Buying a Home – Part 1: Planning Ahead
With the end of the year rapidly approaching, people may find their focus shifting to holiday plans and family events. Traditionally this also means home buying plans take a backseat to the coordination of Thanksgiving dinner and thoughts about how to pay for all the holiday festivities coming up. Actually, now might be a really good time to focus on what it takes to buy your first home.
Part of buying a home is figuring out what it takes to make it all come together. The fun part is deciding where to look, how many bedrooms you need and if you finally get that game room with the large screen TV. The not-so-fun part is figuring out how much that all costs, what sort of down payment is required and what your monthly budget will look like with your dream home in hand. That’s why planning is very important, and what better time than now to work on putting it together?
Step one in the home buying process is to see what you have going on at this time in your life.
In teaching our First-Time Homebuyer Seminars, we get a lot of questions about credit. Why is credit important?
The quick answer everyone gives is, “Credit score is a huge deal!” However, a score is only a product of what your credit profile looks like. If you have always paid on time, you might have a wonderful score. But does that mean that you can buy that $400k home you have been eyeing? The answer could easily be negative.
The best answer I give is to look at your credit as a road map. It shows where you have been and where you are going. Though the new house is the “where we are going” part, the “where you have been” is going to determine if you can keep moving forward or if you should stop and figure out the obstacles. Start by obtaining a copy of your credit report. If you have not recently applied for credit, go to www.annualcreditreport.com. This is a free service that you can use once per year for each credit bureau. It does not give a score, but it does provide a lot of valuable information about your credit history. It’s safe, secure and provided by the bureaus themselves.
So now you have a report – where to next?
To begin, cover the big stuff. Judgments, tax liens and large collections (usually over $1,000) need to be paid or settled before being able to move to Step 2. The old adage “After seven years they go away, right?” doesn’t apply to these scenarios. No matter how old a judgment is, it will need to be removed. Tax liens can come from being behind on IRS taxes, not paying property taxes or simply something you owed to the city or state. Collections are a bit trickier, as medical collections can often be overlooked when it comes to home loans. Though they don’t go away and hurt your overall score, they don’t typically have to be resolved before buying a home. That said – if it isn’t medical, work on settling it before you apply for a home loan.
Now you have cleaned up the obvious, what should you look at after that?
History. The vast majority of your credit score is based on how you pay your bills. The rule of thumb most lenders like to use is not having any late payments in the last 12 months. Though exceptions can be made, recent late payments hurt your score more severely, and consecutive late payments are often a sign of inability to handle debt. From an underwriter’s perspective, if you can’t take care of that $100 payment, what would it look like to add a $1,000 house payment on top of it? So your best answer is to see what is reporting and be sure that you have been paying as you go along.
Along with history comes some combination of major history items. One of the more common questions I get is about bankruptcy. Current rules state that you need to be at least two years out from your settlement before you can apply for a new mortgage. Though there are some exceptions for different types, the majority fall into this rule. For foreclosures, four years is the minimum wait time, and can go as long as seven years for a conventional loan. Having either of these scenarios also means that current pay history is much more important, as lenders want to see that you have established solid credit after a major event.
No judgments, collections, bankruptcy, foreclosure or late payments – everything should be good, right?
Credit’s last component is availability and payments. As a home loan lender, we look to see what payments are already being made and compare that against the gross income a person earns. In most cases, that ratio needs to stay below 45%. What we ask members to do is take your monthly income (before bonuses, overtime, etc.) and multiply it by 45%. Then take that number and subtract out all of the debts you show on your credit history. The remaining total is the maximum payment that you can have for your home.
Last, you’ll need to be sure you keep revolving balances down while you work on your plan for a new home. We all know that life throws curve balls, but perhaps the most important time of the year to watch your spending is during the holidays. Between gifts, travel, decorations and food, these next few months are taxing. But the more you have in debt, the smaller available house payment you have. Further, the less available credit you have on your credit cards, the lower your score goes – even if you pay on time!
Part 2 will focus on what type of loan works best for you and what it means for down payment, requirements and type of home. As always, please feel free to reach out to our home loan department with any questions you might have. And if you’d like to attend our next home buying class, we will be hosting one in January. Watch the website for details!
|Alec Coughlin, mortgage lending manager for EECU, brings more than 10 years of home loan experience to the credit union. In addition to overseeing the credit union’s mortgage lending officers, he teaches frequent seminars for first-time homebuyers.