You think you feel ready to buy your first home, but how do you really know when you are ready? It takes more than the confidence to become a homeowner to buy your first home. You need to be in a good financial position to afford what could be the largest investment of your lifetime.
Keep reading to see if you are ready to buy your first home.
Do You Have a Good Credit Score?
The first thing most lenders will look at is your credit score. Did you take the time to make sure your credit score is as high as possible? At a minimum, you’ll want a 680 credit score, but any credit score over 700 will give you an even better chance of loan approval.
Lenders use your credit score to gauge your level of financial responsibility. They use your credit score to determine which loan program you may qualify for as well as the interest rate they will charge. Take the time to pull your credit (you can get a free copy here) and make sure your credit history is in good condition. You can also check your score with free credit scores from your bank or credit card companies.
Do You Have Money Saved?
You probably know you need a down payment for a new home, but did you know that you also need money for closing costs? They can account for as much as 5% of your loan amount. On a $200,000 loan, that means another $10,000.
Consider how much money you have saved as well as how much of it you must use for a down payment. Each loan program has their own down payment requirements and they are as follows:
- Conventional loans – 5% minimum down payment
- FHA loans – 3.5% minimum down payment
- VA loans – 0% down payment
- USDA loans – 0% down payment
Most new homebuyers use either conventional or FHA loan financing. As you can see, you’ll need a down payment for both programs. If you are a veteran of the military or you have low to moderate income and live in a rural area, you may get away with no money down.
Either way, you’ll need money for the closing costs. Plus you need money on hand in case you have to make repairs or conduct normal house maintenance. You should account for 1% of your home’s purchase price for home maintenance. If you buy a $200,000 home, you should have at least $2,000 on hand for maintenance and repairs.
Do You Have a Good Debt Ratio?
Another factor lenders look at is your debt ratio. They need to know that you can afford the mortgage payment as well as your current consumer debts. They don’t want you to get in over your head because that only puts the banks’ investment in you at risk.
The maximum total debt ratio any loan program can allow is 43%. This means that no more than 43% of your gross monthly income goes towards your monthly debts. Most loan programs also set a housing ratio, which is the maximum amount your mortgage payment can take from your gross monthly income. The typical housing ratio maximums include:
- Conventional loans – 28%
- FHA loans – 31%
- USDA loans – 29%
These are just guidelines; each lender can make the ratios a little tighter if they wish in order to lower the risk of default.
It’s a good idea to keep your debt ratio as low as possible when you are a first-time homebuyer. This is especially true if you don’t have a housing payment history, such as a rental history. The payment shock you experience could be quite high, which could be quite an adjustment for you as a new homeowner.
Do You Have Steady Income and Employment?
Lenders don’t like to see applicants that hop from job to job throughout the year. Ideally, they want applicants with at least a 2-year history at the same job. This helps the lender feel as if your income is stable and reliable.
Lenders also look at the type of income you receive. If you earn a salary, you are the lowest risk. The lender can predict your income each month and calculate the amount of a mortgage payment that you can afford. If you work hourly or work on commission lenders need to take a two-year average of your income to account for the highs and lows that your income likely goes through during the year.
The more steady your income and employment, the better your chances of loan approval as a first-time homebuyer.
Putting all of these factors together makes the ideal first-time homebuyer. Of course, lenders recognize that everyone is different and that some applicants will have a high credit score but high debt ratio while others may have a low credit score but also a low debt ratio. They look at the big picture to determine your likelihood of succeeding as a first-time homebuyer.