Before the subprime mortgage crisis of 2007, getting a loan to buy a house was relatively easy. But as the economy slowed and home foreclosures rose, lenders began tightening their restrictions. Don’t be discouraged, though. Banks are still eager to help you buy the house of your dreams. All you have to do is get your financial ducks in a row.
Understand the Importance of Credit Scores
Your credit score is based on your history of paying debts, such as your credit card accounts, and lenders often look for score of 660 or higher before they’ll approve a home loan. If you’ve had some late payments in the past, your credit score may be lower than it should be, and it's vital that you find out before you start the mortgage process. Some credit card companies provide credit scores free of charge. Alternatively, you can create an account at CreditKarma and receive your score for free.
Correct Errors on Your Credit Report
If you pay your bills on time but your credit score is lower than 660, it could be the result of an error on your credit report. Once each year, you can obtain a free copy of your credit report from AnnualCreditReport.com. You are allowed to receive one copy from each of the three reporting agencies: TransUnion, Equifax, and Experian. If any of the reports have false information, follow the instructions on the report to challenge it. Credit reporting agencies have 30 days to investigate and remove an error.
Calculate Your Debt-to-Income Ratio
Lenders look at a number of factors when deciding whether to approve a home loan, and debt-to-income (DTI) ratio is a big one. To determine yours, add up your monthly debt obligations, such as rent, child support, auto payments, and so on. (Do not include living costs, such as groceries, prescriptions, and utilities.) Divide that sum by your monthly gross income (before taxes). The resulting number (a percentage) is your DTI ratio. If it’s under 35 percent, great! If it’s over 35 percent but under 43 percent, you may still qualify for a loan at some banks. But if it’s over 43 percent, you’ll probably have to pay off some debt before qualifying for a loan.
Get Preapproved Up Front
If you know you’ll be house-hunting soon, you’ll save a lot of time and increase your chances of getting the house you want if you’re preapproved. This entails sitting down with your banker, who will check your credit score, figure your DTI, and analyze your overall financial situation in order to come up with the maximum amount of money that the bank is willing to lend you to purchase a house. Once you’re preapproved for a specific amount, you can start looking for homes in that price range.
Don’t Make Any Large Purchases
Even if you've been preapproved, you’re not home free just yet. During the house-buying process, your bank will do a final check of your credit and DTI before it formally approves a home loan. If you’ve made any large purchases since you were preapproved, such as a new car, your DTI ratio may no longer be acceptable. The general rule is to hold off on all major purchases until your home loan is finalized.
Save for a Down Payment
Lenders believe that if home buyers have some skin in the game, they’ll be less likely to walk away from a house, leaving the lender to foreclose on the property and auction it off. For this reason, the bigger the down payment, the more likely you are to be approved for a home loan. For a conventional loan, your lender will typically require 5 percent to 20 percent of the cost of the house as a down payment.
Don’t Change Jobs
A stable work history is a requirement for getting a home loan, and many lenders require a minimum of six months at the same place of employment in order to be approved. The exceptions are if you’ve been transferred to a new location with the same company or if you’ve taken a new job in the same field at higher pay.
Locate Your Financial Documents
As part of the loan qualification process, most lenders want to see the last two years of your income taxes as well as two years of W-2 forms and a month or two of employment check stubs. If you’re self-employed, you may have to show the deposits and withdrawals you’ve made to your business checking account for the past year, and you may also have to submit a balance sheet (they’ll help you make it).
Look at Houses Within Your Budget
Don’t even consider looking at houses over your budget. If you get preapproved to buy a house of up to $400,000, don’t make an offer over that amount and think that the bank will still give you the loan. Some lenders are very strict about the cutoff amount, and if you go over, you could be turned down.
Don’t Give Up
If you don’t have 5 percent of the cost of the house as a down payment and your credit score isn’t above 660, you may not be approved for a conventional loan, but you might still qualify for a government-insured loan, such as an FHA loan that requires a 3.5 percent down payment and a minimum credit score of 580. Depending on your circumstances, you might also qualify for a VA loan or a USDA loan, both of which require no down payment at all. Not all lenders make VA, FHA, and USDA loans, but a real estate agent can point you to one that does.
Pick the Right Property
Lenders take a financial risk when they lend money to buy a house, so most require that the house be in decent shape. If it’s a fixer-upper, there’s a good chance the loan will be denied. In order for a house to qualify for an FHA, USDA, or VA loan, the property must meet specific criteria, such as having a sound roof, no peeling paint, handrails on steps, and egress (escape) windows in all bedrooms in case of fire.
Your Dream Home is Within Reach
The home mortgage process doesn't have to be scary.
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