A majority of Americans want to buy a house someday. But how can you pull that off with our stagnant wages and student loan debt?
Here’s the 7 crucial steps you must do to qualify to buy a house.
Disclosure: Yes, I am a mortgage lender. No, I am not writing on behalf of my company, offering advice specific to your situation, or implying anything. Just in case some regulatory board finds this… my NMLS is # 1752332. Okay don’t sue me, thanks.
When my website was in its infancy stages, I interviewed a Realtor on how to buy a house (HERE). That article and this one go hand-in-hand, so read both!
Step 1: Be realistic about the budget.
I don’t know about you, but long before I was ever old enough to even buy a house, my best friend and I would spend hours talking about what our future homes would look like.
Four bedrooms, four bathrooms with a massive garage. Perhaps my future home would have a view of the city, or the lake? Maybe it was a historic home filled with charm and character in every square foot, or a brand new home with all of the latest technology and styles?
I’d host parties on the weekends, cookouts in the weeks, and sit on my balcony with a martini and a monocle looking down at all the peasants who couldn’t afford to live the lavish lifestyle that 13 year old Adrian had dreamed out.
However, when the time came to buy a house, I was bold enough to say “I don’t know”.
- What price range should I even be looking at?
- What can I actually afford?
- What would my mortgage payment be?
- What’s a good interest rate, and why do I even care?
- What about city and county taxes?
- How much should homeowners insurance cost?
I could have taken random guesses at all of these questions and pretend that I was knowledge enough to answer them, but let’s be realistic.
We tend to use confirmation bias to make decisions, meaning that I’d say I wanted a cheap home–but after seeing a few lower cost homes, I’d suddenly find a plethora of justifiable reasons to increase my budget. Eventually I would bump into a realtor and they’d tell me exactly what I wanted to hear–spend more money because it’s worth it…even if I actually had no way to ever get approved for that much money.
So, I went to a mortgage lender and we sat down to discuss my situation. Okay, I’m lying… it happened over email. Either way, I asked him what I should be doing with my credit to get ready to buy a house, what kind of down payment is necessary, how much I could qualify for, and what I needed to consider to keep my expenses manageable.
Before you look at homes, look at your wallet with your lender and get a realistic view on what you can afford. Not only will home sellers usually not entertain any offers that do not come with a prequalification letter from a lender (stating that you’re approved), most realtors won’t show homes without it, and you shouldn’t shop for a home that you aren’t sure you can actually afford to buy…right?
Right. Moving on.
Step 2: Shop around. Yes, pull your credit.
One thing I have learned over the years, your mortgage fees are usually negotiable. Most lenders have a little wiggle room to move your figures around, and may offer different products that change the terms of your loan, and the cost, so shop around. Almost all of your fees/closing costs are assessed based on a percentage of the price of your home–so it can add up quickly if you’re not careful.
When you talk to a lender, don’t be afraid to have your credit pulled. Your lender will be able to guarantee an interest rate, approval, and give you the most precise terms possible by pulling your credit…because they can literally view your entire situation with no guesswork needed.
Yes, yes. What about the credit inquiries? Good news, when you shop around for a mortgage, multiple credit checks from mortgage lenders within the same 45-day window are recorded on your credit report as a single inquiry, because it is understood that you are only going to buy one home. You can shop around, get multiple preapprovals and official Loan Estimates, and the impact on your credit is the same no matter how many lenders you consult. Don’t hear it from just me… here’s the Consumer Financial Protection Bureau (CFPB) saying the same thing.
As you’re shopping around, you may hear terms such as 100% financing, or 0% down. They are referring to “loan to value” (LTV), which is a term used by lenders to express the ratio of a loan to the value of an asset purchased.
For example, a borrower taking on a $92,500 mortgage to purchase a home appraised at $100,000 would have an LTV of 92.50% (92,500 divided by 100,000). The term 100% financing is literally the same as 0% down…because they are stating that they will finance 100% of the purchase price (no money down). Semantics, really.
Don’t worry. You’re not contractually obligated to do a loan with ANY lender just because you applied with them. Again, shop around freely until you’ve learned enough to make an informed decision.
Step 3: Understanding Down Payments & Loans.
