If you are looking to buy a home in the near future, it’s important to make sure that you start preparing your credit. So what all do you need to do before applying for a mortgage? Read on for part two of our home ownership series as I share what I’ve learned over the years!
Know Your Score
First things first, you should know your credit score and increase it if it’s low. To even qualify for an FHA loan, you will need at least a credit score of 580. To qualify for a conventional loan, 620 or higher is preferred. When you are preparing your credit for home ownership, knowing your score beforehand gives you the opportunity to increase it, or use it to your advantage if it is high enough. There are many different ways to increase or maintain your credit score, but it really just boils down to paying your bills on time and not getting yourself in massive amounts of debt.
Think About Your Income
While you are preparing your credit for homeownership, you should also be able to pay the bills that come with owning a home. Lenders will look at your gross income (or total earned income) when deciding on your mortgage eligibility.
However, you shouldn’t consider your gross income when determining if you can afford your new home. A good rule of thumb is to not have your home expenses exceed 30%, 25 – 25% is even better. So, if you are making $50,000 a year (gross) but only bring in a net income of $35,000 a year, your living expenses shouldn’t be more than $10,500 per year. . Living expenses being home mortgage, taxes, insurance. While a lender may approve for a $200,000 house based on your $50,000 a year salary, that’s a whopping $1,000 a month on your mortgage payment alone (based on the amount, at a 30-year mortgage, at a 4.5% interest rate). Taxes, insurance and PMI insurance could make your monthly payment $2,000. If you are only making $35,000 net, that’s well over 30% of your income going towards a mortgage. Add in other bills, including lawn maintenance and repairs, and you are basically house poor.
If you want to be able to afford more house, your best bet will be to increase your income or decrease your debt. Which brings me to my next point.
Pay Off Debt
Not only does paying off debt help in preparing your credit for homeownership but it also helps you afford house payments. It can even get you a better interest rate on your mortgage. You can pay all of your bills on time, and have money in the bank, butif your debt to income ratio is too high, a mortgage lender can (and most likely will) disqualify you for a mortgage.
To break this down, let’s think about it this way. If you bring home $3,500 a month, but $2,000 of that goes towards debt (student loans, car loan, credit cards), you’re only bringing in $1,500. That’s not including the fact that you have to eat, pay your bills, and fill up your car. So, a lender isn’t going to give you another loan if they don’t believe you can pay it back.
Even if means you have to take a little longer to get your home, start paying off your debt now so you can qualify for a mortgage later.
What To Do If You’re Married
If you’re single, you know how to live on your income and your income alone. If you are married, you may be living on both your incomes. However, when preparing your credit and deciding on what you can afford, try living on one income.
What’s the reason for this? If one of you were to lose your income would the other be able to pay all of the home’s bills? If not, that home is too expensive. Would they be able to cover any debt payments, plus the mortgage and utilities? Also, what happens if you get divorced? What happens if one of you pass away? These are things to think about when you are married. I don’t advise trying to find a home that requires you to max out both of your incomes.
Preparing your credit for home ownership can take time and diligence, but it is possible! How are you preparing your credit?
Your Financial Coach,
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