First home buyers may be wishing for a housing market crash or, at worst, a correction, and who can blame them?
Currently, in the USA house price inflation is rampant and there are bidding wars for single-family homes.
With no end in sight to rising house prices, first home buyers need to know what they need to do to meet the criteria for a mortgage.
Lenders consider many factors for home loan approvals, and different states and lenders have their own variations too.
In this article, we will cover a few of the following criteria.
- Your credit score
- Income and employment status
- Down payment
- DTI (debt to income)
- LVR (loan to value)
- Mortgage insurance
Mentioning here how the pandemic has changed the mortgage landscape is vital as COVID-19 has changed everything.
Prospective home buyers are questioning shall I rent or buy? Lenders are making their decision easier for now as they reassess their lending criteria. For example, USNews reports lenders have tightened up their credit score criteria resulting in low credit score borrowers being out of the property market.
Although 640 is considered a good credit score, most of the financing you’ll get for a mortgage at this credit score will leave you with a high-interest rate.
Therefore it’s a good idea to build up your credit score until it’s in the 700s.
A credit score lower than 640, although it doesn’t say anything about who you are as a person, can look bad on your credit report.
Taking the time to build it up will allow you to prove your creditworthiness before going hunting for a loan and starting the house search. Some of the ways you can improve your credit score include
- Lower credit score utilization ratio
- Limiting credit score inquires
- Paying your bills on time
- Avoiding unauthorized overdraft
Have you got a savings plan and if so how much do you have for a down payment? The more, the better, of course. Consider a minimum of a 5% deposit or down payment. For example, consider the average property sales price is $400,000. You will want $20,000 for your down payment.
There are lenders and mortgage products that will allow a lower down payment, e.g. 3% instead of 5%; however, the lower the percentage, the higher the risk, so the interest rate and terms are more favorable to the lender. Even 5% is really very low, and ideally, you’d aim for a 20% down payment which would be $80,000.
If you’re buying in a growth market or boom, i.e. house prices are rising. If you’ve bought your home with less than a 20% deposit, you will need mortgage insurance. This doesn’t need to scare you off, as you can apply to have it removed once you’ve got 20% equity in your home.
For example, if you pay $400,000 and have a 10% down payment, but over the next couple of years, your house goes up in value to $450,000, you’ll have a 20% equity stake. Therefore it’s not always the right move to wait until you have a 20% downpayment unless you’re confident you can save $45,000 each year to have the prerequisite $90,000 deposit to purchase the same home now worth $450,000.
Income and Employment
The pandemic was a warning to lenders to be more vigilant in their income and employment criteria. Proving your income and employment status is key to securing a home loan. You will need to produce evidence including:
- Bank statements (2 years)
- W-2 (2 years) or pay stubs (30 days)
- Tax returns (personal, business)
Who doesn’t love a good acronym? :). The debt to income (DTI) is how much debt you can have based on your income. A DTI of 3.5 is total debt three and a half times your income. For example, if your annual household gross income (before tax) is $90,000 and you have no debt, your mortgage amount would be 315,000. You’ve probably worked it out – to get a $400,000 home, your down payment would be $85,000 (21.25%).
The loan to value rate is what percentage of the sales price is the loan. For example, if your lender requires you to have an LVR of 85%, you will need a 15% down payment.
Caveat: the information in this article is a guide only and not to be considered financial advice. Always seek professional input from your approved financial advisors, including your accountant.
Lenders do revise their criteria for mortgage products. Do your homework so you’re informed on what type of home loan and the amount you can borrow before getting too excited about homes for sale.
You can start your savings plan and meeting the lending criteria for months, if not years, before you need a mortgage, too, so consider your options and how you’d qualify now and what you need to do to get the home you want in the future.
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