There’s no better feeling than shopping for a house when you’ve already gotten all the money questions out of the way. If you’re in the market for a new residential home and want to get pre-approved for financing, you’ll need to jump through a few hoops. But, don’t worry, a lot of the effort is about red tape and things you need to do at some point before you buy. The main point to keep in mind is to do the financial stuff now, before viewing properties. By arranging the task in this way, you will know exactly how much house you can afford once you do begin shopping for homes.
It’s important to know the crucial difference between getting pre-approval and being pre-qualified for a loan. Pre-qualification simply means that you are provisionally ready to buy, not that you have been formally approved. Pre-approval, on the other hand, is a stronger position to be in because it means there is little doubt you will obtain a mortgage. Some sellers will want you to give them a letter indicting whether you’ve been pre-approved or pre-qualified. When you can provide the latter, you’re in a better position to get your offer price.
Know the Factors for Getting Pre-Approved
In order to get fast approval on a mortgage, you’ll want to have as large of a down payment as possible, steady income, a stable job and job history, good credit scores, no recent bankruptcy, a debt-to-income ratio at or below 40%, and enough income to comfortably cover your new mortgage expense.
Optimize Your Debt-to-Income Ratio
Nearly every residential lender will calculate your DTI, debt-to-income ratio. It’s a crucial number that shows exactly how much you spend per month on debt compared to the total amount of income you have. For example, if you make a car expense of $500, a student loan of $200, and pay $900 on your current mortgage, then your total monthly debt is $1,600. If your monthly income is $4,000, then your DTI is 1600/4000, or 40%. Most lenders want your DTI to be in this range or lower before financing your new home.
One fast way to lower your DTI and increase chances for approval is to refinance any student loans you currently have. Refinancing does two things, as it lowers your monthly education expense and allows you to save more money. In the above example, is the applicant refinanced the student debt so that the payment declined to $100 per month, the DTI would automatically become 37.5%, a significant improvement. The other key advantage of refinancing student loan payments is the potential to add to immediate savings. Depending how much you owe, a refi can mean several hundred dollars more in your pocket, or savings account every 30 days. If you’re saving up for a down payment, that’s very good news.
Pay as Much Up Front as Possible
Think of it this way, the more money you can put toward an initial payment, the less you’re borrowing. On a $250,000 property, if you get FHA financing and only plan to put 3.5 percent down, you’re looking at financing $241,250. If you can afford to put 25% toward the total, you’re only on the hook for a $187,500 mortgage. More money up front means a smaller loan package and lower monthly payments.
Opt for FHA Financing If You Can
If you are just starting out in your career and don’t think you’ll be able to swing a standard 20 percent initial payment, consider applying for FHA loans. It’s pretty easy to get approved and you can do so even if you’ve owned homes in the past. As long as your credit is in the good or better range, FHA will likely approve you. After that, you’ll have the unique benefit of only having to come up with 3.5 percent of the selling price as a down payment.
Minimize Credit Card and Tax Debt
To boost your DTI and make yourself appear more financially attractive to the lender, it helps to have your credit cards paid down to 10 percent of their total limits, or lower. Don’t close the accounts or you’ll risk hurting yourself in terms of creditworthiness. Keep the cards open but try not to allow balances rise above that critical 10 percent level.
Watch Your Credit Scores Like a Hawk
You can get one free report from each of the three agencies once per year. Better yet, go through your bank or card companies and find out your scores for free whenever you want to see them. Monitor them closely and sign up for a for-fee tracking service if you feel the need. Aim to have ready access to all three bureau scores as well as your FICO score. Read the reports and correct any mistakes you notice. Pay off balances as quickly as possible and discuss other strategies with a credit counselor.