You have finally decided to purchase your first home. You're excited! No more renting for you! But where do you begin?
The first step is actually not so glamorous but it is necessary. Some would say it's the most important thing you will do in the process of buying a home. So here it is: Unless you are planning to pay cash for the home you are purchasing, you will need a loan. Therefore, before you do anything—even before viewing homes—your first step is to speak with a mortgage lender.
Why is seeing a lender the first step?
There are two main reasons:
1) You need to find out how much a lender is willing to lend to you. Knowing how much you are qualified to borrow toward the purchase price and closing costs will help guide your search. No sense in looking at $500,000 homes when you only qualify for a $400,000 home.
2) You will need to obtain a pre-approval letter to give to the seller when you make an offer on a home. (Note that a pre-approval letter is not the same as a pre-qualification letter.)
Gone are the days when sellers will accept an offer with a deposit and verbal promise that you have the funds to purchase the home. Now you must prove it. In fact, normally, sellers require a pre-approval letter from a qualified lender, your FICO score, a deposit (typically 3%) that is wired to escrow, and a bank statement showing funds for the balance of your down payment.
To get a pre-approval letter, you will need to gather some financial documents. You lender will tell you specifically what they need. Be prepared to provide employer information for the last two years: your home address, W-2 forms for all jobs, your most recent 30 days of pay stubs, including year-to-date earnings, your personal tax returns, most recent bank statements (all pages), and most recent statements for any stocks, bonds, mutual funds, IRAs, 401Ks, etc. There may be other items needed, depending on your personal situation.
A pre-approval letter from a lender is virtually the same thing as a commitment from the lender that your loan will go through when you actually go to apply for the loan. Thus, it is very important that you choose a good lender. There are some lenders that have been known to provide a “pre-approval letter” and then turn you down when you apply for the loan or—even worse—deny you at the last minute. Make sure you ask the lender if they will commit to funding your loan based on the pre-approval. If they don’t give you a clear “yes,” go see another lender. Also, don’t think that just because you bank with your lender you’ll get preferential treatment. You won’t.
If you don’t know which lenders are reputable, ask your agent. They know the good lenders that will do right by you, get you the best deal possible, and close on time. Pre-approval letters are generally good for 6 months, giving you time to find the perfect home!
Lending standards have changed in 2014 from previous years. There is now something called the QM Rule, or Qualified Mortgage Rule. This means that you must not have a debt-to-income ratio higher than 43%. If a lender lends money to someone with a higher debt-to-income ratio and the owner defaults on their loan, the lender could be in serious financial trouble. Most lenders do not want to take that risk. There are a few exceptions to this rule but this is pretty standard now.
My message to you is: Do not to disqualify yourself based on anything you’ve heard or suspect. Go to a professional. Share your situation. Then—and only then—will you know what your options are. There are lots of lending programs, and mortgage lenders will help you navigate through the options. For example, are you aware that it is possible to purchase a home with a down payment of just ½%? You may be able to buy a home sooner than you think!
The worst case scenario is that you go to a lender and find out you will not qualify for a loan yet. That’s it! Yes, it’s disappointing but, if that happens, ask the lender what you need to do to qualify. Is it a credit issue? Too much debt? Once you know what you need to do, you can plan and work toward meeting the necessary qualifications.
One more thought: When you are getting ready to purchase a home, you want your credit score and income as high as possible and your debts and defaults as low as possible. Obvious, right? Sometimes people, in their excitement to own a new home, go out and buy a new refrigerator or some other big ticket item. What does this do to your credit? Believe it or now, it can kill your chances of getting a loan. As soon as you decide to actively look for a home and until you have keys in your hand for your new home, do not make any major purchases. Lenders will run your credit again just before they fund a loan. Any negative changes can mean your loan won’t fund.
Once you have your pre-approval letter and funds in the bank, the fun begins! Time to go house-hunting!
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