Do you think you are ready to take a step toward the “American Dream”? Tired of paying rent and want to start building equity and be a homeowner? If you said Yes to those questions but don’t know what to do next, I’m here to help. It’s a lot to cover but we will keep it as concise as possible while still providing value. Read on to learn how easy it can be.

At some point in everyone’s lives they decide to buy a house. For some people unfortunately no matter how much they want to, they will never be able to do it. Either due to poor credit that they were never able to get fixed, low income to not qualify for a loan, or maybe just can’t hold a job. There are several reasons that could prevent someone from buying a home, but for most situations the problems can be resolved and they can purchase a home. Maybe not their dream home, but at least something to call theirs.

If we go back to the early 2000’s it was relatively easy to get a loan to buy a house. Too easy in fact. Banks were handing out money to anyone that could breathe and often much more than the borrower could safely pay back. I experienced it myself. We applied to buy our first home in late 2002 and did purchase our first house in early 2003. At the time my gross income was about $40k per year. My wife did not work so that was all of our household income. Luckily we had no other debts. The bank approved us for about $200k I think, if I remember right. Of course I knew better than to borrow that much. I was surprised they would even let us borrow that much with my income. In the end we were wise and purchased a home we could afford for around $90k. But many others were not so wise and bought more home than they could afford which led to the great housing market collapse in 2008.

Now, post covid-19, getting approved for a home loan is not as easy. Banks are a lot more strict now. They had been loosening up between 2017-2019 but with the risk of jobs closing down, they are not as flexible.

So, if you think you are ready to buy a house, pay attention. There are a few things you need to do BEFORE applying for a loan to help improve your chances of being qualified.

KNOW YOUR FINANCIAL POSITION

You, better than anyone, should know your finances. How much debt do you have? How much savings do you have? And how much income do you make? This is why it is very important to stay out of debt, or at least don’t get yourself into uncontrollable debt. Banks pay attention to your debt-to-income, or DTI. It changes over time but as of now most banks don’t want to see a DTI over 50% some even less. Meaning that based on the debts you have, how much are the minimum payments? If those minimum payments are less than half your income that is good. The lower the better obviously. The bank wants to make sure that you will pay your mortgage. So the lower your DTI the better chances you will have. For example, if you have minimum payments of $1200 per month and your income is $3000 per month, your DTI is 40% ($1200/3000=0.40) This is also a good time to note why getting that expensive new car or truck is NOT a good idea. Most people’s monthly debt is for a vehicle they don’t really need. Of course the best scenario is to always be working to eliminate your debt AND increase your income. Read more on that with a previous post called Grow the Gap.

If you don’t know where you stand, take a month to gather your bills and keep note of them and how much you are spending. And then track your income. This should be easy if you are salaried or if you have regular hours. If your hours vary, then keep note of what your average pay is. If you can eliminate some of your highest monthly payments, do that! Have them paid off for at least two months before applying for a loan so they have time to clear from your credit reports.

KNOW YOUR CREDIT

Credit is kind of a tricky thing. And the rules for it do sometimes change. The higher your credit score the better types of loans and lower interest you will get. Sometimes you may even have a high DTI but if your credit score is 800+ you will probably still get a loan. Most banks do not lend to anyone with a score less than 650. If you can get above 750 you will be in good standing. Your credit is reported through three credit reporting agencies. For whatever reason they all report differently. Banks will usually take your middle score from those 3. So it is important to have an idea of where you are before you go. To find out and to just monitor your credit for suspicious activity you should go to www.annualcreditreport.com There you can run your report from each of the reporting agencies one time each year for free and it will not affect your credit score. The best way to do this regularly is to check one of them every 4 months so you monitor it throughout the year. Right now in 2020, they are offering free weekly reports through April 2021. There are other sites that say they offer free credit reports, but they are usually a gimmick to get you to sign up for their service.

There are many ways to improve your credit score, but we will not discuss them here at this moment. That will be in another post dedicated to just that. But keep in mind every time you get your credit checked by an institution, open a credit or store card, apply for a loan at a bank, all of those inquiries into your credit also appear on the report and banks will see that and it can lower your score if there are a lot of them within a short time-frame. So if you plan to apply for a home loan, do not open any new credit cards or have your credit checked anywhere for at least a few months before. The same goes for making large purchases on credit, like a car. Wait until AFTER you finalize the purchase of your home.

APPLY FOR A LOAN

If you think your income and debt are good and under control, and your credit is great, then you are ready to apply. Keep in mind, you can still apply with lower credit and with other debts, just know that you will likely get approved for less and at a higher interest rate and you may be required to make a larger down payment.

Before you start applying for loans, do some research. Not all banks are the same. With today’s technology it is pretty easy to compare different loans from different banks. They usually have it on their website. But sometimes they have special options that they don’t market to the general public. Many banks have promotions for first-time home buyers where they provide additional help with the down payment or reduced closing costs. Sometimes small local banks or credit unions may be more flexible and willing to work with you than large national banks. So check their websites and call a few and ask them what options they have available for first-time buyers, or whatever the home purchase is.

