When you are preparing to buy a home, you should begin by taking a look at your situation before you begin looking at properties. Some things you must review carefully as you prepare to buy a home are your credit and your ability to secure financing. Your income and debt are also major points to evaluate. Below is a list of factors you should consider before beginning your journey towards purchasing a home.
Know How Much you can Afford
Purchasing a home is one of the biggest financial transactions anyone will make. If you are currently looking to purchase a home, you’re probably wondering “how much house can I afford?” Traditionally lenders don’t’ just look at your income, your assets and the down payment, they may take a look at your liabilities, and obligations as well – including auto loans, credit card debt, child support payments, potential property taxes, insurance premiums, etc. and your overall credit rating.
Mortgage lenders use something called qualification ratios to determine how much they will lend a borrower. This ratio will vary from lender to lender however most are in the same range.
Generally, mortgage payments and mortgage related expenses including: principal interest, real estate taxes and homeowners insurance should not exceed roughly 28 percent of your gross monthly income. As an example, if you and your spouse have a combined income of $100,000, your mortgage payment should not exceed $2,333.
Know Your Debt to Income Ratio
Your debt to income ratio is a valuable number. A lot of lenders use your debt to income ratio to figure out how large of a loan you can handle. Less debt equals more borrowing power. There are two types of debt-to-income ratios. They are known as the front-end and back-end ratios respectively.
Front-end ratio: The housing expense, or front-end ratio as discussed above shows how much of your gross (pretax) monthly income would go toward the mortgage payment. These expenses should not exceed roughly 28 percent of your gross monthly income.
Back-end ratio: The total debt-to-income, or back-end ratio, shows how much of your gross income would go toward all of your debt obligations including: mortgage, car loans, child support, alimony, credit card bills, student loans and condominium fees. In general, your total monthly debt obligation should not exceed roughly 36 percent of your gross income.
Check Your Credit Score
If you want to secure a mortgage, especially one with a low interest rate you’re going to need a good credit score. The most common scoring model is FICO, where scores range from 300-850. Many lenders require a score of at least 680 to get a mortgage, and those with a score in the mid 700s and above usually get the best interest rates.
Reviewing your credit score regularly is a good idea, but it is particularly important to do so before applying for a mortgage. As a good rule of thumb you should check your report at least 60 days before you plan to apply, as it can take some time to resolve issues and discrepancies.
Get pre-approved before you begin house shopping. Pre-approval will determine how much home you can afford and will also increase your bargaining position. It sets you apart and signals to the real estate agent and the home seller that you are serious about the home you want.