Buying a new home can be exciting. But preparing to buy a new home is more than just deciding how many bedrooms you want or which neighborhood you like the best.
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Follow these steps to get your finances in order, which will help you qualify for the lowest rate possible for your mortgage and save you money as the homeowner.
1. Save up for a down payment.
Ok, let’s get the obvious one out of the way. When you are looking to buy a new home, having some cash to put down is a must. The lower your loan-to-value (loan amount, as compared to the home value), the lower your interest rate.
Having a loan-to-value of less than 80% also helps you avoid things like PMI, private mortgage insurance, which will cost you money every month.
2. Shop around to mortgage lenders.
Make calls to potential lenders to check rates or look online. You can find out what rates each lender has to offer by giving them your general information—not everyone that you talk to needs to pull your credit.
You should be able to get a good idea of the types of programs and rates that a specific lender can offer to you, without going through the entire pre-approval process. This is a crucial step because rates can fluctuate from one bank or lender to the next.
3. Get your credit checked—but only by one lender.
Once you have decided which lender to go with, give them all of your information and authorize the credit report to be pulled.
The reason that you don’t want to allow every lender you talk with to pull your credit is because too many inquiries can cause your credit score to drop. This is not what you want to do right at the time that you are trying to get approved for a mortgage.
Credit score, along with your debt ratio and the loan amount that you are taking out, as compared to the home’s value, is all used to determine the rate for which you will qualify.
4. Clean up your credit.
If you have a rough credit history and know it, start working on getting old or negative credit items updated or removed. You’ll want to begin these several months or even a year before you plan to purchase a home.
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Any time that you are trying to get old items removed or updated, you must provide proof that the item has been paid off or settled. Make sure you get a letter from the creditor stating that the debt has been fully satisfied and that you no longer owe.
Once an old account has been paid off, the creditor is supposed to report it to the bureaus, but sometimes this doesn’t happen. Having a letter in writing allows you the ability to send a copy to the credit bureaus yourself to get it updated.
5. Don’t use store credit cards.
You may be wondering what this has to do with a mortgage. When you use a store card to make a purchase, even if you only buy something for $30, the minimum payment is probably $25.
When a creditor is looking at your credit report, each minimum payment that is showing up is used to calculate your debt ratio. So if you have a few store cards showing up, that could throw your DTI (debt-to-income) ratio way off. Most lenders are looking for a debt ratio of 40% or less in order for you to qualify for the lower rates.
6. Don’t make any large purchases.
You want your finances to look as good as possible when trying to qualify for a mortgage. If you have a car that is paid off that you are currently driving, you may want to wait until after your home loan is finalized to buy a new one.
The additional credit pulls could lower your score and the new payment showing up on your credit report could throw your debt ratio too high. The difference between a 38% DTI and a 42% DTI doesn’t sound like a big deal, but it can make a difference in the rate that you will get.
7. Don’t pay for everything with cash.
Don’t fall into the “pay cash for everything” trap. So many people think that they are doing themselves a favor by paying cash for everything, so they have no debt. While having no debt is a good thing, it can also work against you.
If you have no debt, that means you probably don’t have much credit history. The bank looks at your credit history—and how you have paid off previous loans—to qualify you for a mortgage. Lack of creditors reporting to the bureau can mean a low credit score, simply because there is not enough information in your credit history.
If you are currently paying for everything in cash, get one (or two) credit cards—and start using them. You don’t need to rack up a bunch of debt, but use the credit cards to pay for monthly purchases, such as groceries and gas, and then pay them off each month. If you’re worried about debt, try getting a secured credit card instead. These creditors will now report a balance each month to the credit bureaus and also record your payment each month.
8. Find a trusted real estate agent.
A real estate agent isn’t just for selling a home. When you are looking to buy a home, having a real estate agent negotiating for you is essential. It doesn’t cost you any extra because if you buy a home that is listed on the multiple listing service (MLS), realtor fees are already built into the cost of the house that you are buying.
So bringing your agent will allow you to have an agent looking out for your interests in the deal. And when it comes to price negotiations, it could save you thousands of dollars.
9. Get a home inspection on your potential home.
This is different than the appraisal. This is when an actual home inspector comes out to examine your potential new home. This can be invaluable because it will give you peace of mind regarding the structure and condition of the house.
An inspection is essential, especially when it is an older home. Sometimes things look good on the surface, but there could be issues that could cost you hundreds, if not thousands, of dollars to fix later. Learn more about what happens during a home inspection at The Money Pit.
10. Research the county records on your potential home.
Most areas have county records online now, and since they are public information, anyone can access them. Look up the parcel number/address of the home you want to buy. Look at the tax assessment and previous transfer (sale) values. This can give you a good idea of what the house is worth.
Keep in mind the tax assessed value is usually less than the market value. But finding out what the home sold for previously can give you a good idea of what a current value may be. Also, visit Zillow.com to get a current estimated worth of your potential home.
For most people, buying a home and getting a mortgage is the most significant financial decision that they will make, so taking the time to go over your finances and qualifying for the best program possible is paramount.
Don’t rush it. If you need a few extra months to clear up your credit history or create a credit history, it will be worth it if it helps you qualify for a better program. This is a purchase that you will be paying on for, probably, the next 30 years. So take your time and do it right.