You know you want to buy a house in the near future, so you want to know how to prepare. The good news is that the earlier that you prepare, the better your chances are of securing a loan approval.
Getting your finances in order means more than making sure you can afford a mortgage payment. It means making sure that you can prove to the lender that you are a low risk of default and that you deserve the loan.
Below we help you understand what lenders look for and how you can prepare your finances for the best outcome.
Your Credit Score is Your First Impression
First, let’s focus on your credit score. That’s the first thing lenders are going to look at when they decide if they want to give you a loan. They don’t mess with your pay stubs, debt ratio, or anything else. If your credit score doesn’t meet the program guidelines, they don’t move any further with your loan.
You have access to your free credit reports, which shows your credit history here. You may also have access to your actual credit score by looking at the services your bank or credit card companies offer. Many banks and credit card companies partner with credit reporting services to give you your credit score monthly free of charge. Using these two pieces of information, you can decide how you should proceed.
First, looking at your credit score, do you have at least a 680 credit score? That’s a good benchmark to try to reach. If you are far away from a 680 credit score, it’s time to figure out why. This is where your credit history comes in handy. You can go through the reports and see why you may have a lower score than you need. Look for the following:
- Do you have late payments reporting?
- Did you overspend on your credit cards?
- Do you have a bankruptcy reporting in your recent past?
- Do you have too many credit cards with open credit lines?
These are things that will bring your credit score down. The good news is that you can bring it back up, though. If you have late payments, bring your accounts current. If you spent more than 30% of your available credit lines, start paying your debts down and/or off. If you have a BK in your past, let more time pass – you’ll need between 2 and 3 years to pass from the date of discharge before lenders will give you a mortgage anyway.
Your Income is Important Too
Lenders like stability and reliability when it comes to your income. This means staying at the same job for at least the last 2 years. It also means proving that you have had stable income during that time. It’s even better if your income increases during that time.
What’s most important is that you stay at the same job and don’t change. If you do change, you’ll need to provide documentation as to why you changed and why you’ll succeed at the new business. For example, if you went from an accountant to a real estate agent, that’s not within the same industry. But if you can prove that you went to school/training to be a real estate agent, lenders can take that in place of the two years of experience.
Either way, you’ll need to provide proof of your income over the last two years. You can do this with your tax returns and/or W-2s. You’ll also need to provide your most recent 30 days’ pay stubs and your employer’s contact information.
Your Debts Play a Role
You’ll also need to prove that you can afford the loan along with your existing debts. This means lenders will look at your credit report and determine what debts you have right now. They will then compare how much money those debts take out of your gross monthly income. What they want to know is if you have enough money to make your mortgage payment and still have money for the daily cost of living.
If you have a lot of debts, now is the time to pay them down. Lenders look at credit card debt, installment debt, student loans, and personal loans. Any debts that report on your credit report count towards your debt ratio. You want to aim to have a 28% housing ratio and a 36% total debt ratio. This means that your total debts don’t exceed 36% off your gross monthly income including the new mortgage.
The best thing you can do before you buy a home is take a good, long look at your finances. How much debt do you have? Is your income consistent? Is your employment consistent? How well do you pay your current debts? These are the questions you need to ask yourself. If the answers don’t sound good to you, they certainly aren’t going to sound good to a lender. The sooner you start looking at this stuff, the more time you have to make sure you get everything in line.