House shopping and imagining the possibilities for your new life can be really fun. However, before setting out to look at homes with a real estate agent, you’ll want to square away a couple of not-so-fun details so you’re well positioned to make an offer when that dream home comes along. Namely:
- Figure out what price house you can afford. This focuses your time (and emotions) on houses within your financial reach.
- Get preapproved for a loan. Once you see the house that’s the perfect match for you, you’ll be ready to make an offer before other bids come in.
The steps below walk you through getting started in your home buying process. When you’re finished, you’ll be all set to find (and buy) the right home.
Step 1: Check Your Credit Score
Getting your credit score in shape is the first step to securing a loan. Your credit score is important because mortgage lenders will look at it to determine the terms of your home loan. In general, the higher your credit score, the better your interest rate, fees and total amount you can borrow. Home loans are often a 15- to 30-year commitment, so if a higher credit score means a lower interest rate, it can ultimately turn into thousands of dollars in savings.
Knowing your credit score is helpful. You can check your credit score with a free service or contact a loan officer today to see where you stand.
Most lenders provide these common types of home loans. As of July 6th here are some general credit score guidelines which may change at any time:
- Conventional Loans: Loans offered by private lenders, including credit unions, and two government-sponsored agencies, Fannie Mae and Freddie Mac. They typically require up to 20% of the price of the house for a down payment, but there are options as low as 3%. The minimum FICO® score (a brand of credit score) required to qualify for a conventional mortgage is about 620.
- FHA Loan: Loans backed by the Federal Housing Administration. You can qualify with a lower FICO® Score and a 10% minimum down payment. Applicants with a FICO® score higher than 580 may be able to make as low as a 3.5% down payment.
- USDA Loan: Loans issued by the U.S. Department of Agriculture designed for people living in rural America. Applicants usually need a minimum 640 credit score and may qualify with as little as 0% down.
- VA Loan: Loans provided by private lenders, including credit unions, which are guaranteed by the Department of Veterans Affairs. These loans are available to veterans, active duty military, and some military spouses. A VA loan offers options that include no down payment and without the requirement to purchase mortgage insurance. For those eligible for a VA loan, qualification and approval may be easier — including no VA-mandated minimum credit score. However, many lenders will set a minimum credit score similar to other types of loans. And once again, the higher the credit score, the lower the interest rate.
Here are a few rules of thumb on increasing your credit score:
- Pay credit card bills on time
- Keep your credit card balance below 10% of your credit limit
- In the months before you apply for a mortgage, don’t apply for new credit cards or loans because these actions can temporarily decrease your score
A free credit report may suggest tips on improving a credit score. Read more tips from Elevations mortgage pros on your credit score.
Step 2: Determine what you can afford
Big picture, affording a loan for a house usually requires two categories of payments to pay back the loan: a down payment — the flat amount you pay upfront — and monthly payments. Review your debts and what you are currently paying for housing. Do you have enough income to pay for needed items (auto, food, taxes, clothing etc. . Some borrowers are comfortable with Housing expenses as much as 40% depending on their discretionary income available.
- Consider your gross monthly income (salary before taxes) and housing expenses. Housing expenses often include principal, interest, taxes, insurance and HOA dues. Consider what you currently pay for housing and how much more if any you are willing to pay per month. You can use our helpful rent vs own calculator to calculate the difference between renting and owning a home. When you talk to lenders, try to offer a ballpark amount for your target mortgage payment.
- Understand your debt to income ratio. The lower your debt-to-income (DTI) ratio is, the less risk you present to a lender. In general, a DTI of 36% or less is favorable. To calculate DTI, add up your total monthly debt obligations on payments like loans (car, student, solar), child support, credit cards (minimum due) and your estimated housing expenses. Generally, debts don’t include expenses like utilities, groceries or clothes. For example, assume your gross monthly income = $4,000 and your total monthly debt payments equal $1,360 ($1,120 mortgage payment, plus a student loan and one credit card), your debt-to-income ratio is 34% ($1,360/$4,000) = 34%.
Once you know your gross monthly income and housing expense, visit our handy mortgage calculator to see what house price those numbers translate into. Keep in mind that this price is an estimate to help you plan your budget before you buy a house. You’ll get more exact numbers in the steps below.
Step 3: Choose a Mortgage Lender
It’s a good idea to talk to several lenders before choosing one. To compare lenders and rates, ask for a written estimate that outlines loan terms, monthly payments and closing costs for your ideal mortgage. You’ll need to provide the lender with basic financial information to get this estimate, which they can usually turn around in one to three days. Evaluate lenders not just on the rate they can give you but also on the customer service they provide. Are they easy to talk to? Do they make the process clear? Do they respond quickly to your needs? Getting a loan can be stressful, so you’ll want someone who helps lighten the load. In addition, compare lenders and rates, look at their loan terms, monthly payments and closing costs. You’ll need to provide the lender with basic financial information to get this estimate, which they can usually turn around in one to three days.
Step 4: Get a Preapproval Letter
A preapproval letter** is a document from your lender stating that they have thoroughly reviewed your financial information, and it details the definitive terms of the loan you qualify for. While a written estimate of loan terms and fees (described above) is a good ballpark figure for the costs and payments associated with a home you may buy, you can get the edge over other buyers by having a pre-approval letter that has been subjected to underwriting in hand from one or more lenders, showing the seller you’ve passed the financial bar for buying a home. Getting a preapproval letter requires the lender to review very detailed financial information, like your credit score, income and assets which allows them to process your loan more quickly once you find the home you want to buy. Why does your credit score matter? Find out more in our blog post, Homebuying and Your Credit Score: Tips from the Mortgage Pros.
This prep work takes some number crunching and time, but it sets you up to find the right loan and a home within your budget, plus gives you the ability to make a quick offer. When you’re ready for next steps, see our post on How to Find (and Buy) a Great Home.
Ready to talk to a mortgage professional? Our experienced, award-winning team of mortgage lenders is here and happy to serve you.
Download our free Elevations Home Buyer’s Guide:
**A pre-approval letter is not a firm offer of credit. Lenders may require additional information, documentation and underwriting prior to providing a formal approval.