Where do you start when you're ready to buy your first home? It can be tempting to fast-forward to looking at homes and shopping for mortgage loans, but laying solid financial groundwork can save money and streamline the mortgage approval process.
- Employment: Conventional and FHA lenders evaluate your employment to determine that it is stable and continuous. If you've just started or recently changed your career, you may have to establish a track record (work in the field for a year or two) before you get a mortgage. Self-employed borrowers and those who work on commission must be in business for at least two years and show stable earnings.
- Savings: If your savings is under your mattress, get it into a bank account so that you can provide the required two months of bank statements. It's not an absolute requirement, but it will make your life easier.
- Down payment source: Underwriters want to be sure that your funds have not come from prohibited sources (anyone who gains from the sale of the home). That means tracing gift funds to the account they came from, verifying your accounts with statements, and sending out verification forms to your financial institutions.
- Debt to income ratios: Mortgage lenders evaluate two ratios. The front- or top-end ratio consists of total monthly housing expense (principle, interest, taxes and insurance plus HOA fees and mortgage insurance if applicable) divided by your gross monthly income. If your monthly gross income is $4000, and your monthly housing expense is $1000, your front-end ratio is 25 percent of your monthly gross income. Lenders prefer that top-end ratios don't exceed 32 ppercent unless you're a very strong applicant.
- The back-end ratio consists of all monthly installment payments including housing costs (see front end ratio above) and minimum monthly payments for vehicle loans, student loans and credit cards. Conventional lenders prefer 36 percent or lower and FHA loans is 41 percent, unless you have excellent credit, good savings and are conservative with debt.
- Debt and credit scores: Order and review your credit reports and check them for errors. Paying off debts reduces your back-end ratio and may improve your credit scores. Conventional mortgage lenders generally reserve their best mortgage rates for borrowers with FICOs of at least 740.
Pre-qualifying for a mortgage loan tells you how much you qualify to spend on a home, and helps you identify issues that may keep you from getting mortgage approval.