If you are considering purchasing a home in the near future it’s a good idea to get your fiscal house in order. This involves many areas of interest and concern that can affect the outcome of your borrowing process. The path to homeownership is much easier if you have the down payment, know what your credit score is and make the necessary repairs to your credit prior to applying for the loan.
What lenders look at when considering applications for a mortgage?
There are a variety of mortgage types including fixed rates, adjustable rates, balloon, FHA and VA. While the types may vary in their offering of a low introductory interest rate, low monthly payment or a low down payment, they basically use much of the same criteria for a loan approval. Most banks obtain a copy of your credit report from the three credit bureaus: Experian, Equifax and the TransUnion. This report gives them access to your credit score, payment history and outstanding debt. In addition to your credit score the bank will also want proof of income (pay stub), 2 to 3 years of recent tax returns and copies of your bank statements, checking, and savings for the last 2 to 3 months.
Strengthening your credit score
In order to eliminate any surprises on your report that will get you a denial for a loan, or at the very least cause you to have to pay a higher interest rate, acquire a copy from the three credit bureaus in advance. You have the right to one free report every year. There are several companies online that offer this service. Once you have the report, make sure that everything is accurate. If it is and the score is lower than you need to get the best rates, find out why. Are your credit cards maxed out or close to their limits, have you made a few late payments, do you have many cards with high credit limits? Any one of these can reduce your score. If you have the scenario of too much revolving credit, cancel a few of your cards. Unfortunately, even though you aren’t using all of the available credit, the bank tallies up what you have access to and if it exceeds their range of debt-to-income, they may consider you a high risk. The same goes for maxed out cards.
Coming up with the down payment
Many banks live by the traditional 20% down payment as what they want from a potential buyer. However, with the median home price nearly $200,000, a 20% down payment would add up to almost $40,000.00. While this is what lenders want, many will accept 10% or even 5% if your credit score and income are excellent. There are other types of mortgages if the bank will not approve you with less than the 20% or 10% down payment. An FHA loan only requires 3.5% down, on that same $200,000 home you’re looking at $7,000, which is a bit more affordable. An FHA mortgage also accepts a lower credit score of a minimum of 580 and the closing costs are likely less as well. They do charge PMI insurance the same as other lenders until you reach the 20% down payment amount on your mortgage.
Fixed rate or adjustable rate mortgage
There are pros and cons to both the fixed rate and the A.R.M. If the interest rates are low an adjustable rate can save you thousands on your mortgage. On the negative side, this is only in place at this rate for a period of 5 to 7 years, after which time it goes up to the current interest rate which might end up being considerably higher causing your mortgage payments to skyrocket. With a fixed rate mortgage the rate you go in with is the same rate you carry for the full term of the mortgage. If the rates are high you’ll pay more, if you go in at a low rate you’ll retain it, even if the rates jump up. You can always refinance your loan at a later date to get a better rate.
Repairing your credit
If you’ve had a few missed payments and your credit score is not where it needs to be to get a conventional loan, you can wait a little longer to buy your home until you improve your credit score. If you have a good job, improving your debt-to-income ratio is one of the quickest ways to raise a score in just a few months. Reduce your revolving credit by closing out one or two of your cards. Secondly, if you have cards maxed out, put more money each month towards one card and pay the minimum on the others. Then once you get that card below half the available credit work on the next one. Also, avoid making any new purchases. Banks also check the recent history on inquiries into applying for things like new credit cards or loans.