Based upon your answers to the first two questions, you might have some idea about your ability to qualify for a mortgage. However, one of the most common mistakes that potential homebuyers make is to assume that they won’t qualify for a mortgage. Don’t assume that you wont qualify. Go ahead and meet with a lender and see if you can be pre-approved. If you don’t qualify, the lender will tell you why not and then you will know what you need to work on. Many of the HomeOwnership Center’s clients are sent to us by lenders so that we can show the buyers how to become mortgage ready.
Many realtors will not spend much effort on clients that are not pre-approved for a mortgage. Being pre-approved also gives you more negotiating power when dealing with the seller. So, get pre-approved for a loan before you start house hunting.
Here are some indicators that you may not be mortgage ready:
You have a low credit score: Just as we discussed in Part One of this series, lenders will take a hard look at your credit score and credit history. If your credit history is not good enough, you will either be turned down for a mortgage or you will pay a higher interest rate than a buyer with a good credit history.
You have a high debt-to-income ratio: A debt-to income ratio (DTI) is a simple comparison between how much debt you have and your income. The DTI is an indicator to lenders that you will have the ability to pay back the loan.
To find your DTI, simply add up all of your monthly debt payments and divide the sum by your gross monthly income (income before taxes). For instance if you had a monthly gross income of $2,000 and a total of $600 in monthly debt payments, your DTI would be ($600/$2000) or 30%. The lower your DTI, the better. A DTI of 43% or lower will qualify you for most mortgages. However, a DTI of 36% or lower would be preferred.
Some mortgage lenders may express your DTI as two numbers such as 28/36. The first number is the front end DTI while the second number is the back end DTI. A front end DTI compares your housing expenses (mortgage, home insurance, etc.) with your monthly gross income. The back end DTI is the debt to income comparison we discussed earlier. Our own down payment assistance programs require a back end DTI of 31/42 or 30/42 depending on the program.
Multiple recent credit applications: Buying a new car, applying for credit cards, and opening a charge account at a store are all bad ideas when you are preparing to buy a home. Each time you apply for credit, your credit score will temporarily go down. Even worse, your debt-to-income ratio will go up when you take on more debt. Here is a classic example of what not to do:
Your offer has been accepted and you will close in two weeks. Great! This is your first home and you want to run out and buy a new lawn mower and some tools for yard work using your credit card. You also want to open a new charge account to buy a couch and furniture for the extra bedroom. Good idea or bad? Bad. Don’t do anything that will impact your credit history until after you close on the home loan. That buying spree will alter your DTI and lower your credit score. When the lender pulls your credit history one last time before you close, you may no longer qualify for the loan. Hold off until after you close before using your credit cards or opening new accounts.
Unstable job history: Once again, lenders want to see that you can pay back the loan. Changing jobs frequently, job loss, and frequent layoffs can signal that you may not be able to make future mortgage payments, leading to default. An unstable job history is a red flag to lenders.
Lack of savings: Lenders want to see that you have money in the bank. Why? You will need cash for the down payment and closing costs. You should also have cash set aside for emergency savings so that you can replace the hot water heater and make other repairs as they become necessary. Read Part Two of this series to learn more about the cash you will need to buy a home.
What can you do when your credit history doesn’t measure up?If you are not mortgage ready, you should contact the HomeOwnership Center. Our classes and coaching programs will help you to set financial goals and give you the information and skills needed to reach them. We will set you on the right path to homeownership.
This is the third post in the series, Are You Ready to Buy Your Own Home? You can read the other installments in the series by following these links:
Part One: Is Your Credit History Good Enough to Buy a Home?
Part Two: Have You Saved Enough Money to Buy a Home?
Part Three: Are You Mortgage Ready?
Part Four: Are You Planning to Stay in the Home for the Next 5 to 7 Years?
Part Five: Are You a Realistic Homebuyer?
Part Six: Do You Know Enough About the Homebuying Process?