When you're getting ready to buy a home, the two biggest factors to focus on are your down payment and your credit score. They don't count for everything, but these are two major criteria that may impact both approval and your interest rate, so it's good to get started early.
Saving up for a down payment is often the hardest part of buying a home, which is why many buyers opt to put down less than 20 percent. While that may make purchasing a house more feasible for many buyers, there are downfalls. Of course, the lower your down payment, the more you'll have to borrow, which means you'll pay more for your home overall. You may also have a higher interest rate. Plus, many lenders may require you to take out Mortgage Insurance (also called Private Mortgage Insurance, or PMI) as a safeguard for the lender that you won't default on your loan. (It doesn't protect you should you default, though.) All these factors could add up to a hefty monthly payment.
There may be situations where a lower down payment may make sense, for instance if you are applying for a FHA loan. But most buyers are better off socking away a down payment that's as close to 20 percent as possible.
How's your credit score? The higher it is, the more likely you'll be to get a better offer from your lender. And sometimes a higher score can increase your chances of getting a low interest rate.
Here are some factors we consider when reviewing your credit. They don't account for everything, but they're the main elements we look at.
Have you had a lot of late payments lately?
How long have you had your oldest continuous line of credit? The longer, the better, usually.
Are your credit cards maxed out, or do you have ample available credit at your disposal? How much matters.
What percentage of available credit are you currently using?
Recent Credit Inquiries
It's okay for your credit to be checked every once in a while, but frequent inquiries can hurt your score.
New Credit Accounts
Newer credit accounts hurt your average credit age, and can bring down your score.
Shopping for a home before getting pre-approved for a mortgage is the equivalent of walking into a grocery store without a wallet. Yet, the vast majority of homebuyers don't get a loan pre-approval for the house hunt.
Buyers avoid boredom
Buyers often are eager to start looking at homes and tend to leave what they view as the boring, bureaucratic part of the homebuying process for last, says Michael Highfield, associate professor of finance and head of Mississippi State University's department of finance and economics.
"But in this competitive market, any serious buyer should pursue a pre-approval from a lender in advance to beginning a home search," he adds.
Hardly anyone does it
Less than 10% of buyers who got a mortgage in 2014 got loan pre-approvals, according to Home Mortgage Disclosure Act data compiled by LendingPatterns.com. That percentage might be somewhat lower than the actual number of buyers who get pre-approved, some lenders say, because of differences in lenders' definitions of "pr-eapproval."
But real estate and loan professionals say it's common to come across buyers who skip the pre-approval process.
It happens every day," says Patty Da Silva, a real estate agent and owner of Green Realty Properties in Davie, Florida. "I can't believe I still get offers today without a pre-approval."
As with many other agents and sellers, Da Silva says she rejects offers from buyers who don't have preapproval letters from their banks.
"You have to have a pre-approval and it must be a real pre-approval where the lender has verified not just your credit, but bank statements, tax returns -- and I call the lender to verify that," she says.
What is a pre-approval?
A pre-approval is different from a pre-qualification. With a pre-qualification, the lender relies on information provided by the buyer to estimate how much the borrower could qualify for. With a pre-approval, the lender verifies the borrower's information and documentation to determine exactly how much it would be willing to lend to that borrower.
"The documents to get pre-approved are the same documents that you would need to get a mortgage," says Jordan Roth, mortgage specialist with Guardhill Financial Corp. in Glen Rock, New Jersey. Documents like:
Last 2 years' W-2s.
Last 2 federal returns.
Two months' worth of bank statements of all types of accounts.
Your credit report.
A pre-approval is not a loan commitment, but it helps speed up the underwriting and loan approval process, Roth says.
Don't be afraid to face your loan reality
Some buyers put off the loan application because they fear a lender may not approve them for the amount they plan to spend to buy the house, Highfield says.
"It's like when people don't go to the doctor for their annual checkup when they are afraid to find out what's wrong with them," he adds. "That's the same thing with getting pre-approved."
Others simply don't want to share an abundance of private information with a lender until they actually find the home they want, he adds.
Friends and family can't approve you for a loan
It's typical for potential buyers to assume they qualify for a certain mortgage amount based on what a neighbor, friend or relative with a similar credit profile bought, Roth says.
A survey by NeighborWorks America found that nearly 4 in 10 people who are thinking of buying a home first seek advice from friends and family who own a home. Only 16% say they approach a real estate agent for advice in that early stage, and mortgage lenders are approached only 9% of the time, according to the survey.
You are beyond compare
Even if you pay your bills on time and earn about the same as the friend who just got that $300,000 mortgage, don't assume you qualify for the same loan.
"A credit score difference of 700 to 680 can severely affect one's ability in terms of down payment," Roth says.
Getting pre-approved before you shop for a loan also allows buyers time to fix unexpected errors on their credit reports, Da Silva adds.
"There are 40 million errors on credit reports," she says. "You need to have time to fix that if you happen to be one of them. When you find the house that you want, you do not have time to get pre-approved, and if somebody else has it, there's no way the seller is going to look at your offer."
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