Be sure you take notes and write down who you spoke with and at what bank. Ask them about special programs they can offer, what interest rate to expect based on your average credit score (which you already know and can tell them), how many points they charge and what the bank closing costs will be. 

Most banks may offer similar interest rates. But they will differ in their points and closing costs. This is how the bank makes money up front. Points are a percentage of the loan amount. So if they charge 1 point, that is 1 percent of the loan amount you will pay in a fee. Generally the more points you pay up front, the lower your interest rate will be. It’s kind of like paying a bribe for a better deal. They may include the fees in the loan for you, which just means over 30 years you will pay even more for it. Closing costs are other fees they include to pay at closing. Some banks will waive these costs or part of them and some may have low closing costs while others are more. So it is in your best interest to compare what the different lenders can offer.

GATHER YOUR INFORMATION

This could maybe go before the last point but sometimes you don’t know what they will ask for so just have the things in this part ready to grab when you need them.

Once you decide on the bank you want to apply with get your things ready. They will ask for two or three years of W-2s and tax returns, and the last 2 or 3 pay stubs. As well as any other proof of income from any other sources such as child support or some side hustle you may have. Just about everything else they will get when they pull your credit report. Be prepared to explain any anomalies. Once you get a pre-approval letter, which basically tells the seller yuo are qualified to get $X amount of a loan to purchase, you then can start shopping for homes. Do NOT look for homes before getting a pre-approval, or even better an actual approval letter first. That way you know how much you are qualified for and what to expect for payments so you can keep within your budget. Plus if you find a home you love and want to make an offer, without a proof of funds to purchase, they won’t even take your offer seriously. And you may not get approved for that much anyway. So save yourself the heartache and embarrassment and do this before viewing homes.

GET A REAL ESTATE AGENT TO HELP YOU

Contact a Real Estate Agent. Meet with an agent to tell them what you would like to find and they can help you know if that is possible or not. You may want a 6 bed 4 bath home on 2 acres, but your maximum loan is only $150k and that house you want may cost 3 or 4 times that. So keep it realistic. In most areas a Realtor does not cost you anything as a buyer. The seller generally pays the commission for the buying and selling agent. In super competitive markets the seller may not pay the buyer commission, in which case you should be prepared to pay it.

I would highly suggest not trying to buy a home on your own. Even a For Sale By Owner (FSBO) can seem tempting, but you should still have an agent represent you. It offers you more protection and often a FSBO is overpriced so an agent can help analyze the value for you, but more importantly, help with the mounds of documents and paperwork and help coordinate the purchase with the bank and the Title Company or lawyer. States vary on if they use a Title Company or a Real Estate Lawyer for closing on a home purchase.

If you don’t know what agent would be good for you, contact us and we will be happy to refer you to one. We have contacts with agents literally in every state and region so we can help steer you in the right direction, but get your approval first.

MAKE AN OFFER

After you find a home you like, put in an offer. Your agent can help you with what you should ask for with your offer. If accepted you generally are going to pay an Earnest Deposit. This goes toward your down payment but it is a gesture to show you are a serious buyer. You usually can get it back if you cancel the contract if there is some problem with the house or getting financing. But be careful, you may not always get it back. In the current market of 2020 just about everywhere is very competitive, so if you like the house, make the best offer you can as you will probably be competing with other offers.

I also highly suggest paying for a home inspection. It can save you from a huge mistake if you buy a house that has hidden problems. Don’t just choose any inspector. They are not all equal. Ask around for referrals. Unfortunately I have heard of some horror stories of people that bought a house without an inspection and also for ones that had an inspection but there were a lot of bad things that surfaced after they moved in. In that instance you do have some recourse to sue the inspector. But chances are your inspector will be qualified and can help save you from a nightmare situation. Depending on your area, you should also do a Radon test as part of the inspection. Radon is a main source of cancer and most people don’t know they are getting it from living in their home. There is remediation available for it but it can cost anywhere from $1-4k. After your inspection you can then request the seller to do some of the repairs needed or lower the purchase price to account for it. Inspection items are a great source to negotiate the purchase price.

Assuming all goes well you will get to closing where you will sign a lot of papers and where you will bring the money you need for closing which includes your down payment and other closing costs, unless those are paid by the seller or bank. Then depending on the State, you will either get your keys right then and there or you may have to wait for it to be recorded first which could be later in the day or the next day. After that, you can finally relax and/or celebrate. Congratulations! You are now a homeowner.

ONE FINAL SUGGESTION

I wouldn’t be a responsible FI blogger if I didn’t take a moment to once again push for doing a house-hack. Instead of buying a regular single family home for you to live in, buy a small multi-family home such as a duplex or triplex. Live in one unit and rent the others. Or even a house with more rooms than you need and rent out the rooms to family or friends. This will help you to live for free or at least greatly reduce your mortgage payments so that you can save more instead of spending a large part of your income on housing. Check out my previous posts talking about this topic.

Now, get to work and start getting your finances and credit in order so you can work on earning your Financial Independence.