Thinking Of Buying a New Home Next Year? Here's How To Prepare Your Finances.
12.02.2021 | Category: Homebuying
Buying a new home is no easy feat, but you can achieve your goal of home ownership with a little bit of determination, self-discipline, planning and patience. And while homebuying might not be something you can plan to do overnight, it is something you can decide to do in a year or two if the timing is right for you.
If you’re looking to buy a home next year, you'll want to get started right away with good spending and credit habits that are long established, if you haven’t already. Factors like your creditworthiness, debt and income are all important elements in being approved for a home mortgage loan. How much you have saved to put down, employment history and the overall value of the home you wish to purchase are also important to have on hand.
If you already have a long history of using credit wisely, saving well and staying within your budget, you're likely already on your way toward reaching your home ownership goals. However, you might be looking to learn more about how to best prepare your finances for a new home purchase.
How you manage your lines of credit is one of the most important considerations when seeking a home mortgage loan. Your credit score and credit history provide a detailed record of how you manage credit and show if you’re responsible enough to manage a home loan payment.
Your credit score is calculated using five factors that take into consideration how you use credit. Generally, information that impacts your credit score stays on your credit report for seven years, with the exception of a bankruptcy, which will be included in your credit file for 10 years.
Because information is included on your credit report for such a long period of time, it’s important to establish healthy credit habits long before you’re looking to buy a home. Note that there are three major credit bureaus and a variety of scoring models, so not every credit score will be the same and it will change over time.
Here’s a breakdown of the most common items found on your credit report and how long they stay:
Payment History is the most important factor when calculating your credit score and accounts for approximately 35% of your credit score. Even one missed payment can negatively impact your credit score and stay on your credit report for seven years.
Credit Usage or credit utilization ratio is determined by dividing your revolving credit by the total of your credit limits and makes up about 30% of your score. Using more than 30% of your available credit can impact your credit score. Staying below 30% of your credit limit for a long period of time can greatly help your credit score.
Credit History or how long you’ve held credit cards is another factor in your creditworthiness and is roughly 15% of your credit score. The longer you’ve held a credit card, loan or other line of credit positively impacts your credit score. Typically, a line of credit will stay on your credit report for seven years. However, in the case of long-term loans like home mortgage loans, the most recent activity will stay on your credit report for up to ten years.
Credit Mix is the different types of credit you manage and could include major credit cards, retail cards, auto loans, student debt or other credit products. Lenders like to see you can handle a variety of debt and your credit mix accounts for about 10% of your credit score and will appear on your credit report for seven years.
Inquiries are what is included in your credit report when you file a loan application for a new line of credit and is about 10% of your credit score. These only stay on your credit report for two years but too many inquiries in a short period of time – say a credit card application, a retail card application and a home loan application – could impact your prospects for being approved for a home mortgage loan.
Debt and Income
Your total amount of debt divided by your gross monthly income is called your debt-to-income ratio and is used by lenders to measure your ability to be responsible for the monthly payments of a new loan.
To determine your debt-to-income ratio, also called your DTI ratio, you add up all your monthly loan payments and divide them by your gross monthly income. If you’re looking to buy a home, it’s important to work to get your DTI ratio lower than 43% in most cases in order to be approved for a home mortgage loan with a competitive rate.
Often times, when prospective home buyers are looking to improve their DTI, they can take these important steps:
Pay off low loan balances first. Sometimes a little goes a long way and paying the balance of a low credit line – like the balance on a retail card – may really cut into your DTI by freeing that revolving debt.
Pay down high interest loans. If your creditor allows you to pay more than the minimum payment due to avoid interest, consider taking advantage of the opportunity to pay down the debt faster, without accruing additional interest.
Roll balances into a low-interest loan or zero-interest line of credit. If you have a strong credit standing or a high maximum limit on your credit cards, some institutions will allow you to move of your balance from one loan to another at a lower rate or even at 0% for a defined set a time, allowing you to pay down debt faster than you would have if you didn’t transfer the debt.
Be sure not to mistake the loan option you choose with a loan consolidation or loan restructuring, which can sometimes negatively impact your credit score. This is a common mistake and is often applied to student loans, small business loans or personal lines of credit.
Once you feel your debt is being well-managed, it’s time to start saving for a down payment. This is also a great time to reassess your budget, determine what your monthly mortgage payment might be and the type of loan you can qualify for.
Typical examples of different loan types include:
Conventional Home Loan is a mortgage loan not backed by the federal government. There are two types of conventional home loans: a conforming loan and a non-conforming loan.
A conforming loan is any conventional loan that falls within the maximum limits set by the Federal Housing Agency (FHA). Non-conforming loans are those that don’t fit within these limits like jumbo loans.
Generally, lenders look at whether borrowers can put at least 20% down to qualify for a conventional home mortgage loan or require the borrower to pay private mortgage insurance (PMI).
FHA loans are loans insured by the FHA and are specifically tailored for first-time homebuyers to help borrowers that don’t have a 20% down payment or top-tier credit. FHA loans require borrowers to pay two different types of mortgage insurance premiums – one upfront and one paid over the course of the loan.
VA Loans are designed for members of the armed forces and their families and don’t require a down-payment or mortgage insurance. Instead, a funding fee is charged as part of the closing costs and can be rolled into most VA mortgage loans or paid upfront.
Overall Home Value and Loan Amount
After you’ve determined the loan type that best suits your financial picture, you should determine if you prefer a fixed-rate or adjustable rate mortgage and if your loan type allows you to choose. These different types of loan products and loan rates all affect the total loan amount and how much a borrower should save for a down payment for a home.
This is a great time to work with a reputable lender, like Mutual of Omaha Mortgage, to get pre-approved for a home mortgage loan. When you’re ready to seek pre-approval, you will work with a lender to confirm the loan type that best suits your needs and the amount of loan you can qualify for based on your creditworthiness, income, DTI and employment.
You will want to secure a preapproval letter from a mortgage lender right before you start home shopping to show that you’re qualified to make offers on the homes you’re touring. Many real estate agents will want to see that you’re pre-approved before working with you and many offers will need to include a preapproval letter to be taken seriously.
A steady income and recent employment are important when going through the home mortgage approval process. It shows that you can make loan payments reliably and likely won’t default on the loan. Many lenders like to see that a home loan applicant can show a steady two-year history of employment.
However, in this economic climate, lenders realize that it’s likely many homebuyers might have recently experienced a job transition. Even if you recently changed jobs, you can still qualify as long as you can show steady income.
If you did change jobs, or had a change in income, it’s important to readjust your budget and home buying expectations. It’s also wise to be realistic about homeownership and not over-stretch yourself if you’re changing jobs, picking up seasonal work or considering a career change.
There’s no better time to consider if homeownership might be in the cards for you next year but don’t wait until after the holidays to prepare your finances. Instead, use the season to practice good money habits so you’re best prepared to buy your dream home. Be sure to keep in mind that these five factors are the most important financial elements looked at by mortgage lenders as you head into the busiest shopping season of the year.
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