Make These 5 Money Moves Before Applying for a Mortgage
Each year, millions of people apply for a mortgage and purchase a home. This, however, shouldn't convince you that getting a home loan is a piece of cake. In reality, a mortgage is one of the hardest loans to qualify for. But if you make these money moves before meeting with a lender, you can swing the odds in your favor.
1. Pay off debt
Getting approved for a mortgage doesn't require zero debt, but the more you currently owe, the harder it can be to qualify for a desired amount.
To avoid any roadblocks along the way, come up with a clearsighted plan to pay off as much of your debt as possible, especially credit card debt. A high credit utilization ratio — which is your credit card balance compared to your credit limit — can lower your credit score and make it difficult to qualify for a mortgage or trigger a higher mortgage interest rate.
As a personal goal, keep credit card balances below 30 percent of your credit limit. To attain this, stop using cards and pay more than your minimums every month. Also, ask creditors to lower your interest rate. If you can pay less interest, you'll reduce the principal faster.
Take it a step further and make higher monthly payments on other types of debts as well, such as a car loan, student loan, etc. This is to your advantage because the less expenses you have, the easier it'll be to adjust to a mortgage payment.
2. Determine what you're comfortable spending
Your mortgage lender decides an affordable amount based on your income and existing debt. Still, it helps to have an idea of what you are comfortable spending on a house before meeting with a bank. Typically, banks allow borrowers to spend between 28 percent and 31 percent of their gross monthly income on a mortgage payment.
Do the math and calculate 31 percent of your gross monthly income, and then review your budget to see if you can realistically afford this amount on a monthly basis. After determining a comfortable monthly payment, use a mortgage calculator to estimate the maximum you can borrow based on the desired payment range.
3. Devise a savings plan
Qualifying for a mortgage entails money — lots of it. Not just money for the monthly payment, but also cash for a down payment (between 3.5 percent and 20 percent of the home's value), plus there's the cost of closing. These fees can run up to 5 percent of the purchase price.
Even if you can afford a house payment at a certain price point, you'll only qualify for a particular amount if you have enough in reserves for mortgage-related fees. Let's say you want to purchase a $300,000 house. Your income may show an ability to afford the monthly payment. But if you only have $7,500 in savings for a down payment, instead of the required $10,500 (assuming you get an FHA home loan), you can't purchase the home. You then have two options — purchase a cheaper home, or postpone buying until you save additional cash.
Once you have an idea of how much you'll spend on a property, devise a plan to save for your down payment and closing costs. Based on your amount of disposable income each month and your desired time frame for purchasing a property, decide how much to save. Keep this money in a designated high-yield savings account.
4. Pay your bills on time
There are no hard rules regarding how many late payments a lender allows within 12 or 24 months before applying for a home loan. If there are late payments on your recent credit history, it's up to your lender to calculate the risk level and determine whether you're creditworthy. To do this, some lenders request an explanation to assess whether lateness was due to irresponsibility or circumstances beyond a borrower's control. (See also: 5 Simple Ways to Never Make a Late Credit Card Payment)
Either way, late payments in your recent history can result in a higher interest rate, which means you'll pay more for your home loan in the long run. Therefore, aim to pay all your bills on time. If you often forget due dates, set up recurring or automatic monthly payments.
5. Shop around for lenders
According to the Consumer Finance Protection Bureau, 47 percent of homebuyers don't compare mortgage lenders when applying for a home loan. What's even more surprising, 77 percent apply to only one lender at all. It might seem convenient to get this step out of the way ASAP, but it just doesn't make smart financial sense.
When you're ready to apply for a home loan, you need to do research and shop around. Don't just settle for the first mortgage lender who approves you. You might be eager to get the process underway, but be patient. The first person to give you the green light might not be offering the lowest interest rates (or charging the lowest fees), which could mean the difference between thousands of dollars. Maybe they're just not the right fit for you, or they don't take the time to really earn your business. You won't know unless you compare, and that step can save you a lot of stress (and money) down the line. (See also: 4 Mortgage Secrets Only Your Broker Knows)
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