How to Ace Your Home Purchase or Refinance Application
In matters of homeownership, it should cost you less to know more about how mortgages – purchase or refinance – work. This makes for a better transition from homebuying to homeownership. Don’t focus on the rates just yet, but on certain areas where you can certainly improve on before you purchase or refinance a home.
Savings Before and After
When you buy a home, you would need a down payment. This is where savings could help you. Because the propensity to save varies among individuals, just think of the home price you think you can practically afford and 20% of that projected price should be what you’ll prepare for.
Why 20%? It will spare you from paying a private mortgage insurance, which costs up to 1% of the total loan amount every year. Twenty percent is also the equity required by lenders to be built into the home to refinance and avoid PMI.
If the down payment is too hefty for you, you can ask your friends and family to gift you a down payment or seek down payment assistance from local and state housing agencies.
Your savings could also save you during those times when your current funds are not enough for your monthly mortgage payments. Financial planners advise setting aside some three to six months’ worth of living expenses that should include your housing and related maintenance costs.
Credit + Income
This formidable pair is what lenders primarily look at when they review your loan application.
Credit primarily dictates your mortgage rate. Depending on how healthy your credit is, it could put you at risk of being denied of a loan or getting approved but with a not-so-good rate.
To be sure you are credit-ready and get a good rate, obtain a free copy of your 12-month credit report at each credit reporting company here. Make sure everything that is reflected there is correct and accurate.
You can prepare your credit score for your mortgage application or refinance next time by:
- Paying your bills on time and in full every month.
- Take on fewer debts. For example, if you have a credit limit of $1,000, your credit card balance should be $300 or less.
- Avoid opening a new line of credit but don’t close existing ones either because it might affect your length of history.
If you have existing red marks in your credit report such as debt in collections, missed payments, or worse a default, it might hurt your chances but it never hurts to try and explain them to the lenders.
Next is, are you financially capable of repaying the loan? When it comes to mortgages, income is generally approached in two ways.
You must establish a verifiable source of income from a steady job or business. To be safe, hold on to your current job while you are in the process of getting a loan.
Your income yields a metric called a debt-to-income ratio. This measures if you are living too close to the edge, i.e. if most of your income goes to your debts every month. Avoid taking on a new debt just yet because it will increase your DTI ratio.
There’s more to mortgage application and refinance and that’s the closing costs attached to both. Closing costs can cost between 2% and 5% of your total loan amount. Consider these scenarios:
- If you pay for your closing costs in cash, you have to produce funds out of pocket upfront and at closing.
- If you are allowed to finance them into the loan, you could be paying more as the repayment gets stretched throughout the life of the loan.
The issue of closing costs is especially relevant to mortgage refinances. Because you have to pay a new set of closing costs when you do a refinance, the transaction could be said worthwhile if:
- If you can afford the closing costs in cash or when financed.
- If you stay long enough to realize the savings of refinancing and the benefits of amortization.
- If you are qualified per credit, income, and equity standards.
A mortgage is a huge financial responsibility as it is, it helps to know where you stand before you apply, be it for a purchase or refinance. Always shop around to get the best rates.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.