Buying your first home is an exciting journey and a marker of a new phase in your life. According to a recent survey, many in the age bracket of first time home buyers, however, feel stressed and mystified by the process. If you are in a place of wanting to buy a home but need guidance as to where to begin the learning process, here are four crucial areas you ought to understand and some advice for each.
Your DTI and Credit Score
Your debt to income ratio (DTI) and credit score are the most significant factors in your loan application. A healthy DTI and credit score will enable you to qualify for the best terms on your loan. Before you begin the home buying process, it’s crucial to reach a place of financial health in these areas.
A borrower’s DTI is usually required to be no more than 43% to qualify for a loan, but lower is better. Your DTI is how much debt you have versus how much you make a month. To calculate your DTI ratio, add up all the payments you make toward your debt during an average month then divide your monthly debt payments by your monthly gross income (this is how much you make before taxes). Once you do this, multiply by 100 so you can see your percentage. You can improve DTI by paying down debt, avoiding new loans, and finding ways to increase your income.
For a good credit score it’s necessary to have a pattern of paying your bills on time. You also need a history of creditworthiness. This means you have been paying your credit cards over a long period of time, and you haven’t opened or closed new credit lines in the last eight months. Good credit also means that your balances are not too high. You should owe no more than half the max limit on your cards.
The Importance of Pre-Approval
The 2021 market tilts heavily in the seller’s favor, so pre-approval is more important than ever. Getting pre-approved for your home loan also gives your real estate agent an idea of what you can afford and presents you as a credible and serious buyer. Where pre-qualification is a good indication of whether or not you can get the desired loan amount, pre-approval is the official answer.
To go through this process you’ll need to have your financial documents in order. This usually includes your most recent bank statements, last three months pay stubs, and most recent W2 or tax returns.
What You Can Afford
Most financial advisors agree that your mortgage payment should be no more than 30% of your take home pay. Your lender will also decide what they think is feasible when evaluating your DTI. However, just because you can get a larger loan amount doesn’t mean you should. It’s important to know precisely what you can afford comfortably.
One way to learn this is to create a zero based budget and follow it before you begin shopping for a home. Establish what you can realistically set aside while maintaining a pattern of saving and not incurring any debt. Whatever amount you can comfortably save, not counting retirement or emergency savings, plus your current rent, is the max you should look to spend on your monthly mortgage payment. The goal of the zero based budget is to ascertain what you can afford while still having flexibility in your finances.
The Surprise Costs of Home Buying
When you look at a home’s price tag, it’s not the only cost in purchasing a home. You’ll also have to pay closing costs and various fees. Closing costs are, mostly, covered by the seller, but the buyer pays on average between 2% and 5% of the home purchase price toward them. These costs include appraisal, various fees, and insurance costs. Costs usually vary by jurisdiction, and many buyers often choose to bundle these costs into the home loan.
Guidance You Can Trust
We on the Reed Team are here to help first time buyers by leveraging our experience, resources, and professional connections in your favor. This is your first time walking through this process, but it certainly isn’t ours. If you’re considering buying a home or have questions, reach out to us here or contact us at 949-392-6400.