If you’re considering getting a mortgage in the near future you may be wondering “what do I need to buy house?”
Mortgage loans can be complicated and have requirements many first-time homebuyers don’t realize.
In this article we’re going to go over the various things you need in order to purchase a home.
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1. A Descent Credit Score
While there are types of mortgage loans, like FHA loans that allow for low credit scores. You will still need to have at least a descent FICO score to qualify. Lenders look at your mid score when determining your creditworthiness.
You have a credit rating from all three major credit bureaus, Transunion, Equifax, and Experian. Lenders will take the middle score as your credit score used.
For example if you have a 650, 630, and a 640 score from each credit bureau the 640 score is going to be used by lenders.
Having at least a 620 score is recommended, if you have a 580 credit score you may qualify for an FHA mortgage. If you have a score below 580 it is recommended you work on improving your credit before applying for a mortgage.
2. Two Years of Employment with the Same Company
Solid employment history, a steady paycheck, and solid income is needed to be able to qualify for a home loan. Most lenders will require that you have been with the same company for at least two years.
Being a regular W2 employee receiving a salary or hourly pay is best. Contract workers or commission based jobs are seen as a higher risk because the paychecks are usually not very consistent. Commission employees will have their last 2 years of tax returns averaged to come up with their average annual income.
3. Enough Money Saved for the Down Payment
FHA loans for example offer 97% loan-to-value financing meaning a buyer needs at least 3.5% of the purchase price as a down payment with a 580 credit score. You will typically need between a 5% – 20% down payment for a conventional loan.
The down payment will need to come from money you have saved up in a bank account, IRA, 401k, or other investment account. In some cases you can use gift funds for the down payment.
Here are the required down payment amounts for each type of mortgage loan.
- FHA Loans – 3.5% down with a 580 credit score (10% down with a 500 credit score)
- VA Loans – No down payment needed
- USDA Loans – No down payment required
- 203k Loans – 3.5% down
- HomePath Loans – 3% down
- Conventional Loans – 5% – 20% down
- Conventional 97 Loans – 3% down
4. Debt-to-Income Ratio Below 41%
Lenders use your debt-to-income ratio (DTI ratio) to determine how much house you can afford. Your DTI ratio is calculated by taking your total monthly debt payments such as your mortgage payment, credit card payments, personal and student loans, etc. and divide by your total monthly income, pre-tax.
For example if your income is $5,000 monthly and your total monthly payments including your estimated mortgage payment is $2,000 monthly. Your debt-to-income ratio is 40%.
Most home loans will require a back-end ratio of 41% or low in order to qualify. FHA loans are a little more relaxed and allow for a higher DTI ratio in some cases.
There are two types of DTI ratios, front-end and back-end.
Front-end ratio – Your DTI ratio before adding your estimated monthly mortgage payment.
Back-end ratio – Your debt-to-income ratio after adding in your estimated mortgage payment.
5. Budget for Extra Costs
There are several costs associated with homeownership besides just the mortgage payment many first-time buyers don’t plan for. There are mortgage insurance premiums, homeowners insurance, property taxes, homeowner association dues, home appraisal, and more.
Private mortgage insurance (PMI) is required on all home loans (except VA loans) with a loan-to-value ratio higher than 80%. FHA loans require a mortgage insurance premium (MIP) regardless of how much a borrower puts down.
Mortgage insurance ranges from 0.50% – 1.00% of the loan amount depending on which type of loan you have.
Homeowners insurance is not optional, if you have a mortgage you’re required to have it. The average cost of homeowners insurance is around $1,000 annually. Your mortgage lender will set up an escrow account and you will pay for homeowners insurance and your property taxes monthly.
Home Appraisal and Inspection
The home appraisal is an additional cost that is paid by the buyer before closing. On average a home appraisal costs between $400-$600. A home inspection is not required but highly recommended, even if you’re buying a new home. You can get your new home inspected for around $300 – $500 in most cases.
6. A Pre-Approval Letter
Before you start house hunting you will need to get a pre-approval letter first. In fact most real estate agents won’t even start showing you homes without one. And many sellers won’t accept any offer from a buyer that isn’t pre-approved for a mortgage.
A pre-approval letter means that you have spoken to a lender and they have pulled a copy of your credit report and verified employment and income documents and you should qualify for a mortgage.
In order to get pre approved you’ll need a few documents to give to a loan officer.
Income Verification – You’ll need W2’s, pay-stubs, and the last two years of tax returns. A loan officer will verify that you have been employed with the same company for at least two years and verify income sufficient for the amount of home you want to buy.
Asset Verification – The loan officer will verify that you have enough cash to cover the down payment. How much down you need to have to depend on the type of mortgage you’re seeking. At least 3.5% down can be expected.
Credit Report – A copy of your credit report will be requested. You’ll need to meet the minimum credit score requirements needed by your mortgage lender.
7. A Knowledgable Real Estate Agent
Some first-time buyers believe they can save some money by not hiring a real estate agent. This couldn’t be farther from the truth. In fact, not using a real estate agent can cost you big time. You may end up paying for items that are usually paid for by the seller.
You also should never use the sellers agent. The sellers realtor works for the seller and will always have their best interest in mind, not yours. You should hire your own real estate agent. You can ask friends or family members for a recommendation or find one on websites like Trulia or Realtor.com.
8. Know if You Want a Fixed-Rate or Adjustable-Rate Mortgage
There are two types of mortgage terms a fixed-rated mortgage, which means you will have the same interest rate for the life of the loan. And an adjustable-rate mortgage in which the rate is initially lower than a fixed-rate but increases annually after a short period, usually five years.
You also have a few options when it comes to a fixed-rate mortgage loan. A 30-year loan is the most common term chosen by homebuyers. You could also choose a 15-year term which will have a lower rate than a 30-year term and will save you tens of thousands of dollars in interest.
There are several things you need to buy a house. Descent credit and consistent income top the list, but there are many things you’ll need when buying a home.
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