Buying means borrowing… not for everyone, but for the vast majority of consumers. So, now that you have decided it is time to start looking at properties, it is time to examine your current financial circumstances.
Prep work should be started prior to beginning your home search. It serves no purpose to look at properties which you cannot afford; nor is it desirable to find “the home of your dreams” only to have your offer rejected by the Seller because it is not accompanied by a pre-approval letter (NOTE: this is particularly true in a “seller’s market”, when many Sellers will not entertain an offer unless it is accompanied by a pre-approval letter).
Where should you start? Order a free credit report that provides your FICO credit score (Equifax? Trans Union?). Now, thoroughly examine it… and then begin the process of “cleaning it up”. Dispute errors. Pay off debt obligations with small balances, and pay others down as best as you can. Do NOT open new lines of credit or close old lines of credit (either may impact your credit score).
Nearly all loan programs will require you to have a minimum score of 600… the vast majority will require a score of 640+. If your credit score is less than those thresholds, talk to someone about steps you can take to increase your score (NOTE: you would be well advised to follow the steps set forth below to select a mortgage broker, and then seek guidance from that person with respect to increasing your credit score).
Your credit score will have a significant impact on your forthcoming purchase. It will impact which loan programs you qualify for and what the corresponding interest rate will be… which determines what your monthly interest and principal payments will be… which determines what your maximum purchase price can be.
Part of this initial examination should include an assessment of your financial resources: that is, how much money do you have for a down payment, if any? Do you have resources available to increase the amount of your down payment (ie, parents who will provide you a monetary gift)?
Assuming your score is 640 or higher, it is time to find a mortgage broker and secure a pre-approval letter. It is typically quick and painless process that will take only a couple of days to complete, though it can take longer depending on your particular circumstances. You should begin interviewing prospective lenders as soon as you choose a REALTOR (NOTE: most consumers have little or no experience with mortgage brokers, and REALTORS can almost always provide informed input on the brokers with whom they have worked).
The pre-approval process includes: 1) meeting with a lender or mortgage broker, 2) providing them with an assortment of documentation and information, and 3) authorizing the lender to examine your credit history and current financial circumstances (employment, wages, debt, etc). Upon completing this analysis, the lender will determine your eligibility for a mortgage. They will provide you with a statement setting forth the loan program(s) for which you qualify and the maximum amount you can borrow to purchase your home, assuming you qualify.
The pre-qualification is a cursory examination of your financial condition. It does not guarantee you will ultimately receive the loan. The final loan commitment will come much later in the process after a more thorough examination of your financial circumstances, a review of the property (condition and value), etc.
The pre-approval letter conveys to the seller that you are motivated, that your financial condition has been vetted by a lender, and there is a significant likelihood you will be able to complete the intended transaction. The letter will dramatically increase the possibility an offer may be accepted.
Do you NEED to wait until you have interviewed or selected a REALTOR to start preparing? No. The sooner you start preparing, the better off you will be when it really matters. Your REALTOR can be an invaluable resource when selecting a lender or mortgage broker, but you should begin have no impact on your preparations.
Buy an expanding file folder. Start gathering all of your documents and put them in the folder in an organized fashion… placing them all in one spot will prove to be a great advantage. And, importantly, being organized will help minimize the stress you will experience when the home-buying process gets underway.
What documents should you start to collect? Tax returns (two years) for anyone who will be on the mortgage. The most recent pay stubs (eight weeks) for all borrowers. Bank statements. Auto loan statements. Credit card bills. Investment, life insurance and retirement records.
Another note on the pre-approval process: don’t be afraid to shop around! When a lender pulls your credit bureau, the inquiry will lower your credit score by a few points. If additional lenders request additional credit reports for the same purpose (a mortgage application) within thirty (30) days of the date of the first report, then your credit score should experience no further reduction. (NOTE: laws and regulations change, so please confirm this fact with your lender at the time you meet with them)
A final comment on your financial condition: You have begun the home buying process – now is not the time to make decisions that will significantly alter your financial condition. Thinking about changing jobs? Doing so will likely take you out of the market to purchase a new home for at least 12 months (and perhaps quite a bit longer)… so you may want to wait until AFTER you have purchased your new home. Want to buy a new car or truck… or maybe new furniture for your new home? Those purchases will significantly alter your debt to income ratio, which will impact – and possibly prevent you – from being able to buy your home. In this instance, discretion is the better course of valor. Wait until the day AFTER you close on your new house to go shopping!