Can You Buy a House? Here’s What You Need to Find Out
The path to homeownership can be challenging. A house is generally the largest single purchase anyone will make, and a home loan — also called a mortgage — is almost always required. The mortgage application and qualification process can be the most difficult and complex element of figuring out whether you can buy a house, and how much you can afford to spend.
To know if you qualify for a home mortgage, you will need the documentation that banks use in consideration for loan approval. This includes work history, your income, assets, debts, and your credit report/credit score. These items will help give the lender an idea of your creditworthiness and your ability to make the monthly mortgage payments.
What Is a Mortgage?
A mortgage is a special type of loan used to finance real estate purchases. It represents a legal agreement between you and the creditor (or lender): in exchange for providing a buyer with the cash needed up-front to buy a house, the buyer agrees to repay the loan with interest. Once you pay the mortgage in full — generally over a period of 15 or 30 years — the creditor will release the title of the house to you (the homeowner). Over the life of the mortgage, the home is used as collateral to secure the loan. That means that if a borrower fails to make timely payments (defaulting on the loan), the lender can repossess the home and sell it to recoup the value of the mortgage.
Getting approved for a mortgage isn’t easy, and it can be one of the primary barriers to buying a home. Millennials rank the lowest in homeownership compared to other generations, and they also carry a larger share of student loan debt compared to different age groups. Because they are already struggling to pay off significant debts, it can be difficult to take on the additional debt of a mortgage in order to buy a home.
What You Need to Get a Mortgage
To get a mortgage, you will need a good credit score, a steady verifiable income source (proof of employment and salary), and a record of timely payments shown on your credit report. If you have changed jobs or if you are self-employed, the lender might require you to show pay stubs from your paychecks, statements from a bank, or other retirement or investment accounts. If you had a loan that you recently paid off that is not reflected on your credit report when you apply, the lender might ask you for a letter from the original creditor.
A Decent Credit Score
A lender examines your credit score to judge how likely you are to repay a mortgage over time, or default. Every payment you make on a loan in your name, a credit card, and many other sources of debt or recurring bills can influence credit scores. Credit scores are set in ranges from poor, fair, good, and excellent. Each lender has its scale in determining if a borrower’s credit score is within the range to lend money. Also, this scale determines the interest rate set for the loan.
A low credit score would fall within the 500s, with the 800s being excellent. The Federal Reserve reported 90% of people who qualified for a mortgage in the first quarter of 2019 had a minimum 650 credit score, and only 10% had a score below 647.
If you have a low credit score and need help with credit repair, there are companies out there that can assist you with discrepancies on your credit report, help you find other methods for credit repair, and provide financial counseling.
Lenders prefer to see you have a stable work history for the previous two years. Those who are self-employed or have recently changed occupations may have to give the lender extra credentials such as an income verification letter from your employer for example.
A Down Payment
The optimum down payment amount is 20% of the asking price for a house. However, there are alternatives for lower down payments through government-insured home loans. If you are a veteran, some programs do not require a down payment at all. Rural areas may have government-assisted loan options; however, specific stipulations apply.
FHA and other government-insured loans, improvements, and grants are also alternatives for those who qualify. With an FHA loan, the down payment is three-and-a-half percent of the cost of the home. For example, if you apply for an FHA loan, and the purchase price is $185,000, you would follow the following formula:
$185,000 x 3.5% = $6,475 for the down payment (this does not include any closing costs)
A Low Debt-to-Income Ratio
Having a debt-to-income ratio of 43% or less is ideal for approval. This ratio is your total monthly debt divided by your monthly gross income (income from all sources before taxes). For example, if you have $2,500 in monthly debt and $5,000 income, you would use the following formula: $2,500 (monthly debts) divided by $ 5,000 (gross income) = 50% debt-to-income ratio.
In this example, you would not fall in the ideal category for homeownership. You would need to make a plan to reduce your debts by seven percent (or $175 dollars) per month. Depending on your circumstances, this may be credit card or another loan payment that needs to be reduced or paid off to qualify.
If you need help in improving your debt-to-income ratio, debt relief companies and programs exist to assist you in debt consolidation, credit counseling, and in planning to reduce or eliminate your debt. This can take some time, however doing so will help you achieve the credit score necessary to buy a house.
Before you explore the inventory of homes available, you need to be pre-qualified with a lender. They will require a list of your assets, debts, income verification, and credit report. Once you are pre-qualified, typically the lender will give you 90 days to find a home. Presenting your pre-approval letter means you are a candidate for loan approval; it does not mean that you already have the loan.
Be careful during the time between pre-approval to the day you close. Do not make large purchases, switch jobs, or apply for another loan during this time. If the seller accepts your offer, the closing takes around four to six weeks. Most lenders will recheck your credit a few days to a week before closing to make sure you remain in good standing for the mortgage approval.
Some Extra Money Set Aside
Escrow is an account that you can set up with the title company while you go through mortgage approval. This is a pool of funds for property taxes, insurance, and private mortgage insurance. All homeowners must pay property taxes and insurance, and if you financed over 80% of your mortgage, they might require you to purchase private mortgage insurance.
The title company will have their closing fees, so it is vital to have additional funds set aside for your down payment to cover those costs. You need to consider that although your house payment is fixed, the future costs such as maintenance and property taxes may fluctuate over the life of the loan.
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