Budgeting is the first and most important step that a homebuyer must take in order to have a successful home purchase. Purchasing a home can make a tremendous impact on your monthly budget, so having a good understanding of your personal finances will help you see how homeownership will fit into your lifestyle before you buy a home.
You need to gather your most recent pay stubs and bank statements, and go to a local lender to get pre-qualified for a loan. The lender will look at your debt-to-income ratio and your credit score. Generally, your debt-to-income ratio cannot exceed 40 percent of your gross monthly income and your mortgage payment cannot exceed 30 percent of your gross monthly income. The pre-qualification letter shows you how much of a down payment you must provide. Typically down payments range between 5 and 20 percent. 20/28/36 rule is a useful rule for mortgage affordability:
• Use a down payment of 20%.
• No more than 28% of your gross annual income should go to mortgage, insurance, homeowner’s fees and real estate taxes.
• No more than 36% of your gross annual income should go to mortgage, home and other debt expenses such as credit card debt, car and school loans, etc.
A good budget plan begins one or two years before the buyer makes an offer. When it comes to securing a loan at the best mortgage rate, credit is king. The most important focus for all potential buyers should be improving their credit score. A low score can prevent someone from buying a home or at least from qualifying for an affordable mortgage rate. Everyone should check their credit report for accuracy and fix any mistakes. It can take months to correct errors.
To improve their credit scores, Holmes says that buyers should pay off past-due bills, pay every bill on time and reduce their balances to less than 30 percent of the credit limit on every account. Also, it is best to have three to five credit accounts, such as a car loan, student loan, or credit card, for one year or longer. Lenders do not want to see a lot of credit inquiries or too many new accounts because this could indicate someone who is about to take on a lot of extra debt.
Future buyers should create a simple budget and set a savings goal. They can make “virtual” mortgage payments today as a way to build up savings and learn to budget for actual mortgage payments down the road.
Debt-to-income ratios are an important element in a loan approval. If your debt-to-income ratio is over 40 percent, you need to pay off your debt before even thinking of buying a home.