When you prepare for buying your first home, getting your finances in order is a critical first step. As one of the main steps of home buying, proper financial preparation will pave the way for a successful home shopping experience.
In this article, we’ll answer 9 common questions about what it means to be financially prepared to buy a house.
9 Financial Questions to Prepare for Buying Your First Home
There’s no two ways about it: preparing for buying your first home involves a lot of moving pieces (and paperwork)!
Thankfully the internet is full of resources to help you out. With this article, you’ll get some high-level answers to your financial questions as well as links for further suggested reading.
1. What are Lenders Looking at?
When lenders dig into your finances, they’ll be looking at what outstanding debts you have, any recent applications for credit, payment history and credit utilization, as well as your assets and monthly income.
For a list of trusted lenders we work with, vist the Financial & Legal section of our Real Estate Resources Page.
2. What Paperwork Should You Gather?
Your lender will want to see bank statements, pay stubs, tax returns, and reports on any investments, including retirement accounts.
They’ll also want a recent credit score report, which they’ll ask for your consent for before pulling. And speaking of credit reports…
3. What Should Your Credit Score Be?
Your credit score is just one aspect of what banks and lenders look at when determining your rates, but it’s a big one. Coming into a real estate transaction with a lower credit score will likely mean paying a higher interest rate on your home loan.
That’s why many first time buyers will focus on paying down debt prior to home shopping. That way, by the time loan officers are looking at their credit score it will have improved, therefore increasing their chances at approval.
The credit score you need will largely depend on the kind of loan you’re getting. Here’s how that looks according to Rocket Mortgage:
|Type of Loan||Credit Score Minimum|
4. How Much Will Your Down Payment Be?
How much cash you need to have socked away will depend on a variety of factors. Of course, the price range you’re looking at will determine a base amount.
As Ameriprise Financial says, “Conventional loans usually require a 5% – 20% down payment. If you put less than 20% down, conventional loans require you to pay private mortgage insurance (PMI), which is an extra cost on top of your principal and interest, until you have 20% equity in your house.”
In other words, a $500,000 house will require a down payment of between $25,000 and $100,000. In this scenario, if you have less than $100,000 (20% of $500,000), it doesn’t mean you’re out of luck. It means your lender will help arrange for you to get private mortgage insurance which you’ll pay in installments along with your regular mortgage payments. Once you’ve made enough payments to reach that $100,000 mark, you won’t have to pay the extra PMI payment with your mortgage anymore.
If you’re purchasing a second home, you may be able to include your equity in your first home to help with your down payments costs.
5. What About Selling A Home While Buying a New One?
If you’re selling a house in order to purchase another home, your lender will want to see what you expect your current home to sell for in order to know how much cash you’ll have to go toward your next purchase.
This is a number that your listing agent will help you determine before turning over this paperwork to your lender.
6. What is Loan-to-Value Ratio?
The loan-to-value (LTV) ratio is a number expressed as a percentage that compares the total mortgage amount to the value of the property.
For example, an 80% LTV means you’ve financed 80% of the home and brought 20% in cash to the sale.
Why does this number matter?
As NerdWallet puts it, “From the lender’s standpoint, a mortgage with a high loan-to-value ratio is more risky. Most mortgages with loan-to-value ratios above 80% require mortgage insurance.”
The more cash you bring to the table, the lower your LTV will be, and the less likely you’ll need mortgage insurance.
7. What is Debt-to-Income Ratio?
When lenders and banks assess how financially feasible it is to lend you money, they’ll be looking at your debt-to-income ratio (DTI). This means they’ll look at how much of your monthly income is going toward outstanding debts (such as credit cards, school loans, etc).
This number is taken as a percentage. For example, if you have a monthly income of $5,000 monthly and $1,000 goes to monthly debt payments, then your DTI is 20%
Generally, lenders want your DTI to be below 43%.
8. When You Prepare For Buying Your First Home, What Is Included in Closing Costs?
Closing costs are usually between 2%-5% of the total home price. Closing costs include the cost of the loan, underwriting, and other associated fees.
According to Investopedia, typically closing costs include:
- Credit report fees
- Application fees
- Recording fees & title insurance fees
- Underwriting or processing fees
- Closing fees & escrow fees
- Origination fees & prepaid interest
- Survey fees
9. What Problems Can Come Up When You Prepare for Buying Your First Home?
The financial aspect of homebuying is one key place that homebuyers may hit a snafu. The most common place for this to happen is regarding debt.
For example, if your debt-to-income ratio is too high (above that 43% mark), you may run into trouble getting qualified. But a good lender will counsel and advise you on how to prepare yourself to purchase. It could be a matter of waiting a few more months to pay down some debt before you start actively shopping for houses.
Get Your Money Ready:
Prepare for Buying Your First Home
While the financial aspect of homebuying can be complicated, with a trustworthy team on your side, it doesn’t have to be overwhelming.
The job of your real estate agent and your lending team is to know all the ins-and-outs of the homebuying processes and to guide you through it as painlessly as possible.
IN THIS ARTICLE
Ameriprise Financial: Buying a House
Rocket Mortgage: What Credit Score Do You Need to Buy a House?
Investopedia: 6 Requirements to Buy a House
NerdWallet: Loan-to-Value Calculator