Preparation of getting a right mortgage for first-time homebuyers
Getting a mortgage to purchase your first home can be a daunting process, but no less on excitement. It could be a big investment yet for you. Nonetheless before you begin this journey, it is always good if you are well prepared ahead of time, so it will make your home purchase experience more enjoyable and memorable. The following steps will help you to do so:
Plan your budget
In general, the total monthly payment is the main driven factor of how much property you can afford. There are two components of the total monthly payment. The first component is the housing payment that includes principle, interest, tax, insurance, and homeowner association’s fee (if applicable). There is also monthly mortgage insurance premium if the loan amount is over 80% of the purchase price, or an additional insurance premium if the property locates in a flood zone. Ideally, this monthly housing payment should not go over 28% of your total monthly gross income, we call this the front-end ratio. The second component is the back-end ratio that is combined of the housing payment and other payments such as installment loans, credit cards, child support, alimony, etc. The back-end ratio should not be over 43% of your total monthly gross income. Occasionally, this ratio can reach up to 49%, case by case.
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Meanwhile, you need to plan on the down payment. It varies from 3% to a certain percentage that you can afford, typically 20% of the purchase price, but not necessary. The down payment can be from your own funds, or gifts from your relatives. In addition, you need to factor in the closing costs to finalize your mortgage loan, and they typically range from 2% to 6% of the loan amount.
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You also need to set aside some funds after the purchase for the move-in expenses, immediate home repairs, upgrades, and furnishings.
Check and polish your credit
It is always good to know your credit scores prior to applying for a mortgage loan. These scores will determine the loan approval decision, loan stipulations, and most importantly the interest rate. Having high credit scores generally will get you a lower interest rate as well as less loan stipulations needed. Typically, all mortgage lenders will utilize credit scores from three credit bureaus - Experian, Equifax, and TransUnion. You can obtain free copies of your credit reports from these credit bureaus through Annualcreditreport.com that is authorized by Federal law. Currently, these bureaus are offering free weekly online credit reports.
It is also important to review your reports for any errors, such as late payments, collection accounts, and disputed accounts. You need to address those errors with the creditors as early as possible. Meanwhile, these following steps can help to polish your credit scores:
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Make your payments on time.
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Keep credit card balances as low as possible, ideally you should not use no more than 30% of the available credit. If possible, using 10% or less provides the biggest boast to your scores.
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Pay off your smallest debts first while making minimum payments on larger debts.
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Avoid balance transfer credit cards with low introductory interest rates but high transfer fees.
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Avoid opening new credit accounts before and during applying for a mortgage loan.
Gather your documents
When you apply for a pre-approval or a mortgage loan, lenders generally will ask for your financial documents to verify your income, assets, and debt. You should gather these following documents:
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If you are a wage earner, copy of most recent paystubs, and W-2s and/or 1099s.
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If you are self-employed, copy of most recent two years of personal (form 1040) and business (form 1065, 1120, or 1120S) Federal income tax returns.
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Most recent statements of bank, brokerage, and retirement accounts.
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Records of your student loans, auto loans or auto leases.
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Records of other events, such as divorce decree, bankruptcy, or foreclosure.
You don't have to provide all these documents together yet to the lenders at the beginning of application process. It is because each loan application is unique, so each file has its own set of stipulations; therefore, the lenders will inform you what specific documents are needed after they have run your application through Automated Underwriting System (AUS).
Obtain a pre-approval letter
Obtaining a pre-approval letter from a lender can be nerve-racking, frustrating, and exciting all together during this process, because you just don’t know whether your loan application will be approved or not, and how much loan amount you can be qualified for. Regardless, this is a MUST-TO-HAVE process for all home buyers. A pre-approval letter will not secure you a loan from a lender yet, but it gives you confidence when you shop for your dream home, and it proves to a seller that you are a serious buyer who is able to receive financing for your purchase. In addition, it also helps to determine whether all stipulations for your loan application can be quickly satisfied or need more work. The main point is to avoid any delays on closing your purchase on time that could potentially cost you more money or even losing your earnest money deposit if the loan does not go through.
It is important to recognize the difference between a pre-approval letter and a pre-qualification letter even though these terms have been quite often used interchangeably. A pre-qualification is less detailed process, while a pre-approval is more comprehensive, which requires thorough investigation of the borrower’s credit history and financial information. So, a pre-approval letter is highly recommended.
Instead of getting one pre-approval letter from one lender, you should also get pre-approval letters from multiple lenders, preferably three different lenders. So, you can compare for a better interest rate and fees. Each lender is required to provide a Loan Estimate (LE) to you within 3 business days from your application’s date. You should put all Loan Estimates side by side, and compare line by line for any differences, so you can make your decision on which lender gives you a better loan.
