Buying a home is a huge accomplishment, and an opportunity to put down roots and build equity.
But with national inventory down almost 30%, the housing market has become more competitive.
That’s especially true when it comes to mid-priced, affordable houses.
So how do you get ahead in a hot market? The key is preparation.
The sooner you start preparing to buy a house, the easier it’ll be to beat the competition.
But even if you’re already house hunting, it’s not too late to take some of these steps and improve your homebuying prospects.
Preparing to buy a house: Early stages
- Check your credit
- Figure out DTI
- Save money
- Determine your budget
How to prepare if you’re ready to buy a house now
- Research loan programs
- Get pre-approved for a mortgage
- Find a real estate agent
- Be ready to pay an earnest money deposit
How to prepare to buy a house if you’re in the early stages
If you’re in the early stages of preparing to buy a house, you have a leg up.
You have extra time to get ahead of your credit, debt, and savings — which means you’ll have a bigger home buying budget and lower mortgage rate when you’re ready to buy.
Here are four steps to help you prepare if you’re a ways out from buying a house:
1. Check your credit
Once you decide to buy a home, the first thing you’ll need to do is check your credit. This involves getting your credit report from each of the three bureaus (Experian, TransUnion, and Equifax), and pulling your credit score.
Your credit determines whether you’re eligible for a mortgage, and it influences your mortgage rate. The higher your score, the lower your rate.
Most mortgage programs require a minimum credit score between 580 and 620.
Ideally, you should check your credit at least six to 12 months before applying for a mortgage. This allows time to improve a low personal score, if necessary.
You should also check your report for accuracy and dispute any errors, especially negative errors that decrease your score.
To get your credit file, contact each of the three bureaus separately, or order all three copies from AnnualCreditReport.com. Each year you’re entitled to one free report from each of the bureaus.
2. Figure out your DTI
Your debt-to-income (DTI) ratio is the percent of your monthly gross income that goes toward debt repayment. Mortgage lenders use this percentage to gauge affordability.
Typically, lenders prefer a DTI ratio that’s no higher than 36% to 43%, depending on the mortgage program.
- If you have a gross monthly income of $4,000
- Your monthly debt payments (including a future mortgage payment) shouldn’t exceed $1,720
- Your DTI is 43% ($1,720 / $4,000 = 0.43)
Some mortgage lenders allow a higher DTI, but only when a borrower has “compensating factors” such as a high credit score or a large cash reserve.
To improve your DTI ratio, pay off as much debt as possible before applying for a mortgage. This includes credit cards, auto loans, student loans, and other loans.
You don’t have to be debt-free to purchase a home, but less debt can increase purchasing power.
3. Save money
Today, the majority of mortgage programs require a down payment. This amount ranges from a minimum 3% to 5% for a conventional loan, and a minimum 3.5% for an FHA home loan.
So if you pay $200,000 for a house, you’ll need at least $6,000 to $10,000 as a down payment.
A down payment isn’t required with a VA loan or a USDA loan.
Keep in mind, too, if you purchase with less than a 20% down payment, you’ll likely pay mortgage insurance. This insurance protects your lender in the event of default.
You’re also responsible for closing costs — which are roughly 2% to 5% of the loan amount (or $4,000-$10,000 on a $200K loan).
If you’re having trouble saving for a down payment, it’s possible to use gift funds or down payment assistance to help you qualify.
When applying for a mortgage loan, your lender will ask for copies of your bank statements to confirm you have enough in reserves for your down payment and closing costs.
If you don’t have enough cash, some mortgage programs allow borrowers to use gift funds to cover all or a percentage of their mortgage-related expenses.
There are also multiple down payment assistance programs (DPAs) in every state. These offer grants or loans — often, forgivable loans — to qualified homebuyers who need help with their down payments.
So if you need a little extra help with the out-of-pocket costs, DPA is definitely worth looking into.
See if you qualify for a home loan. Start here (Aug 6th, 2020)
4. Determine your budget
Before meeting with a mortgage lender, use an online mortgage calculator to estimate affordability.
Once you know what you’re likely to afford, you can then estimate how much to save for your down payment and closing costs.