Most lenders offer programs and loans that require various types of down payments. Your down payment is figured off the purchase price of the time, and deducted accordingly before the loan is finalized.
Common Down Payments:
- 0% down. These usually target specific areas of your city/region and sometimes have annual fees and/or Private Mortgage Insurance* (PMI). My very first mortgage was one of these. They can be a great tool to get into a home and let you start building wealth/equity.
- 2.5% down. The Federal Housing Administration (FHA) backs these loans, and typically sets the interest rate and/or PMI on them. So, no matter what lender you go to, you’ll get the same interest rate (not loan fees..interest rate. Recognize the difference). Yes, they usually have PMI, also.
- 5% down. Another typical loan…with PMI, are you noticing a pattern, here?
- 20% down. This is the most ideal scenario, as you avoid PMI.
*Private Mortgage Insurance (PMI) is a type of mortgage insurance you might be required to pay for if you have a conventional loan. Like other kinds of mortgage insurance, PMI protects the lender—not you—if you stop making payments on your loan. Basically, it’s a fee that you pay.
Other types of loans, such as FHA’s “Mortgage Insurance Premium”, United States Department of Agriculture (USDA)’s Rural Development “Guarantee Fee”, and the Veterans Affair’s (VA) “Funding Fee” operate in similar fashions..but are technically different. Ask your lender to specify.
There are also certain programs that will grant you the money needed for a down payment, sometimes with a clause that you must live in the home for X number of years–or repay the entire grant if you sell too early. Ask your lender if that’s the case.
What I’m getting at… make sure you ask questions, understand the fees behind your mortgage, and avoid paying PMI by putting more money down if you can swing it. Not only will you save on PMI and interest over the life of the loan, you will have some equity in the house.
That’s crucial, as you do not want to be upside down on your home and owe more than it’s worth.
Likewise, you can put as much down as you feel comfortable doing…so long as it’s more than the minimum. My first house (before I refinanced to a mortgage without PMI) was 0% down. My current home was purchased with a 10% down payment. I’m paying a small amount of PMI on it, but I was willing to do this so I could keep cash on hand to deal with the costs behind maintaining two homes until the other one is occupied.
Personal finance is personal. That’s what worked for me. Do what works for you.
Types of Loans:
You may bump into any of the terms I mentioned above (Conventional, FHA, RD/USDA, VA) as you shop around. Those are loan products. However as a payment-maker, I preach that you truly understand these two types of ANY loan:
- Adjustable Rate Mortgage (ARM): A mortgage where the interest rate on the note periodically adjusted based on an index which reflects the cost to the lender of borrowing on the credit markets.
- Fixed Rate: A mortgage that has an interest rate that remains the same for the life of the loan.
There are pros and cons to each. Personally, I advocate fixed rate mortgages because I like consistency and predictability, but there are some instances when an ARM may be more logical. Your loan estimate will specify which one you were quoted, and can clarify which you should go with, but either way… ASK YOUR LENDER what they’re basing your approval off of and why that’s the best option for you.
Understanding your loan makes a huge difference in your comfort with making the payment each month.
Step 4: Ask questions.
If you’re lucky like I was… a simple email to a mortgage lender asking how I can qualify for a mortgage was replied with an official letter saying “YOU’RE APPROVED” with the exact price range I should shop within, and how much my monthly payment would be. Sidebar, my heart skipped a beat when I read those words. I still remember exactly where I was standing, too.
No matter what they say, ask questions. You are spending hundreds-of-thousands of dollars. Make sure you understand what you’re getting. I know, I keep saying that. You’d think I meant it or something.
If your lender comes back and states that there are some things that you should work on to get approved (or have a better loan), listen carefully to them and ask them to elaborate if you do not understand. Two of the most common things they want to see are:
Your lender wants to see that you can hold a job for more than a few months and consistently earn a paycheck. It does not necessarily have to be 25 years with the same company, but rather at least two years of steady employment somewhere.
Whether you’re hourly, salary, or self employed (with 1-2 years of tax returns)–your ability to demonstrate that you can repay this loan is imperative. Usually, they also want your debt to income ratio (DTI) to be at or near 45%.
Before I apply for any loan, I always “soft underwrite” myself by figuring out my DTI.
