The Magic Formula that Can Turn Anyone Into a Homeowner
Prospective homeowners often wonder what it takes to become a qualified buyer. They want to know if there is a magic formula that they can follow in order to transform themselves into someone who is ready to qualify for a mortgage. Luckily, as it turns out, there is.
We’ve outlined the 4 puzzle pieces that will get you ready to buy your first home. Read on below to learn how to get these financial factors into shape and put yourself in good standing to get pre-approved. With a little hard work, you’ll be ready to start your house hunt in no time.
1. Steady Income
This one is self-explanatory. Banks see steady income as an indicator that you’ll be able to make your mortgage payment every month. They work under the presumption that, if you have the same amount of money coming in consistently, you’ll allocate it appropriately.
For those of you with regular, full-time jobs, this step is fairly easy. All you’ll need to do is show the lender your work history and W-2’s. As long as you’ve put in at least two years at the same company, you should be good to go. For those of us who freelance or are self-employed, the process is a bit more complicated. Since our income is variable, banks often have stricter standards for what they consider financeable. However, the base principle is still the same, two years of high, verifiable income — net, not gross — is a must.
Keep in mind that “steady income” doesn’t necessarily mean stagnant. Your income can certainly increase in the amount of time that you’re trying to sure up your finances. In fact, that’s all the better. You just don’t want it to drop.
2. Good Credit
Good credit is more or less an insurance policy for mortgage companies. They use your credit score to, again, determine the likelihood that you’ll pay back your loan. As for what counts as “good credit”, that will depend on the type of mortgage that you’re looking to apply for. According to Credit Sesame, the minimum score needed to qualify for an FHA loan is 580. However, if your goal is to go conventional, that number rises to 620.
If your score isn’t quite up to snuff yet, don’t worry. There are lots of things you can do to help bump it up. The first and most important is to make your payments — on time — every, single month. You should also try and pay as far above the minimum payment as possible and to consolidate your balances.
3. Low Debt
Whether it’s from student loans or medical bills, banks understand that most of us will be coming to the table with some debt when we apply for a mortgage. They do, however, want to make sure that level of debt is manageable enough that we won’t forgo paying back their loan in favor of other, more pressing bills. To manage that risk, they determine whether or not someone is qualifiable using a debt-to-income ratio.
Banks calculate your debt-to-income ratio by subtracting your recurring monthly debts – things like rents, car payments, and insurances – from your gross income, or total salary. As for what number is acceptable, according to the experts at the Consumer Finance Protection Bureau, while most conventional loan programs only accept a ratio of 36%, an FHA loan will go up to 41%. As a general rule, the lower your ratio is, the better.
If your ratio falls outside those numbers, there are two things you can do: make more money or pay down your debts. Typically credit card debts are the easiest debt is tackle since they often comes with the lowest balances and highest interest rates. Work towards consolidating your balances and paying them down. Then, move onto other paying down other sources.
4. Substantial Assets
The last piece of the financial puzzle is your assets, or how much money you have in the bank. Many potential home buyers think of this as the amount of money that they have set aside to put towards a down payment and closing costs. However, in actuality, you need a little bit more than that. Banks like to see that you have a little bit of a financial cushion so that you’ll still be able to pay the loan in the event of an unexpected emergency.
As for how much you should save up, that varies. In the past, you needed to be able to put down 20% of a home’s purchase price in order to qualify. These days, loan programs are a bit more flexible and can accept as little as 5%. In addition, though, you’ll need account for closing costs, which typically amount to another 2-3% of the loan.
That said, aim to put away as much as possible. In this situation, having more than the recommended minimum never hurts.