, you may need to reduce your debt before qualifying for a loan. Note also that your DTI also affects the amount of loan that you qualify for. Speak to your lender to see if your debt to income ratio is acceptable.
If you currently own your home or other real estate, you will also want to discuss with the lender how the mortgage on those homes will affect the amount for which you qualify. You may need to either sell your home first or add a contingency for the sale of your existing real estate.
Different loan products have different credit score requirements. Credit scores for FHA can be as low as 580. However, minimum credit scores can vary by lender. Credit score requirements for conventional loans are generally higher than FHA. In addition to the score, the credit details are also important. Late payments, bankruptcies, judgments and previous foreclosures also affect whether you will qualify for a home loan. FHA has more lenient qualifications than conventional but your lender can tell you if there are any issues that need to be addressed.
Income will be based on your average adjusted gross income (per your tax returns) for the last two years. This becomes an issue if your income has varied widely in the last two years or if you have tax deductions which significantly lower your adjustable income (this may be an issue if you are self-employed). Some lenders have friendlier programs for self-employed borrowers so don’t give up if you get turned down at a lender.
Interest rates have been at historically low levels for almost a decade. They were being kept artificially low by the Federal Reserve but the decision was made to change that in 2017. Rates are rising so you should be aware of the impact of interest rates on your monthly mortgage payment. Information is easily available on line about what to expect in terms of the interest rate on your mortgage. Note though that interest rates change constantly and your individual credit score and other qualifying factors may impact the interest rate you pay.
It is best to meet with a lender early in the process. A lender is the best source for you to know whether you are financially prepared to buy your new home. In addition to assessing your qualifications, a lender will give you a dollar amount of how much you can expect to get. On top of whatever you are told by your lender, you also need to look at your individual obligations. You need to factor in tuition payments, child care costs, retirement savings, emergency savings and any other obligation that determines how much you can afford to pay for a mortgage. These are not included in the bank’s debt to income calculation but may be part of your monthly household budget.
It’s a lot to consider but buying a home should not be an impulse decision. You may also want to compare lenders or mortgage products to make sure you are getting the best option. It is still a great time to buy. Rates are still low and prices are still great. This is an incredible time to buy that dream home, downsize, purchase an investment property or second home.