The Home Buyer's Guide to Getting Mortgage Ready

Dated: December 19 2019

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The Home Buyer's Guide to Getting Mortgage Ready


Don’t wait until you’re ready to move to start preparing financially to buy a home.

 

If you’re like the vast majority of home buyers, you will choose to finance your purchase with a mortgage loan. By preparing in advance, you can avoid the common delays and roadblocks many buyers face when applying for a mortgage.

 

The requirements to secure a mortgage may seem overwhelming, especially if you’re a first-time buyer. But we’ve outlined three simple steps to get you started on your path to homeownership.

 

Even if you’re a current homeowner, it’s a good idea to prepare in advance so you don’t encounter any surprises along the way. Lending requirements have become more rigorous in recent years, and changes to your credit history, debt levels, job type and other factors could impact your chances of approval.

 

It’s never too early to start preparing to buy a home. Follow these three steps to begin laying the foundation for your future home purchase today!

 

 

STEP 1: CHECK YOUR CREDIT SCORE

 

Your credit score is one of the first things a lender will check to see if you qualify for a loan. It’s a good idea to review your credit report and score yourself before you’re ready to apply for a mortgage. If you have a low score, you will need time to raise it. And sometimes fraudulent activity or erroneous information will appear on your report, which can take months to correct.

 

The credit score most lenders use is your FICO score, a weighted score developed by the Fair Isaac Corporation that takes into account your payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%).1

 

Source: myFico.com

 

 

Base FICO scores range from 300 to 850. A higher FICO score will help you qualify for a lower mortgage interest rate, which will save you money.2

 

By federal law, you are entitled to one free copy of your credit report every 12 months from each of the three major credit bureaus (Equifax, Experian and Transunion). Request your free credit report at https://www.annualcreditreport.com.

 

Minimum Score Requirements

 

To qualify for the lowest interest rates available, you will usually need a FICO score of 760 or higher. Most lenders require a score of at least 620 to qualify for a conventional mortgage.3

 

If your FICO score is less than 620, you may be able to qualify for a non-conventional mortgage. However, you should expect to pay higher interest rates and fees. For example, you may be able to secure an FHA loan (one issued by a private lender but insured by the Federal Housing Administration) with a credit score as low as 580 if you can make a 3.5 percent down payment. And FHA loans are available to applicants with credit scores as low as 500 with a 10 percent down payment.4

 

Increase Your Credit Score

 

There’s no quick fix for a low credit score, but the following steps will help you increase it over time.5

 

1. Make Payments on Time

At 35 percent, your payment history accounts for the largest portion of your credit score. Therefore, it’s crucial to get caught up on any late payments and make all of your future payments on time.

 

If you have trouble remembering to pay your bills on time, set up payment reminders through your online banking platform, a free money management tool like Mint, or an app like BillMinder.

 

2. Avoid Applying for New Credit You Don’t Need

New accounts will lower your average account age, which could negatively impact your length of credit history. Also, each time you apply for credit, it can result in a small decrease in your credit score.

 

The exception to this rule? If you don’t have any credit cards—or any credit accounts at all—you should open an account to establish a credit history. Just be sure to use it responsibly and pay it off in full each month.

 

If you need to shop for a new credit account, for example, a car loan, be sure to complete your loan applications within a short period of time. FICO attempts to distinguish between a search for a single loan and applications to open several new lines of credit by the window of time during which inquiries occur.

 

3. Pay Down Credit Cards

When you pay off your credit cards and other revolving credit, you lower your amounts owed, or credit utilization ratio (ratio of account balances to credit limits). Some experts recommend starting with your highest-interest debt and paying it off first. Others suggest paying off your lowest balance first and then rolling that payment into your next-lowest balance to create momentum.

 

Whichever method you choose, the first step is to make a list of all of your credit card balances and then start tackling them one by one. Make the minimum payments on all of your cards except one. Pay as much as possible on that card until it’s paid in full, then cross it off your list and move on to the next card.

 

Debt

Interest Rate

Total Payoff

Minimum Payment

Credit Card 1

12.5%

$460

$18.40

Credit Card 2

18.9%

$1,012

$40.48

Credit Card 3

3.11%

$6,300

$252

 

 

4. Avoid Closing Old Accounts

Closing an old account will not remove it from your credit report. In fact, it can hurt your score, as it can raise your credit utilization ratio—since you’ll have less available credit—and decrease your average length of credit history.

 

Similarly, paying off a collection account will not remove it from your report. It remains on your credit report for seven years, however, the negative impact on your score will decrease over time.

 

5. Correct Errors on Your Report

Mistakes or fraudulent activity can negatively impact your credit score. That’s why it’s a good idea to check your credit report at least once per year. The Federal Trade Commission has instructions on their website for disputing errors on your report.

 

While it may seem like a lot of effort to raise your credit score, your hard work will pay off in the long run. Not only will it help you qualify for a mortgage, a high credit score can help you secure a lower interest rate on car loans and credit cards, as well. You may even qualify for lower rates on insurance premiums.6

 

 

STEP 2: SAVE UP FOR A DOWN PAYMENT AND CLOSING COSTS

 

The next step in preparing for your home purchase is to save up for a down payment and closing costs.

 

Down Payment

 

When you purchase a home, you typically pay for a portion of it in cash (down payment) and take out a loan to cover the remaining balance (mortgage). 

 

Many first-time buyers wonder: How much do I need to save for a down payment? The answer is … it depends.

 

Generally speaking, the higher your down payment, the more money you will save on interest and fees. For example, you will qualify for a lower interest rate and avoid paying for mortgage insurance if your down payment is at least 20 percent of the property’s purchase price. But what if you can’t afford to put down 20 percent?

 

On a conventional loan, you will be required to purchase private mortgage insurance (PMI) if your down payment is less than 20 percent. PMI is insurance that compensates your lender if you default on your loan.7

 

PMI will cost you between 0.3 to 1.5 percent of the overall mortgage amount each year.8 So, on a $100,000 loan, you can expect to pay between $300 and $1500 per year for PMI until your mortgage balance falls below 80 percent of the appraised value.9 For a conventional mortgage with PMI, most lenders will accept a minimum down payment of five percent of the purchase price.7

 

If a five-percent down payment is still too high, an FHA-insured loan may be an option for you. Because they are guaranteed by the Federal Housing Administration, FHA loans only require a 3.5 percent down payment if your credit score is 580 or higher.7

 

The downside of getting an FHA loan? You’ll be required to pay an upfront mortgage insurance premium (MIP) of 1.75 percent of the total loan amount, as well as an annual MIP of between 0.80 and 1.05 percent of your loan balance on a 30-year note. There are also certain limitations on the types of loans and properties that qualify.10

 

There are a variety of other government-sponsored programs created to assist home buyers, as well. For example, veterans and current members of the Armed Forces may qualify for a VA-backed loan requiring a $0 down payment.7 Consult a mortgage lender about what options are available to you.

 

TYPE

MINIMUM DOWN

ADDITIONAL FEES

Conventional Loan

20%

Qualify for the best rates and no mortgage insurance required

Conventional Loan

5%

Must purchase private mortgage insurance costing 0.3 - 1.5% of mortgage annually

FHA Loan

3.5%

Upfront mortgage insurance premium of 1.75% of loan amount and annual fee of 0.8 - 1.05%

 

 

Blog author image

Yashu Toprani

I am a full-time real estate agent. Actually, much more than full time. I work early mornings, evenings and weekends; whenever is convenient for my client. I love what I do, so quite often it really d....

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