As we approach the spring homebuying season and real estate activity picks up, many first-time buyers will be entering the market and seeking home financing. While we’ll discuss a few common tips, such as staying on top of your credit score and determining how much you can afford, we delve deeper in this month’s Insights to uncover some of the less obvious things you may encounter as a first-time buyer.
Know Your Numbers
For starters, anyone seeking a mortgage should be aware of their credit standing. Aside from regularly monitoring your monthly debt obligations, such as credit cards, student loans or auto loans, consider using one of several free online options to pull your credit history. This will ensure you’re squared away on all of your bills, including non-recurring ones, like a medical bill from a one-time visit to the hospital.
Once you pull your credit history, it’s important to make sure that all accounts listed under your name belong to you and that the account balances are accurate. It can take months to have an error removed from your credit report so the earlier you check your credit history, the more time you’ll have to fix the problem. Also, hold off on opening or closing credit cards or making big purchases until after completing the homebuying process so that there are no flags or “inquiries” that you will have to explain to a lender when they pull your credit.
Calculate Your Cash Flow
Before taking on what will likely be your largest monthly expense, it’s crucial that you understand how much you can afford. A lender will calculate this by determining your debt-to-income (DTI) ratio, which equals all monthly expenses (mortgage payment, taxes, insurance, credit cards, auto loans, student loans, etc.) divided over your monthly gross household income (typically your salary divided over 12 months). The general industry rule of thumb is to keep your household DTI ratio under 43 percent, but some mortgage lenders may have a lower DTI ratio that you cannot exceed.
Looking Beyond the Down Payment
One issue that may be top of mind when you’re buying your first home is saving for a down payment, but that’s just one of many homebuying expenses. Some lenders require a certain minimum in savings, called reserves, to show that you have an accessible source of backup money to make mortgage payments if your income is disrupted. Don’t wipe out your entire savings account on the down payment alone. That way you have some flexibility if unexpected costs pop up during the process.
Once you have your financial profile in order, there are a few things to consider that may be out of your control. The most prominent economic factors this year are a shortage in the housing supply in some markets and increased interest rates. Total housing inventory has declined for 18 consecutive months, driving supply down and prices up. This is all the more reason to be nimble in your home search and be prepared to provide a mortgage lender with all required paperwork and documentation. You don’t want to lose a great home in a market with limited opportunities because your mortgage approval is delayed.
Lastly, don’t forget that the Federal Funds rate impacts the interest rates lenders can offer on a loan. It’s important to pay close attention to the Federal Reserve’s meetings in case they change rates. The end of 2016 marked the second rate increase by the Federal Reserve since the financial crisis in 2008. While current interest rates are still historically low, they aren’t expected to stay at this level for long. Even though there may be more increases to come, it would take a drastic increase for rates to reach pre-crisis levels any time soon. Ultimately, it comes down to whether you can afford the monthly payment at the rate your lender offers.
The earlier you can prepare the better. Look to your lenders for guidance throughout the homebuying process. Working upfront with your lender to understand the process from start to finish, paperwork requirements and mortgage options will save time, alleviate stress and help you become a homeowner in 2017.