Buying a home is the most important purchase you'll ever make and should not be entered into lightly. The process involves more than picking out a house and paying the seller for it. Before you even think of purchasing a home, take stock of your finances, your credit score, and your ability to finance a home. If you're a first time homebuyer and have no idea where to start, use Military.com's "The Prospective Homebuyers Guide" to help you sort through the most important purchase of your life.
The first step in homeownership is to determine how much house you can afford -- realistically. In fact, if you can't afford your dream house, then you may have to borrow money from the bank. Or as the lending industry calls it, taking out a mortgage. This step can either make or break your homeownership prospects for these three reasons:
Reason 1: Your ability to pay the mortgage
Your lender will want to know not only how much money you have, but also how much you will earn in the next 30 years. In addition, the lender has the right to snoop around in your debt history. For example, what's your credit card debt situation? Do you have any outstanding debts or loans that you?re slow to repay. And property such as a car or boat is figured into how much the bank will lend you.
Before the mortgage is issued, lenders want you to come up with 20 percent of the home value to use for as a down payment. But there are special financing arrangements that may get you into a new home for as little as 3 percent of the asking price.
The lender will also plug your income numbers into a couple of formulas: the front-end ratio (having to do with your mortgage payments) and the back-end ratio (having to do with your debt).
Let's say your gross income is $4,000 a month, and you have $1,000 a month in debt payments. The rule of thumb is that they'll allow you to pay 29 percent of your gross income toward your mortgage payment every month. This is known as the front-end ratio. In this example, 29 percent of $4,000 is just under $1,200 a month -- so, they'll reason, you can put $1,200 toward your mortgage payment.
Your debt ratio, or back-end ratio, on the other hand, is 1,000/4,000, or 25 percent . That's not bad. They don't want more than 41 percent going to your other debt. (These ratios can vary somewhat; the ones given here are good examples.)
Reason 2: Your past financial history
Your credit rating is one of the most important factors to qualify for a mortgage. The three major credit-reporting agencies are Experian, Equifax, and Trans Union. You can request your credit report individually from each agency.
Your credit report -- a nifty little compilation of your personal financial history -- will reveal whether you have a track record of paying your bills on time. If not, there are ways to clean up your credit that will make you more attractive to lenders.
Reason 3: What kind of collateral you posses in case you can?t pay the mortgage
In case you can't repay the loan, the bank can decide to do something really nasty: foreclose on the mortgage and repossess the house. That means they own it, and you no longer do. You then find yourself out on the street with your dog and your La-Z-Boy. Your house now belongs to the bank, and it is unlikely that anyone will ever loan you money again. Avoid this scenario at all costs.
In determining whether you should buy a new home, think about how long you're planning to stay in it. It generally doesn't make economic sense to buy if you're planning to stay there for less than four years. Why? Because you will pay fees to buy and sell your house. It would have to appreciate in value very quickly between the buying and selling to make it financially worthwhile. In other words, you'd have to get lucky.
Your Comfort Zone
Before you borrow $90,000 or $200,000 figure out whether you can really afford it. Just because the bank will loan it to you doesn't mean that you will live your life in such a way as to be able to pay it back. Are you planning on having a big family? Would you rather replace your Cavalier with a new Mercedes? Your house payment is just one piece of your financial puzzle. What might you need to give up to make that house a reality?
Shopping for a Loan
There are thousands of mortgage lenders across the country, and all have different loan products. From lenders who only sell to the most creditworthy borrowers (at the best rates) to those who will lend 50 percent of a property's value (at high rates), there's a mortgage product for just about everyone.
One place to check is your local bank. This can result in a reasonably good deal for the qualified customer. In many other cases, the bank will not have a program that fits your needs, or you may fall outside the guidelines of its lending ability.
Once you have visited your bank, look in the real estate section of your local paper for the rates at other banks. It's a good idea to start the legwork on your own, before bringing in a mortgage broker, so that you'll 1) avoid the hard sell from the get-go, and 2) have a better idea of what you could find on your own.
The Web provides you the opportunity to comparison shop. Not only that, but you don't have to hunt down a hundred different banks -- certain aggregator sites have done that for you.
You may well find the cheapest rates in town (or in the country) from the Internet. If, however, you end up working with a real estate agent, you may feel more secure with a lender that has a relationship with your agent. The idea is this: The agent brings business to the lender, and so the lender has some sense ofresponsibility toward honoring commitments with that agent's clients.
*Helpful Hint: There is no reason why you shouldn't take out a loan with a bank in California if you live in Virginia, or vice-versa.
When should I shop for a mortgage?
Ideally, you should find a mortgage before you ever start looking for a house. Not only will you feel more confident knowing that you'll have a certain amount of money, but you'll be a more serious candidate to sellers.
What information should I get from the mortgage company?
There are many questions to ask prospective lenders. You may find yourself feeling a little nervous. After all, you may feel like they have you by the... suspenders. But don't think of it that way. You are going to pay them a lot of money for a very long time. They serve you, not the other way around. Don't let them take advantage of you or bully you into a deal that isn't to your advantage.