To buy that new – or next – home you must first get your house in order. Your “financial house,” that is.
Any reputable lender will tell you that the process of getting approved for a mortgage includes preparation – and possibly perspiration – on the part of the loan applicant. Why? Because lenders look at a buyer’s credit and income history, among other factors, before determining your loan qualifications.
In most circumstances, people thinking of applying for a mortgage should take 6-12 months before speaking with lenders to address their credit reports, pay off as much existing debt as possible and review income patterns. Of course, this advice does not apply to people with excellent credit, debt that is paid off monthly and high-income earners – or to those fortunate to pay for a home in cash. I’m thinking of you, Bill and Melinda!
Households in Seattle need a staggering $109,275 of annual income to afford monthly payments on a median-priced house in the metro area. That’s according to a report from HSH.com, a mortgage and consumer loan-info company. The report, from August 2018, said the median price of a Seattle home was $530,300, a jump of 9.5% from a year ago. To make the median monthly mortgage of $2,550, a resident would need to earn $109K+, assuming a down payment on the home of 20%. The median salary would increase to $129,019 if a buyer put only 10% down.
Buyer beware? How about buyer be prepared?
Preparation starts with ordering your credit report (free annually from the big three agencies) to review every line for accuracy. That includes ensuring your name is consistent and as it appears on your passport or visa. Variations to your name can cause credit reporting agencies to accidentally omit information that could boost your credit standing or to mistakenly having too much information on your file, such as your father’s credit info if you share a similar name.
Your credit report can also include incorrect history. Call if Financial Fake News. Treat every inaccuracy as a red mark against your reputation as a potential borrower. Take swift action by contacting the credit reporting agency about the error on your report – a process that can take months.
Then there’s the all-important credit score. HSH said buyers need a score of at least 620 to get a mortgage and a number of 740 or above to earn significantly better terms on the loan. More than anything else, a person’s credit payment history and total debts generally drive the direction of a score. It’s worth speaking with different lenders to determine which one offers the most favorable terms and can meet your needs.
Priority Home Lending is a mortgage lender based in our John L. Scott office. Feel free to give them a call to answer your questions.
Look for opportunities to improve your credit score by chipping away at those outstanding debts. It usually makes sense to pay off debt with the highest interest rate. Pay down your credit card bills – without being delinquent on other financial responsibilities – and consider signing up for automatic payments each month to avoid those high-interest bank fees.
Something else to avoid: opening new credit accounts – such as an auto loan, student loan or bank card – or big-ticket purchases until after you have purchased your home. Sorry, that new living room furniture set is going to have to wait until after closing.
Look at your income potential for the next 6-12 months. Do you earn more in certain months because of commissions or overtime? When might you receive that much-wanted raise? Is there a chance you can pick up a second job to help further strengthen your financial footing? Factor in all these positives as you decide when to start applying for a mortgage. Most lenders look at all types of income – wages, disability or Social Security checks, gifts, investment income, 401(k) payments if over 59 1/2 years, among others – over the past two months, and other income-verification documentation for up to two years, to determine a consistent and verifiable pattern.
A mortgage lender typically wants to see your debt-to-income (DTI) ratio reach no higher than 43%, but some lenders will go as dangerously high as 50%. The lower the DTI the better. If your gross (pretax) income were, say, $10,000 a month, a lender would want to see total debts – including that new mortgage but not your current housing costs (rent or mortgage) – at no higher than $4,300. Lenders review obligated minimum payments on credit cards and exclude from their calculations all non-obligated costs such as school tuition, phone bills and church tithing. (Think about it: The lender believes the loan applicant is not obligated to attend school, own a phone or give to a house of worship, though she/he is obligated to pay off all loans and credit card debts.)
If you haven’t already done so, set up a budget to better track income and expenses and put away as much savings each month. (Chart your personal finances with this spreadsheet that does the math for you!) A standard rule is to aim for a home price 2-2 1/2 times (but no more!) of your gross annual income.
Try your best to save for a 20% down payment to avoid paying an additional 1.75% of the loan in mortgage insurance. Talk to a personal finance expert or your lender for advice on meeting that 20% threshold. (Mortgage insurance, or MPI, protects the lender from losses if a borrower were to default on the loan and is required until your mortgage is 20% paid off; you can request in writing to stop paying the fee at 18%.)
Bottom line: Buyers in a sellers’ market need to be as financially sound as possible before speaking with lenders.
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