What to Consider Before Applying for a Mortgage
Are you among the 46 percent of renters who considered purchasing a home during their last move? With a rent increase being the primary motivator for most moves, you may be wondering at what point should you buy a home. Having a fixed monthly housing payment for the next 15 to 30 years is only one of the advantages of being a homeowner. The ability to build equity, express your unique interior design skills on your terms, and take eligible tax deductions for mortgage interest paid are just a few of the many reasons renters become homeowners when they can.
Here are some key considerations for renters whose next move might be homeownership.
Credit Health
Of primary importance to every mortgage lender is the borrower’s ability to repay the loan as agreed. To assist in determining the risk associated with approving the loan, the lender will examine your credit history report and request a credit score from one of the major credit reporting bureaus: Experian, Equifax, or TransUnion. You should review your credit before they do. Obtain a copy of each credit history report from AnnualCreditReport.com at no cost.
Examine each credit history report. If you have a recent history of missed or late payments, high balances on your credit lines, or adverse financial judgments, i.e., bankruptcy, you will have difficulty securing a mortgage loan with a competitive interest rate and favorable repayment terms. Does this mean you can never purchase a home? Fortunately, you can clean up your credit. It takes time but should be done before applying for the mortgage loan.
Focus on bringing past due accounts current, make all of your payments on time and pay down outstanding debts. When you repay your debt obligations as agreed and avoid maxing out your credit cards, lenders are less likely to view you as a high credit risk.
Debt Load
Carrying debt month to month not only costs you in interest charges but can hurt your ability to obtain mortgage loan approval. While having zero debt obligations isn’t required or realistic, your ability to handle the financial weight of a mortgage payment factors into the loan approval process. Lenders use a simple debt-to-income (DTI) calculation to figure loan affordability.
Your DTI can be figured on a monthly or annual basis by comparing your minimum required debt payments to your gross income. Many lenders prefer DTIs of less than 36 percent.
Here’s an example of how to calculate the DTI percentage:
Linda Loan has a gross monthly income of $5,000. Her loans and credit cards cost her $2,000 in minimum payments each month. Her DTI is 40 percent.
You can decrease your DTI percentage by reducing or eliminating debt or increasing your gross income.
Homeownership Expenses
Unlike when you’re renting a home, repairs aren’t simply a matter of delegating responsibility to a landlord. After you move into your home, you’ll likely have new or increased expenses that didn’t exist when you were renting. Additional expenses might include:
Private Mortgage Insurance (PMI) – A type of mortgage insurance paid by the homeowner to insure the mortgage if a loan default occurs. PMI is usually required on home loans where less than 20 percent down was provided at closing. Your specific loan program will determine whether PMI is necessary. Payments are typically made monthly and will cost between 0.5 to 1 percent of the amount of the loan, figured annually.
Homeowners Association (HOA) fees – These are fees paid by residents in a neighborhood to cover the costs of maintaining amenities and landscaping. Fees vary widely across the nation but are usually paid monthly or quarterly.
Utilities and Other Services – Are utilities, cable, and other services included in your monthly rental rate? You pay for them separately when you’re a homeowner. If you moved from a rental that operated on gas and your new home runs mainly on electricity, you might see an increase in your monthly utility statement. The size of the house will also influence utility costs.
General Maintenance and Repair Costs – Keeping your home in top shape is one of the simplest ways to avoid costly expenses. Repairing major systems, e.g., HVAC, plumbing, and electrical, can be expensive. But, even with proper maintenance, not every major expense can be avoided. New homeowners should be prepared to pay such expenses as a normal cost of homeownership.
Homeowners with a financial safety net for planned and emergency expenses sleep better at night. A You Name It Savings account that holds at least three months of living expenses can relieve anxiety felt by new homeowners who would otherwise turn to credit cards during a financial emergency.
Monthly Budget
Your debt load and potential homeownership expenses probably have you thinking about your monthly budget. Now is a great time to streamline your budget and eliminate nonessentials that can add up quickly, e.g., monthly app subscriptions, extra cable packages, etc. Use a How Much Home Can I Afford calculator to estimate the highest payment you can afford while keeping your other monthly payment obligations in mind. Next, test drive a homeowner’s budget. For the next four months, live as if you had to pay the mortgage payment instead of your regular rent payment.
For example:
If your rent payment is $1,500 a month and you expect an estimated mortgage payment of $1,800 a month, pay your rent as usual and stash the extra $300 into your You Name It Savings account. This will help you determine your comfort level of paying a mortgage each month and give you a jumpstart on your emergency savings account.
Before you apply for a mortgage, consider more than the down payment and closing costs. Preparing your credit, reducing your debt load, saving for unanticipated expenses, and adjusting your budget are ways to place yourself in the best financial position for homeownership. If you’d like your next move to be into a new home, contact us today at 520-794-8341 to schedule a free pre-qualification meeting. We can run preliminary calculations to help you determine how much home you can afford.