If buying a home is in your not-so-distant future, now is the time to get your finances in order for the big purchase. In doing so, you can avoid many of the stressors other first-time homebuyers face.
According to TD Bank’s Mortgage Service Index, released in April, 69 percent of homebuyers find buying a home to be stressful, with about one-quarter of those surveyed describing home buying as “extremely” or “very stressful” and 45 percent classifying the process as “somewhat stressful.”
To make the home-buying process run as smoothly as possible—and to keep your sanity long enough to enjoy your new place—consider these five tips to start preparing your finances now:
1. Order a copy of your credit report.
Credit is one of the first things lenders assess in a prospective homebuyer, so pull a copy of your credit report to get an idea of where you stand. Every consumer is entitled to one free credit report each year from each of the three national credit reporting agencies through annualcreditreport.com. To access your credit score, you will need to pay about $9.
Mortgage lenders will evaluate your credit based on your FICO Score, which will be close, but maybe not identical, to the credit score you access through annualcreditreport.com. By knowing your current credit score, you’ll get an idea of how your credit history will look to a lender, and it will help you shop around before applying for a loan.
2. Address any issues or discrepancies on your credit report.
Reducing your debt can reflect positively on your credit history, so make sure that all of your accounts are in good standing (which means you have paid at least the minimum balances).
Any inaccurate information in your credit report may also impact your credit score. If you have been a victim of fraud, or if a creditor incorrectly reports your account as delinquent, it may harm your score and affect the terms and interest rate of your loan.
If any of your account information is incorrect, you can file a dispute with the credit reporting agency for free. At Equifax, you can file your dispute online, by mail, or by phone. You can also contact your creditor directly to dispute inaccurate information.
3. Figure out what you can afford.
You should plan to spend between 25 percent and 33 percent of your gross monthly income on just your housing expenses, depending on how conservative you want to be with your finances.
Comparatively, mortgage lenders generally agree you can pay between 28 percent and 36 percent of your gross income in total debt service. This means that your mortgage principal and interest payments, along with your other debt payments, can’t be more than 36 percent of your gross monthly income.
Remember to keep a close eye on mortgage interest rates, which are likely to climb until they return to their normal 6 percent or 7 percent and could affect how much you can afford.
4. Set a savings goal.
Once you know what you can afford, take a hard look at your current lifestyle and determine how much you need to save—and where you can make some cuts. Reducing unnecessary daily expenses, like buying gourmet coffee or eating meals out, can turn into big savings each month.
If you are saving up for your down payment, you will need at least 3.5 percent of the purchase price in cash for an FHA home—more if you’re using conventional financing—and you also need to account for closing costs and the price tag that will come with your move.
It can be tempting to borrow money from your retirement savings to put toward a down payment, but you may want to think twice about doing so. Borrowing now from your 401(k) or IRA means you’ll have to reimburse your retirement account later, after you’ve taken on the extra expense of a mortgage.
If you do borrow from your 401(k) or other retirement accounts, borrow only a small percentage and pay it back within a few years, with interest.
5. Educate yourself on current lending guidelines, and collect all the information you need to present to a lender.
As you prepare for the big purchase, work on getting all of your documentation together so you are ready to apply for your home loan. You’ll find current copies of lending guidelines online for Freddie Mac, Fannie Mae and the Federal Housing Administration.
Gather and organize all of the documents your lender will need, like W2 forms; copies of completed federal tax forms for the last two or three years; copies of one month’s worth of pay stubs; and copies of the last two or three bank statements for every bank account, IRA, 401(k), or other retirement or brokerage accounts.
By preparing now for your home purchase, you can avoid the hassles that come with buying a home.
What other tips do you have for first-time homebuyers? Share them in the comments.
Ilyce Glink is the author of ten books, including the bestselling 100 Questions Every First-Time Home Buyer Should Ask. Her nationally syndicated column, “Real Estate Matters,” appears in more than 125 newspapers and Websites, and her online “Ask Ilyce” columns are read by hundreds of thousands of people every month. She is a top-rated radio host on WSB Radio in Atlanta, the Home Equity blogger at CBS MoneyWatch.com, host of the Internet program “Expert Real Estate Tips,” managing editor of the Equifax Personal Finance Blog, and publisher of ThinkGlink.com.