Are you tired of being a renter? Perhaps you are dreaming of finally getting a puppy, but your landlord doesn’t allow pets. Or, you are hoping to make other renovations to your living space that are only possible as a homeowner. Many people want to make the leap from renter to homeowner for a variety of personal and financial reasons. How can you prepare to make the process go smoothly?
Evaluate Your Finances
Check your credit score using a site like CreditKarma. If your score is below 670, it will probably be an issue when applying for a mortgage. You should do what you can to improve your credit score in the meantime: Stop applying for new credit cards; reduce the outstanding balance on any existing credit cards, so that you are using no more than 30% of each card’s limit; and make sure that payments are on time. If your score is above 740, then you are likely to qualify for the best rates. Check out these articles from Bankrate and NerdWallet for more on how your credit score impacts your mortgage rate.
Consult With a Mortgage Broker
The mortgage broker will ask you basic financial questions to gauge how much you are qualified to borrow. If you aren’t ready to talk to a broker yet, you can get an estimate by using an online calculator like this one from Quicken Loans.
Your annual mortgage payments, along with property taxes and homeowner’s insurance, should not exceed 28% of your income. In addition, your mortgage payment, along with all of your other long-term debt, should not exceed 36%. But, don’t be surprised if the mortgage broker tells you that you qualify for a higher amount.
Once you give the mortgage broker some basic financial information, they can “prequalify” you for a loan amount. However, in a seller’s market, you will need at least a preapproval letter, which you will get when you complete the full mortgage application and provide some additional financial information. Wait to seriously shop for a home until you have been preapproved, as that is one of the first steps a real estate broker will ask if you have completed.
Find the Right Home for You
With the mortgage prequalification or preapproval in hand, it is time to start house shopping. The amount you can afford to pay for the house should be the size of the mortgage you qualify for plus your down payment. In an ideal world, your down payment would be 20%. With a 20% down payment, you don’t have to pay Private Mortgage Insurance (PMI), which could be a few hundred dollars per month. That being said, saving 20% for a $350,000 house might take many years. It is possible to buy with as little as a 5% down payment, but the lending standards are very strict, and you will have to pay those PMI payments until you reach the 20% equity threshold.
Mortgage brokers may tell you that you can qualify for a larger mortgage than the 28/36 recommended ratios would support, and REALTORS® are happy to show you more expensive homes that will increase the size of their commissions. However, just because you can get a bigger mortgage or buy a more expensive house, doesn’t mean you should. When I bought my first house, we used all of our savings on the down payment, and when the grass started growing in the spring, we panicked because there wasn’t any extra money to buy a lawnmower. It’s important to select the house and mortgage that you can comfortably afford, even if your financial circumstances change.
Are you considering whether renting or buying makes the most sense for your personal and financial goals? Consider connecting with a CFP® professional in your area.