Thinking of becoming a home owner? It can be an intimidating process, especially if it’s your first time. Here are 3 tips to help you toward your goal.
Is your goal to be a first time home buyer? Condominium, townhome, house, the choice is yours. Believe it or not, buying a home may be a more tangible goal than you think. Millennials / GenYers ages 36 and younger represent 34 percent of all home buyers, which is the largest generational group in a study by the National Association of Realtors (NAR). Of that group, 66 percent are first-time home buyers.
For some, the road to homeownership seems never ending. It may be paved with income issues, debt problems or credit score blunders. If you just can’t seem to make the move from your parents’ home to first time home buyer, you’re not alone. The NAR reports that 20 percent of first time homebuyers lived in homes owned by parents, relatives, or friends rather than renting their own place prior to purchasing their home. If these buyers can make the move after living with family, so can you.
Most buyers purchase a home with a mortgage loan, so qualifying for a mortgage is a big key to acquiring a home. But having the income and savings to cover the expenses of getting and continually paying the mortgage once you get it is also crucial to homeownership. To create the balance that lenders seek, Grownups should focus on some of the key pieces to the puzzle: your income, your expenses, and your credit score. And don’t wait until the last minute. Just like almost anything financial planning related, planning ahead (at least one year before a home purchase in this case) will give you a better chance of reaching your goals.
1. Work to Increase Income
Buying a home means saving money for a down payment, closing costs, moving expenses, and other necessary costs. To a lender, income shows your ability to repay a mortgage, as well as other home and personal expenses. That means your job is an important part of the income equation. Any employment counts—self-employment, contract work or part-time jobs—as long as the income is documented.
Documentation usually consists of standard W-2s or 1099s. If you own a business, income taxes and financial statements can be used for proof of income. It helps if your two- or three-year work history shows solid employment, and you haven’t just started a new job before you purchase.
It’s a helpful exercise to calculate your income and expenses. If your income is less than your expenses, one solution is to work toward increasing the money you make. You could get a higher-paying job, work toward a better position at your current place of employment or get some freelance work on the side. Whatever you do, your work history should be steady.
2. Manage Debt Reduction
Now, take an even closer look at your expenses. Especially your credit card, vehicle and student loan debts, as well as any other loan payments you make on a monthly basis. A good rule of thumb is to shoot for a monthly pre-tax income of three times the amount of your monthly debt payments. This is known as debt-to-income (DTI) ratio. Lenders are looking for buyers to have a DTI of 36 percent or less, with less being better. This shows lenders your debt is under control and gives you room to save for emergencies or home repairs.
If your DTI is higher than 36 percent, don’t panic! You can work toward increasing your income, reducing debt or better yet, doing both. This is where planning ahead comes into play. If you don’t wait for the last minute, you’ll have time to work toward a better financial picture through the eyes of your lender. Maybe you could take a second job on the weekends to make extra money to pay down your creditors, or you could slash your budget and use the savings to bring expenses down. For instance, make coffee at home instead of always heading to that fancy spot down the road or go out to eat less and keep spending on a credit card to a minimum. Before you purchase a home is not the time to go on a buying spree, as it reflects poorly to a lender.
Managing your debt says to the lender “I’m reliable and handle my money well.” A lender takes less of a risk to loan money to a buyer with a low DTI. It makes lenders feel confident you are not mismanaging money, which they can further tell by your credit score.
3. How to Improve Your Credit Score
Credit score, or FICO score, as an example, is another important number that figures into the type of loan to apply for and the ability to be approved for a loan. Scores run from a high of 850 to a low of 300 or less. This figure indicates your willingness and/or ability to repay creditors, so the higher your score, the better. Different lenders have different rules, but generally a score of 700 or higher is considered a “good” credit score. The better your credit score, the better your chance of getting a favorable interest rate. Remember, with a mortgage loan that can last for decades, even a slightly higher interest rate can have a big impact on the amount you pay over the term of the loan.
Nowadays, it’s easy to see your credit score for free. Scores are derived by three credit bureaus—Equifax, Experian, Transunion—who will each provide one free report a year. Sites like Credit Karma show your credit scores and whom you owe at no charge, including reporting any old debts dragging your score down.
Don’t have a credit score because you paid cash for your vehicle and worked your way through school owing no one? More power to you. However, lenders want to see that you are willing and able to pay off a long-term loan.
To remedy the lack of credit, research interest rates and other charges and apply for credit cards at least seven months before (it takes about six months to see your first credit score) you intend to purchase a home and, once one is obtained, continually use it for smaller charges. Then, make sure your payments are made on time and never use more than 30% of your credit limit. The longer you have used and make timely payments on your credit card, the better your score.
In conclusion, homeownership can help create some financial stability.
A Bank of America survey reported in Money shows that, “Among Millennials who already own a home, 79 percent said their homes are having a positive impact on their long-term financial picture, with 86 percent responding that owning a home is more affordable than renting.”
If you have homeownership as a financial goal, you can get there. But it may not happen overnight. Just be patient because it may take some work to find the right balance of income, debt management, and credit score to appeal to lenders.
Using her 14 years experience as a Realtor®, Elizabeth R. Elstien is a real estate writer, editor, educator, and consultant. Follow her Real Estate News & Views blog at eElstien.com.
Any third-party resources or websites referenced above are not under Society of Grownups control. Society of Grownups cannot guarantee and are not responsible for the accuracy of the resources, websites, or any products or services available through such resources or websites.
While Society of Grownups hopes the information is useful, it’s only intended to provide general education. It’s not legal, tax, or investment advice, and may not apply or be useful to your specific financial situation. If you need recommendations geared to your personal financial situation, schedule time with a financial planner.