Am I ready to buy a house?
Each homebuyer is different, and the next wave of first time home buyers has the potential to throw the mortgage banks for a loop. With hoardes of freelancers & contractors marching towards self-employment, or companies like Uber, Udemy, and AirBnB offering new, unprecedented ways to make money, income streams are less consistent and more diversified. After the financial crisis in 2008, many people rejected the use of credit cards and worked to eliminate debt. Some are even rejecting banks outright
Please, pretty pretty please, don’t ever use a video game store as a bank. Seriously.
These shifts create awesome new opportunities, and you should totally take advantage of them. But the mortgage lenders aren’t known for dealing with change well, and they haven’t really adapted to the new economic realities. Being self-employed or lacking credit history can make getting a home loan complex. Here are some common scenarios & what you can do to address the issue.
Six things to check to see if you’re ready to buy a home
Is your credit score high enough?
Do you know your credit score? If not, quit dragging your feet and go to CreditKarma.com right now. I’ll wait… Got it? Good, see how easy that was?! Many mortgage lenders require a minimum credit score to lend money. Every lender is different, but a good target minimum score is 600. The higher your score, the less risky you seem to the lender, and the better interest rate you’ll get. Anything above 780 will usually get you the best rates. If you have bad credit don’t worry – working with a credit repair company now can get you in shape for when you’re ready.
Also worth noting, different types of lenders use different math to determine your credit score – your FICO score for your auto loan is different than the score for your credit card or your mortgage. Often times the score you’re given online is wrong, and the mortgage score tends to be lower than the rest, so don’t be surprised if the score your mortgage lender gives you is different than what you expected.
Do you have enough saved for your down payment?
A Google Consumer Survey found the average person in the US has less than $1,000 in savings. A standard loan requires 20% down, but there are many products that ask for far less – from 10%, 5%, and in some cases 0% down. Still, a down payment is not the only thing you’ll need cash for when buying a home – many first time home buyers don’t realize there are closing costs that must also be paid. But don’t fret – there are many options to deal with these as well – from having the seller cover the costs or having the lender cover them.
If you’re interested in buying a home at some point, the best thing you can do is open a dedicated “house fund” and start saving money. For me, I had to make my house fund hard to access so I didn’t dip into it. To keep myself honest, I opened a new account at an online bank. I made sure it was different than my main bank I use. I chose CapitalOne360, but I’ve also heard Ally Bank has a great site. Whichever bank you use, set up an auto-transfer to that account, and make your password really annoying. If it’s hard to access, you’re less likely to touch it! Setting a goal is important here, and automating that goal makes the process painless.
What if I’m getting a gift for my down payment?
This goes along with the low down payment / no money for closing costs conundrum. In many cases, family (or some really supportive friends) can gift money to a borrower to help cover the down payment or closing costs. These are called “gift funds,” and they can make lenders nervous. A lender will require a letter from the person giving the money stating that it is not a loan and does not need to be repaid. Getting this letter ahead of time is a great proactive step.
Do you have consistent income for the last two years?
Lenders want to see consistent income over a long period of time. They’ll check your tax returns as a way of proving your income. This can make getting a loan tricky for those who recently received a large raise, have multiple sources of income, or are self employed.
Getting a mortgage as a self-employed person is completely possible, even if you come into the transaction having done no prep work. However, there are a number of things you can do right now to make your life easier down the road. One of the big differences in doing a loan as a self-employed person is the document requirements – lenders will require not only your personal tax returns and bank statements, but also your business tax returns and business bank statements. Having those things handy and organized out of the gate will save you a ton of time. Also, if you have your own company – be it an LLC, S-corp, or C-corp – there are many things you can do during tax season that could help or hurt you.
Do you stick to a budget?
Budgeting in general is important, but new home buyers will need to budget for home specific expenses like furniture, decorating, renovating (interior), yard improvements, etc. Make sure that you have a good understanding of what your current monthly expenses are and what they might look like after you purchase a home. Using a personal finance tool like Mint can help you quickly understand your spending habits.
Do you have emergency savings?
This is a biggie. Also, some mortgages have a reserve requirement – a proper emergency fund can help show you have cash in the bank in case the lender requires 3-6 months worth of payments in reserves. You’ll also need that cash on hand in case you have unexpected expenses that come up after your purchase. You’ll never know when you’ll need to fix a leaky roof or replace an old hot water heater. At the very least you’ll want enough money saved to work through our proactive home maintenance checklist.
Have you taken care of your existing debt?
outside of your income & down payment, your monthly debt payments are the next biggest thing for affordability. Eliminating even $100 in monthly payments can increase your affordability by tens of thousands of dollars.
- Lowering debt is step number 1 – There are a million articles online about lowering your overall debt. We like the debt snowball approach but there are many strategies to pay off debt.
- Consolidate debt where possible – interest rates are rising, now is a good time to refinance variable rate student loans, consolidate credit card debt, etc. I’ve never loved another company as much as I love Earnest – refinancing my student loan was a breeze, but the magic really comes after the loan is done. Balance transfers on 0% interest cards can be a great tool too, especially when they give you cash back or travel rewards. Just make sure you pay the debt off before the interest rate cranks up!
- Open new lines of credit – this is counter intuitive, but opening and aging credit lines can actually improve your credit score in the long term. To the same point, canceling some of your credit cards can actually hurt your credit score. Credit cards aren’t all bad – owning a home has the potential for large or unexpected expenses, having credit cards provides a safety net in case of emergency. Establish credit early, minimize the impacts of a credit inquiry by getting new accounts long before you apply for a mortgage, and make best of use rewards cards!
Let’s take a step back for a second. If you’ve gotten this far, you’re already ahead – many people jump into getting a mortgage without understanding what goes into it and it can break a deal. Knowledge is power. Taking the steps outlined here will put you lightyears ahead in the process. A quick checklist, and then we’ll get into the meat and potatoes – understanding how much home you can afford
- I know my credit score, and I’m taking steps to make it higher!
- I have a goal amount to save for a down payment! And if that includes gift funds, I’m going to get them deposited as early as possible!
- I have a consistent income! And if I’m self employed, and I’m taking steps now to make to make my home buying process easier!
- I’ve got a budget and I’m sticking to it!
- I’ve got an emergency fund!
- I’ve eliminated my debt using the Mortgage Monk Debt Snowball (or a strategy that works better for me), or I’ve at least consolidated my debt and lowered my payments!