Homeownership Readiness Plan
For many of the people who contact AFS, homeownership is a goal that stands along side their goal of becoming debt free. As the economy changes, interest rates rise and housing prices begin to ebb, we thought it would be a good time to share information on the homebuying process, how to prepare your finances for the big leap and how to get the lowest interest rate possible.
Here are some steps you can take to ensure your finances and your planning are in order!
Credit Dos and Don'ts
Check your credit report. Visit www.annualcreditreport.com to receive a free copy of your three major credit bureau reports. Review the information in the reports to make sure that it is all correct and represents your situation accurately. If the information is not correct, dispute it through the credit reporting agencies.
While the reports are free, they do not include a credit score. You may have to pay to receive a credit score. Mortgage loan products have different requirements for credit scores. However, some require a minimum score of 620 unless you have a large downpayment. We recommend viewing your FICO credit score if you are considering purchasing a home. It is the scoring model most widely used in the home lending process.
Some other important credit points include:
- Pay bills on time, every time and stay current on all credit-based payments.
- Avoid carrying large balances on credit cards – keep balances at less than 30% of the credit limit.
- Avoid opening new credit cards to expand your available credit.
- Leave older credit-based accounts open as you pay them down, as they show a longer history of on time payments.
Get Ready for the Down Payment
Start saving for a down payment as soon as possible. Although you may be able to put down as little as 5% on a home (0% for some loans), there are many benefits to putting down 15%, 20% or more.
Saving for a down payment also helps in feeling ready to take on a new mortgage payment. If you suspect the payment on a home will increase from what you currently pay for rent, try making that payment to yourself each month. You’ll add money to savings and feel confident about your ability to make a mortgage payment of that size in the future. For example:
Current rent = $1,000 and Future Mortgage = $1,500
Pay: Rent + $500 in savings
Also, if you are a first-time home buyer, your community may have down payment assistance programs. Down payment assistance comes in the form of grants, loans and other programs. It is typically reserved only for borrowers who qualify as first-time home buyers.
Eligibility is determined by your household income and credit history and can also vary by the program. Many down payment programs require that the homeowners participate in a homebuyer education class or one-on-one counseling. You can find a out more about these programs by talking with a HUD housing counseling agency in your area.
Other Benefits of a Down Payment
Most banks won’t require you to get Private Mortgage Insurance (PMI) if you put down 20% or more, which can significantly lower your monthly payment. PMI protects the lender if you stop making payments on your mortgage.
Also, the more you put down, the lower your principal, meaning you’ll borrow less money. It also means you accrue far less interest over the term of the loan. Example: Cost of the home $250,000 - $10,000 down payment = $240,000 home loan (principal).
Similarly, the more you put down the less you have to pay off, meaning you may be able to pay it off faster and even cut years off your loan term. Rather than taking out a loan for 30 years, you can take a 15-year loan and pay much less in interest.
Other Important Considerations When Beginning the Home Buying Process
- Think honestly about what you can afford. Although you’ll often hear people say you shouldn’t spend more than 30% of your gross monthly income on housing, there are really two numbers to consider. First is how much of your income goes to your mortgage or housing payment. Second is how much of your income goes to all of your other household debt. That number can look different across households.
- One number most lenders consider when making that determination is your debt-to-income ratio (DTI). Your DTI is calculated by totaling all monthly debt payments and dividing it by your gross monthly income. Lenders prefer people have a DTI of less than 43% of your gross income, including all debt payments and the mortgage. Below is an example. Total debt payments are $1,900 and total income is $5,000. That means 38% of their income is currently assigned to repayment. Again, having a DTI of less than 43% is ideal and lower is better.
|Monthly debt payments:||Monthly income:||Debt-to-Income|
|Credit cards||$200||DTI = 1900/5000|
|Current rent/mortgage||$1,400||= .38|
- Factor in your lifestyle and how much you’d need to budget for emergency repairs, like a broken A/C or water heater.
- Start listing neighborhoods of interest and home features you desire before you even begin your search in earnest. It can help to make a list of wants and a list of must-haves to further hone your home desires. This can include your thoughts on:
- Homeowners Associations (HOAs) - are private organizations that oversee the management of some residential communities. HOAs establish sets of rules and regulations called bylaws for those living in the community that homeowners must follow. Most HOAs have regular dues.
- Funds you may need to set aside for home repairs, like a broken water heater or furnace.
- How much lawn maintenance or care are you interested in doing?
- How much are the property taxes in the area where you’d like to buy?
- What does home insurance average for properties of similar sizes and age?
- Finally, make sure you get preapproved for a mortgage. Many real estate agents won’t even work with home shoppers who aren’t preapproved for a home loan. Preapproval also gives you better negotiating power, as you can put a hard upper limit on your offers.
Not Sure Your Credit Is Good Enough to Qualify for a Home Loan? We Can Help.
If you or someone you know wants to realize the dream of homeownership but are concerned that their credit isn’t good enough to qualify for a loan due to outstanding debt, contact American Financial Solutions at (888) 282-5811. We would be happy to discuss paths to lower debt!
Published May 15, 2023.