Get Your Finances in Order Before Buying a House
Getting Financials in Order
You always pay your bills on time, you have a great job, and you are very proud of your credit score. All of that will not get you a mortgage if the lender determines you are living to close to the financial edge.
The financial edge is measured by your debt to income ratio. It is important for you to know your debt to income ratio as it is to know your credit score when applying for a home loan.
Your debt to income is comprised of the "Front-end-ratio and Back-end-ratio." Typically for a conventional loan, lenders would prefer the front-end-ratio to be no more than 28% and the back-end-ratio no more than 36%. Obviously, lower would be better.
Front-end-ratio - This ratio is calculated by totaling all of your monthly housing expenses and dividing it by your monthly gross income. Typical monthly housing expenses include mortgage principal, interest, taxes, and insurance.
Example: If your annual income is $84,000.00, your monthly income is $7,000.00. Check with your lender to find out what front-end ratio they require. If the lender requires 28%, you can allocate $1,960.00 for principal, interest, taxes and insurance to be approved.
Back-end-ratio - This ratio is calculated by totaling all of your monthly debt and dividing it by your monthly gross income.
Typical total monthly debt expenses include mortgage payments, credit card payments, personal loans, car payments, student loans, child support payments, alimony payments, and legal judgments. A lender will want to see how much debt your income can handle before you would struggle financially.
Example: If your total monthly expenses are $2,450.00, using your monthly gross income of $7,000.00, your back-end ratio would be 35%, and you would be approved if your lender's back-end-ratio is 36%.
Keep in mind, these debt to income ratios are not cut in stone, so talk to your lender.
Also, FHA, VA, and USDA loans typically have higher ratios.
It is so important to understand your credit needs and borrowing ability. Determine when you would like to buy a house so that you may use your financial and credit information to establish a budget. Try as hard as you can to save that 20% down payment plus closing costs.
Think about the following questions and comments before you go house hunting:
* Check your credit report and score months before you start house hunting. Strengthen your credit score. The higher your credit score, the lower your interest and your monthly payment will be.
* Correct any credit issues immediately.
* Save for a 20% down payment.
* Get pre-approved for a mortgage and obtain a pre-approval letter. This will determine how much you can afford along with you not wasting time looking at houses out of your price range. There are times when you may need a pre-approval letter just to make an offer on a house. The time frame for a pre-approval letter to expire is usually 60-90 days.
* Create a budget. List all of your monthly expenses including mortgage or rent, home owners or rental insurance, vehicle costs, student loans, credit card payments, groceries, health and life insurance, utilities including telephone, internet, day care, property taxes, home maintenance, HOA dues, non-reimbursed medical expenses, pets, gifts, donations, etc. Be honest with yourself and make this list as complete as possible.
* With your approval letter, you know what you can borrow. Don't over spend! Just because the lending institution has approved a loan amount of $250,000.00, don't use it. Give yourself some wiggle room.
* How much cash will you need at closing?
* Don't strap yourself by using all your cash.
* List all of your tentative costs for your new house:
- Will real estate taxes be included in your monthly payment?
- What will insurance cost and will it be included in your monthly payment?
- What will utilities cost?
- Make sure you budget for maintenance and repairs.
- What will it cost to move?
- How much will an inspector cost?
- Have an emergency fund. (Pad it before you move.)
-Will there be HOA fees? Run a check on the association. Increasing fees at a later date because of bad management could mean trouble in the future. Understand the power of a Home Owner's Association. There are stories about people not paying their home owner's association fees. The house was foreclosed and sold for back fees, so be careful.
So you see, it's important to make sure your finances are in order when buying a house. To be successful, you'll need sound financial planning.
