When you decide you want to buy a home, you have many preparations to make. In other words, it is not a decision to take lightly. It is also not a decision you can act upon quickly. It takes plenty of time and planning. You must financially prepare yourself for what is probably the largest investment of your life. If you take the right steps, though, you can be a successful homeowner for many years.
Fix Your Credit Score
The first step is to fix your credit score. You might not even know what your score is right now. You are eligible to receive a free credit score from each credit bureau one time per year. Order your credit report from a bureau and go over it. Do you have any late payments reporting? Do you have a large amount of available credit outstanding? These are things you want to fix right away. Bring your late payments current and continue to make your payments on time. You should also try to pay your balances down. Both of these steps will increase your credit score. You want to aim for a “good” credit score, which means a score between 700 and 749.
Go Over your Debts
The goal with any new mortgage is to have your debt ratio as low as possible. This gives the lender more incentive to approve you for the loan. Most programs do not want your mortgage payment to exceed between 28 and 30 percent of your monthly income. They also do not want your total debt to exceed around 36 percent of your income. If you have numerous debts going into the mortgage application, you will have a harder time securing a decent size mortgage. Instead of risking your mortgage, figure out which debts you can pay off completely as this makes a lender more likely to approve you.
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Start Saving Money to Buy a Home
You know you need money to buy a home, but do you know how much? The amount depends on the price of the house as well as the mortgage program you use. For example, an FHA loan only requires a 3.5% down payment whereas a conventional loan might require as much as 20% down. This is a vast difference. If you purchased a home for $200,000, the FHA loan requires $7,000 down while a conventional loan might require as much as $40,000. Conventional loan down payments depend on your credit, debt ratio, and the interest rate you want to receive.
In addition to money for a down payment, you also need money for closing costs. The average loan costs as much as 6% of the loan amount in closing costs. This can vary based on the loan program you use and even the lender. Generally, you should shop around with different lenders to find the best deal available to you. You can also negotiate your closing costs. Lenders are often willing to adjust the costs in exchange for a slightly higher interest rate. In addition, some sellers will contribute towards your costs in order to sell their home.
Lastly, you need money to set up an escrow account. This is the account that pays for your taxes and homeowner’s insurance. If your lender requires an escrow account, at a minimum, you have to fill it with 2 months’ worth of taxes and insurance premiums. However, the time of year you close on the loan will determine how much more you need to add to the account.
Create a Reserve Account
Aside from having money to pay for the loan, you need money in reserves. This can be a savings account, money market, or any other account that you can access the money immediately. Some loan programs require reserves on hand in order to qualify for the loan. Other times reserves serve as a compensating factor. For example, if your debt ratio is slightly high, but you have six months of mortgage payments in a liquid account, the lender might approve you for the loan. If you did not have those reserves, you might not receive the approval. There is no rule regarding how much you should save, but 3 to 6 months’ worth of mortgage payments is usually a good idea.
Talk to a Lender
When you decide you want to buy a home, talk to a lender. This is one of the best ways to prepare yourself financially to buy a home. The lender can give you a good idea of what you need to fix and save in order to successfully purchase a home. There might be things you do not realize that make it difficult to gain approval. The lender will look at your credit, income, and assets. They will talk to you about your employment and the type of income you receive to help you understand what you need. For example, if you are self-employed, you will need more proof of your income than someone who is not self-employed. This is because there is a higher risk in loaning money to people who work for themselves.
Financially preparing to buy a home is not hard, but it does require time. Generally, starting two years before you want to purchase a home increases your chances of success. The more money you save, the better your credit, and the lower your debts, the higher your chances of approval.