Preparing to buy our first home twenty years ago was laughter-filled, scary, stressful, and exhilarating, all rolled into one. Having now watched clients, friends, and family members go through the process, here are my top ten tips on how to take out the 'scary' and the 'stressful', and keep the 'laughter-filled' and 'exhilarating'.
1. Understand how mortgage lenders calculate and grade debt to earnings. The basic rule of thumb is that, if a person makes, for example, $48K per year, we divide that by 12 months to come to $4K per month. 50% of that $4K can go to paying debt (car payment, student loans, alimony, credit cards AND your mortgage), which in this example would be $2K per month to work with. If total monthly debt before the future mortgage is $500 per month, that would leave you with $1500/month to go towards mortgage payments. From there, you can figure out the total max price that can be paid for a house (download a smart calculator app, like this one from Academy Mortgage). These calculators take into account local taxes, insurance, pmi, as well as look at geographic eligibility for USDA loans, FHA loans, etc...
2. Give yourself six months to move your credit score to an optimal level. This means getting rid of unused credit cards (but remember that credit scores look at length of time the account is open, so it is better to start using those unused cards rather than to close them and start anew with a similar card), having the correct number of active credit cards (credit reporting agencies recommend 3-4), start paying all of your bills on time if you aren't currently, and stop applying for new credit cards (that $50 savings from Home Depot or Sierra Trading Post could cost you thousands with a lower credit score!).
3. Not all credit scoring is the same. Assume that your credit score will be lower than what Experian, Equifax, and TransUnion report to you once a year. Think about it-lenders giving car loans look at how likely a person is to default on a car loan. Likewise, mortgage lenders take into account an even stricter set of criteria, especially since they are dealing with $100,000-$1,000,000 in loans per transaction. Keep in mind that scores of 740 or above typically qualify for the best rates (and for PMI as well-a buyer with a 620 borrower could expect to pay 1.1% in PMI, while a 760 borrower could pay as little as 0.30%), conventional usually require 620, FHA with 3.5% down require 580, FHA with 10% down require 500, but that these can depend on the individual lender as well.
4. How much down payment do you need to buy a house? Many first time home buyers think that 20% down is a requirement, but that is only if you are trying to avoid the Private Mortgage Insurance (PMI) fees. In fact, the average down payment for first time home buyers is only 6%, and there are loan programs that require even less. FHA require 3.5%, VA and USDA require 0%, and conventional 97 require 3% down.
5. Take into account your total PITI payment, and not just your principal payment. Principal + Interest + Taxes + Insurance (PITI) makes up a mortgage payment, with taxes averaging 1-2% of your home's value annually, while insurance comprises 0.25 - 0.50 of your home's value annually. Luckily, our property taxes here in Colorado are much lower than those in the midwest or on the coasts. Compared to Nebraska where we're originally from, property taxes in Colorado are 1/3 that of Nebraska. Wow!
6. Have you made any hard credit inquiries recently? A hard inquiry stays on your credit record for one to two years (but stops affecting your score after six months), and not only includes inquiries for consolidating debt, applying for credit cards and car loans, but also for utilities like electricity and internet, proof of insurance when a name changes, renting from a landlord, etc...
7. Catch 22-Shopping around for mortgage interest rates is money-smart, but can hurt your credit score if you make too many applications. Lenders and credit reporting agencies realize this, and so an exception is made if applications for the same kind of credit are made, i.e. home loans. Although there are a few windows of time (14 day, 30 day, 45 day) that various credit reporting agencies consider, all applications of one type should probably take place in a 14 day window, to be on the safe side. If you consider five lenders and are unhappy with all five, and then a few weeks or months go by, it is best to wait until you are ready to make another burst of applications to say, five more lenders and then lump that second set of applications into another 14 day window. By going this route, you are essentially making two applications, versus ten applications.
8. Go with a local lender, and ask how long the loan approval process will take. Some lenders focus on refinancing, and don't make the time for home buyers. We have a few lenders here in Northern Colorado that not only give great service, but also will never sell your loan (something that you will be grateful for once you go to sell your house in the future). Because local lenders do business primarily in your state, there won't be surprises at or before closing concerning out of state rules or laws, which happens much more frequently with national, online companies.
9. Major credit scoring factors comprise the following: Payment history 35%, amount of debt 30%, age of accounts 15%, account mix 10%, history of credit applications 10%. Go through your credit reports with a fine-tooth comb to make sure there are no discrepancies (seeing multiple, unauthorized hard inquiries for credit cards is a sign of fraud), and to fine tune each component of the credit score.
10. Do your kids a favor and add them as authorized users. Our children are now 15 and 11, and we added them to our credit cards as authorized users last year. By the time they reach 18, they should have much better credit ratings, allowing them more freedom for a house/condo mortgage or car loan.
Image by James Sack
Please feel free to reach out to me to discuss your move into or out of Northern Colorado. Thank you!
James Sack, REALTOR®
Coldwell Banker Residential Brokerage
1109 Oak Park Drive | Fort Collins, CO 80525
C: (970) 217-9705 | O: (970) 223-6500 | E: James.Sack@coloradohomes.com | W: www.JamesSack.com