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Our Credit Isn’t Perfect; How Can We Prepare to Get Home Financing?

You want your financial ducks in a row before you even begin looking at houses. And if you or a co-applicant has a credit issue, this becomes ever-more important. Here’s what to do with your finances in the months leading up to buying a home.

6808984167_303833e1e1_zQ: I’m 27 and recently got married. My husband and I are ready to buy a home. We have enough saved for a down payment, but his credit isn’t great because of a couple of credit cards he didn’t pay about four years ago, and we’re nervous about getting approved for financing. Where do we start? — Kristen F.

The biggest thing I emphasize to everybody is that you want your financial ducks in a row before you even begin looking at houses. And with your husband’s credit issue, this is especially important before applying for a mortgage.

As real estate markets around the country tip in favor of sellers, there’s enormous pressure on buyers to make offers when they see something they like. And if that offer is accepted, that will mean applying for a mortgage within a few days. And you don’t want to wait until you’re under contract to realize that could have problems getting approved for the loan or the interest rate you need.

Here’s what you should do before anything else:

1. Grab copies of both of your credit reports from annualcreditreport.com and an estimated credit score from a free site like CreditKarma.com.

You’ll want to make sure everything’s accurate on the reports (although there may not be enough time to fix errors before you apply for the loan). But basically you just want to know what’s on there so there aren’t any surprises.

Your credit scores are actually the more important piece of the puzzle when it comes to getting a home loan. Anything above 700 should be passable … and obviously the higher, the better. Assuming your husband’s score is in the 600s, you should consider taking the information you pulled to a mortgage broker or bank loan officer and discussing your options.

It’s better to do this with the information you pulled rather than asking them to pull it for you, which results in a hard inquiry on your credit report. (Not the end of the world, but in general it’s just best to minimize these.)

Your mortgage broker will be able to explain how to best treat your different credit scores. Some underwriters rely on the lower of the two scores, but others will average them. If you can afford it, you can also consider applying for the mortgage in your name alone, although that means you’ll need to qualify for the monthly payments based on just your income.

2. Avoid using credit.

When you apply for a mortgage, the underwriters will scrutinize your credit report and pay close attention to recent changes. Try to keep the balances on all of your credit cards low and do not open new credit accounts for at least two months before you apply for your mortgage. You don’t want to add any additional reasons for the underwriters to scrutinize your application.

3. Understand how much you can afford.

Banks may qualify you for a mortgage that has a payment of up to 35 percent of your gross monthly income. But that’s the max. I tell people to be conservative and aim for a mortgage payment that is no more than 25 percent of gross monthly income. (Not always possible in expensive urban markets.) Use that mortgage payment to identify your target price range with you realtor.

Again, you’ll want to figure out if you can apply for the loan together with your husband or will need to do it alone, and calculate how much house you can buy accordingly.

4. Get your documents in order.

When you apply for your mortgage, you’ll need to provide recent paystubs, bank account statements, current mortgage statements and, if you have freelance or self-employment income, copies of your last one or two tax returns. You can make things go smoothly later if you get these documents ready.

5. Get pre-approved.

When you start shopping for homes, it’s time to get a pre-qualification letter or pre-approval from the bank. A pre-qualification letter simply states that based on your income and assets, the bank believes you could get a mortgage for X amount. A pre-approval letter takes into account your credit report and other application information. Although neither document guarantees you’ll get financing for a particular house, taking these steps can prevent surprises later and can make your offer more attractive to sellers.

6. Apply and close.

When your offer is accepted, it’s time to finish your mortgage application and lock in your interest rate. The lock ensures that even if it takes many weeks to close on the loan, your interest rate won’t go up. At this point the bank will do most of the work, although you should be ready to get them any additional information they request — the faster the better. For example, they may want to see proof of funds you’ll use for the down payment going into your checking account.

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. Outstanding advice, David,spot on! And Kristen, congratulations on saving up enough for a down payment, and for seeking some advice before venturing out – both wise moves! I’d add just a couple of more to points to what David has said. First, part of being ready to buy is being sure that you can commit to STAYING in the house you buy for a good long while – I recommend at least five years. Today’s employment landscape is more fluid than ever, and giving up the flexibility to follow opportunities deserves some serious thought. Second, you’ve saved up enough for a down payment – but how much is “enough”? For a first time home buyer, my advice is that it should be at least 27% of the price range you’re considering. It sounds like a huge amount of money – and it is! – but here are the three components. You want to put 20% down, EVEN IF you find a lender that doesn’t require it – 20% eliminates the need for private mortgage insurance, AND gives you a healthy cushion between your mortgage balance and the never-predictable market price. Then, you’ll need 3-5% for closing costs, and it’s better to have that saved up rather than borrow it. And finally, there’s a long laundry list of “first time home buyer expenses” ranging from appliances to home repair tools to furnishings, so it’s wise to have another 2% set aside for those. If you’re not quite up to 27% saved yet, that gives you more time to take the credit score research and improvement steps that David has recommended. Good luck!

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