How can you figure your DTI? For example, if you pay $1500 a month for your mortgage and another $100 a month for an auto loan and $400 a month for the rest of your debts, your monthly debt payments are $2,000. ($1500 + $100 + $400 = $2,000.) If your gross monthly income (before taxes) is $6,000, then your debt-to-income ratio is 33 percent.
Don’t forget, debts are items that report on your credit such as credit card payments, car payments, and student loan payments…not phone bills or Netflix. Don’t include non-debts in your DTI.
Having student loan debt does not necessarily disqualify you from purchasing a home, so long as your DTI is still low enough. If you have student loan debt that’s deferred (no payment required at this time), your lender may use a percentage of your balance (such as 1%) as a payment when they figure your DTI… because in the future, you’ll have to pay back your student loans alongside your mortgage.
Loophole: if you went to college (for example) to become a nurse and secured a job as a nurse after graduation… your lender can use that entire time-frame that you were in school as time towards your employment–since you were becoming educated to do your specific job.
You do not need immaculate credit with a spotless history to get approved. My first mortgage was 2 years after I paid off two collection items, and my credit score reflected that.
Generally, you want your score to be above 620-640 to score a pre-qualification, but better is always best, because the better your credit, the better your interest rate and terms.
If this is something that’s holding you back from an approval, remember that good credit takes TIME. If there was some “trick” to rebuild your credit, everyone would be doing it! Don’t fall for credit repair schemes such as paying a fee to fix it, or disputing everything on your report. The only way to fix your credit is by doing it the old-fashioned way. Pay your debts on time every month. Satisfy bad credit/loans, and get a couple of new lines of credit that you pay as-agreed on every single month. Show the person reviewing your credit report that you’ve made mistakes in the past, but the past was yesterday and you’ve proven that you’re good for it today.
Do this…and you’re on your way.
Step 5: Approved? Good. Chill out.
This one is simple. If your lender approved you, it’s based on the exact financial situation that you presented. Don’t change it.
- Don’t go finance a new car.
- Don’t spend all of your cash or even your down payment.
- Don’t open a credit card for new furniture or appliances.
- Don’t quit your job.
- Don’t omit or lie about anything. They double check it all.
You can do all of that AFTER you’ve got the keys and close on the house, if you want. However, if you alter your financial situation before you buy, you may skew your DTI and jeopardize your entire approval. I’ve seen people lose their new homes because they showed up to the closing table in a brand new car. Don’t be one of them.
Step 6: Assemble your team.
Meet with realtors and find one that you mesh well with, who understands your situation, and is willing to fight to get you the best deal.
Fun fact. Your realtor is paid for by the SELLER of the home, not you. If you’re buying a house, the realtor is free to you, so find somebody willing to be your advocate and work in your best interests.
Don’t just go with the name on the sign of the house you want to view. Why? That agent is working for the sellers to get them the highest price possible. They can legally, but cannot (ethically) also work for you to get you the lowest price possible. Want some tips from a realtor? Read my article on that HERE.
Once you’ve got your realtor and your mortgage lender picked out, exchange their expertise for your loyalty. Nearly all realtors and mortgage lenders (such as myself) work off of commission only and receive no salary or hourly pay.
If they do a great job, give them your business and tell somebody you know that you are highly satisfied. If they do a poor job, discuss your issues with them and consider ending your agreement.
One tip if you’re buying a home, in your first offer on a property, see if the sellers will pay for your “prepaids and closing costs“. These are your taxes/insurance/homeowners association dues/etc and the costs behind your new mortgage. Why not save a few bucks? I’ve bought two homes and I have had a 100% success rate in getting the seller to pay all of my closing costs (2013 & 2018).
Step 7: Move In!
Once you find the perfect house, negotiate a great price, get your loan final approved, and sign on the dotted line… pop open a bottle of champagne and breathe!
Easy enough, right?
Now that you’ve bought the house… change the locks on your door, replace your toilet seats (because, ew), and enjoy the home!
Don’t forget to read my article where I interviewed a Realtor on how to buy a house (HERE). That article and this one go hand-in-hand, so read both!
Pic Credit: Fox; The Simpsons