This weekend, one of my close friends in Louisville KY told me that she was thinking about buying her first home. After I congratulated her, she expressed concern that she would not be preapproved for a large enough amount, and so we got into a discussion of the main factors that affect you when buying a home. Based on the following information, my friend felt much better about her current financial position. If you have questions about whether you are financially ready to buy a house, then keep reading! Not only will these numbers impact your ability to buy, but they can impact your interest rates, preapproval amount, and your overall buying power.
Your credit score is likely the first and most important thing that your loan officer will review. This number quickly gives the lender an idea of how financially responsible you are and how much existing credit you have. There are five key factors that impact your score and each varies in importance. They are: payment history (35%), amounts owed (30%), length of credit history (15%), credit mix (10%), and new credit (10%).
If your credit score is in the low 600s or even under 600, that does not necessarily rule you out from qualifying for a loan. Certain lenders can go as low as 580 but that is the very bottom line in Louisville KY and in most other places. To qualify for the best possible interest rate, aim for a score of 760 or higher.
If you have time before buying a home and want to improve your financial position, focus on increasing your credit score. The most efficient ways to do this are to make ALL payments on time and to decrease your credit utilization, by using as little of your available credit as possible.
The amount of money you plan on bringing to the table for your down payment will also have a significant impact on your mortgage. Generally, the less you have for a down payment, the higher the interest rate will be. Lenders do this because when you have very little equity to start off, the loan is riskier for the lender, and they protect themselves by increasing the interest rate.
Also, if your down payment is less than 20%, you will have to pay Private Mortgage Insurance (PMI.) This is a form of insurance that protects the lender when you have less than 20% equity. This will be an additional monthly expense that you must be prepared to pay since it is not optional in most cases.
If you are familiar with the loan application process, you have probably heard the term “debt-to-income ratio.” This calculation provides an important number for the lender. There are two ratios that the lender evaluates.
First, the lender looks at your monthly housing payment divided by your total monthly income. For example, if you currently pay rent of $850 per month, and your total monthly income is $2,500, then this ratio is $850/$2500 = 0.34 = 34%. This number should be at or below 28%… so in this example, the renter would not qualify.
In addition, the lender looks at your total debt to income ratio, which is your total monthly debt (housing payments, car loans, student debt, credit cards, etc.) divided by your total monthly income. For example, if you total monthly debt is $1,200, and your total monthly income is $4,000, then this ratio is $1200/$4000 = 0.30 = 30%. Lenders require this number to be at or below 36%, so this example would qualify.
Last but not least, lenders will want to see your existing assets, because they want you to be able to show where the money for the down payment is coming from. Do you have $30,000 set aside in your savings account? Great. However, was $10,000 of that just transferred into your savings account from your parents? Not so great. The loan officer will trace payments into and out of your bank account, and if they find that someone else is providing a significant amount for your down payment, then that could negatively impact you. So make sure that YOU have the money for the down payment.
The Bottom Line
My friend who is planning on buying her first home in Louisville KY realized that she is in great shape. There is nothing that would be a red flag to a lender. But there are lots of people who don’t realize all that goes into a loan application. The best things to do to qualify for a loan are to increase your credit score, save money, and pay down debt. Now go get started!
Ready to buy your first home? Explore the current listings on our website or give me a call now at 502-551-1286! I am never too busy to talk to you!