For example, if a calculator says you’re likely to afford a $250,000 home, aim to save a minimum $12,500 for your down payment, and perhaps another $5,000 to $7,500 for closing costs.
- Estimated purchase price: $250,000
- 5% down payment (typical for a conventional loan): $12,500
- Estimated closing costs (about 3% of loan amount): $7,500
- Minimum amount to save: $20,000
Mortgage calculators vary. Some estimate your monthly payment based on the home price, down payment amount, interest rate, loan term, and other monthly mortgage expenses like homeowner’s insurance and property taxes.
Other calculators, however, estimate affordability using information you provide about your income and current debt payments.
But remember that this is only an estimation. You’ll still need to contact a mortgage lender to learn how much you really qualify for.
Get a custom loan estimate (Aug 6th, 2020)
How to prepare if you’re ready to buy a house now
These are steps everyone can and should take before buying a house.
But even if you found your dream home out of the blue, and you feel rushed to buy, a little preparation will position you to get the best financing available and make a competitive offer.
Here’s what to do.
1. Research loan programs
Even though your mortgage lender will discuss different home loan solutions, do your own research before meeting with the bank.
Once you’re ready to buy, the process is going to move fast. It can be difficult to digest everything your lender says — and you might not feel like you have time to explore financing options.
Once you’re ready to buy, things move fast. You might not feel you have time to explore all your financing options.
If you settle for the first loan you’re offered, you might miss out on lower rates or a more affordable loan program.
So take your time and educate yourself on different mortgage products. Think about what you really want in a mortgage. Is it:
- The lowest down payment?
- The lowest possible monthly payment?
- Avoiding mortgage insurance?
- Paying off your loan in the shortest time possible?
All these things are possible. But a loan officer can only help you find the right match if you know what your priorities are.
Knowledge is your best weapon to make an informed decision and choose the best loan for your situation.
2. Get pre-qualified/pre-approved
A mortgage pre-qualification and mortgage pre-approval can jump-start the buying process. But while both steps sound similar, they’re quite different.
A pre-qualification is a preliminary step where you provide the mortgage lender with basic information about your financial situation via an online form. The lender doesn’t verify this information, but uses it to determine whether you might qualify for financing.
A pre-approval, on the other hand, involves submitting a mortgage application and providing your lender with supporting documentation. This includes tax returns, paycheck stubs, W2s, financial statements, and a credit check.
A pre-approval is the most important step before house-hunting… Some Realtors and sellers will only work with pre-approved buyers.
The underwriter reviews this information and determines how much you can afford to spend on a property.
A pre-approval doesn’t guarantee financing, but it’s a lender’s way of saying they will likely approve you, provided you meet other loan conditions.
A pre-approval is the most important step before house-hunting.
You’ll know what you can afford before searching for a home — plus some Realtors and sellers will only work with pre-approved buyers.
3. Find a real estate agent
Buying a home can be a complicated, intimidating process, so you’ll need a professional on your side to answer questions and look out for your best interests.
Don’t rely on the seller’s agent to provide advice and guidance. It’s their job to advise their client, not you.
To find a good real estate agent, get recommendations from friends and family. You should also read online reviews, and interview two or three agents before making a final decision.
4. Be ready to pay an earnest money deposit
Make sure you have liquid cash for your earnest money deposit. Once you find a property, you’ll need to submit an earnest money check with your offer. This is good faith money that says, “I’m a serious buyer.”
Earnest money deposits vary but typically range from 1% to 2% of the purchase price — usually a minimum of $500 to $1,000.
The seller doesn’t pocket the money, though. Funds are held in an escrow account, and either returned to you at closing or applied to your closing costs and/or down payment.
Home buying moves fast, so don’t rush your preparation
Buying a house is a huge decision, so it’s important that you don’t rush.
Some eager buyers act too quickly and end up skipping vital steps such as a home inspection and comparison shopping.
In a worst-case scenario, you could end up with a fixer-upper when you thought you were buying a turn-key home, or end up spending thousands extra in mortgage interest.
On the flip side, a little savvy can save you tens of thousands over your mortgage term and even boost your home buying budget.