If you are thinking about buying a home, here is a crash course on down payments, closing costs, credit scores, credit reports and more!
Down Payments and Home Buying
There’s a lot of myths about down payments floating around. Plenty of people still think you must have a 20% down payment. Let me clear up a few things about down payments to start:
Why Your Down Payment is Important
There is no doubt that it takes a long time to save up a down payment. It will be one of the largest single payments you’ll make for anything. When you buy a home, the down payment is the amount of money that goes into the initial home investment. Your down payment is taken off of the cost of the house. For many homeowners, their down payment gives them some instant equity in their home.
How Much Down Payment Should You Put Down?
There is no right or wrong answer but in general, the more you can afford to put down the better. Down payments vary from 3-20% of the home’s cost. There are a few ways to finance a home without a down payment such as USDA Rural mortgages.
If you put less down, you will have fewer mortgage options and pay an increased interest rate. How much you put down depends on your financial situation, credit worthiness and desire to own a home. Also, if you put more down it should mean a lower monthly payment.
Saving up 20% of a home’s total price can take a lot of time and effort. However, this can be the ideal amount to put down. If you put 20% down, you’ll be able to avoid paying for Private Mortgage Insurance (PMI).
There is no right answer or wrong answer to how much is the correct amount to put down. It could be that you spend less in the long run if you can put more down.
The key thing to consider is you do not want to walk out of closing and be flat broke. But you also don’t want a higher monthly payment. You must decide what is best for you and your unique situation.
Check out these charts showing how long it takes to save either a 3% or 10% down payment:
Check Your Credit Reports and Credit Scores
Unless you are paying all cash, then you are going to need to get a mortgage. And that means your credit needs to be checked at least 6 months to a year BEFORE you start looking at homes. This will give you time to fix any problems or mistakes on your credit reports.
The better your credit, the more likely you are to receive a good rate on your mortgage. Your credit reports and scores are important factors that the banks use to qualify you for a loan. The banks use them to determine how much they will lend you and how much interest to charge you.
How to Get Your Credit Reports for Free
The good news is that getting your credit report is free from AnnualCreditReport.com. Like I said, doing this now will prepare you for what your mortgage lender will see. And by doing it early, you can clean up any mistakes or problems before you find a home you want to buy!
A credit report contains information about the status of your accounts and your payment history. Checking your credit reports will not hurt your credit score BUT your free credit reports do not include your credit scores!
Your Credit Scores
Credit scores are calculated using a mathematical formula using the data in your credit report. The banks use credit scores to predict how likely you are to pay back a loan. Credit scores range from 300 to 850. A higher score is better and means you have a better chance of being approved and getting a better rate and terms.
Some people are confused to learn they don’t have just one credit score. Your credit scores vary based on the formula the lender uses.
Different lenders use different formulas to determine credit scores. Most mortgage lenders use a FICO score when deciding whether to approve you for a mortgage and what interest rate to give you. One lender’s FICO may not be the same as another lender’s.
Getting Your Credit Score
You can get a credit score in several ways and some of them are free. Some credit card companies and banks include a credit score on their monthly statements.
Or you can buy a FICO credit score at myfico.com. Be careful of other websites that claim to give you a credit score for free as they may require you sign up for credit monitoring or some other service.
If your credit score is low, please be careful about some of the credit repair scammers! Please read How to recognize a credit repair scam
Raise Your Credit Score By:
- Remove Errors From Your Credit Report
- No Late Payments
- Pay Off Big Credit Card Balances
- Cut Small Balances
- Pay Credit Card Bills Early
- Don’t Close Accounts After They’re Paid Off
- Consolidate High-Interest Debt With a Personal Loan
- Get Tax Liens Off Your Credit Report
Check out this chart showing the FICO scores for various types of mortgages:
How Much You Can And Should Pay for a Home
You have probably played around with some of the various mortgage calculators online. A mortgage calculator uses the home price and interest rate to give you a monthly payment.
I must warn you this is a ballpark estimate of your monthly payment and won’t give you an accurate picture of all the costs. That’s why you shouldn’t use a mortgage calculator to set your maximum house price!
The problems with a mortgage calculator is it does not tell you everything. After all, the mortgage calculator only knows what you tell it!
The principal is the amount you borrowed and have to pay back, and interest is what the lender charges for lending you the money. Principal and interest make up the majority of a monthly mortgage payment.
Principal and interest are not the only costs you’ll need to pay every month.
If you use a mortgage calculator, you could be too low on how much you’ll have to pay each month. You need to allow for homeowner’s insurance, property taxes, mortgage insurance, home maintenance and any HOA or condo dues.
Closing Costs and Home Buying
You also need to remember that there are costs involved with buying a home such as closing costs. This includes lender fees, appraisals, inspections, closing attorney and prepaids such as insurance and taxes.
How much closing costs you need will vary by lender and by what type of mortgage you decide is best for you. This is something to discuss with your mortgage professional and your buyers agent.
Your lender will be able to tell you how much closing costs should be. The type of financing you select also means you may only be able to look at certain homes or areas!
It is possible to get the seller to pay some or all of your closing costs. But this means you are paying more than what the seller is willing to take for the home. And you are financing this amount for the 15 to 30 years that it may take to pay off your mortgage!
Determine Your Debt to Income
It’s important to determine your debt-to-income ratio when setting your budget. Your debt to income can be determined by taking what you would be paying for a home, add your monthly bills and divide that by your monthly gross income.
Different lenders have different debt to income standards. Some will go to 43% but I suggest going lower. Look at the total of all your monthly bills including the mortgage and the extras I mentioned. Is there plenty left over?
You do not want to be sitting in your new home wondering how you are going to pay for groceries…
Buying a Home Means Documenting Your Rental and Financial History
You need the canceled checks so you can document that you have been paying the rent on time. The lender is going to ask for all kinds of paperwork.
Do not be alarmed or think this is unusual. After the housing crash, banks starting checking to see if people could actually repay them. It isn’t anything personal and I know it feels like an invasion of your privacy. Even if you have awesome credit, you can expect the bank to want all kinds of paperwork.
It sucks but this is part of getting a mortgage today. When your lender asks for any kind of documents or information, you need to get it to them ASAP!
There are a lot of things to know when it comes to getting a mortgage and buying a home. Please subscribe to get more articles about home buying!