The moment you walk into a for-sale house and realize it’s exactly what you’re looking for is an unforgettable one. Like most homebuyers, you’re probably envisioning what life will be like in your new home, but you still have a ways to go before you get the keys. How you’re going to finance the purchase is the most important step in the home-buying process. Before you put in an offer, you should start the pre-qualification process with a mortgage lender.
Getting pre-qualified shows that you’re a serious buyer and, as long as everything goes smoothly, that the bank is willing to lend you the money you need. But how do you know if you qualify for a mortgage? This can be a tricky question, especially for first-time homebuyers.
In this article, we’ll discuss all the mortgage essentials: the down payment, your credit score, and the documents you need for a successful loan application.
How Much Down Payment Do You Need?
When you start to seriously consider purchasing a property, you’ll hear the term “down payment” thrown around a lot. In simple terms, the down payment is the amount of money you’ll pay upfront for the property. The amount leftover will turn into your mortgage loan.
The size of your down payment depends on two factors: the price of the property and the type of loan you borrow. As a general rule, the more expensive the property, the higher your down payment will be. The type of mortgage loan you qualify for will also impact the down payment. Some loans ask for as little as 3% upfront, while others need as much as 20%.
Prior to applying for the loan, you should do a little math to figure out how much cash you can put down. If the loan’s down payment is more than you can afford upfront, you can explore other types of mortgage loans or set aside some additional time to save up.
What Are the Credit Requirements?
Your credit score has a major influence on whether or not the bank approves your mortgage. A higher credit score boosts your odds of approval in addition to giving you access to better loans. What counts as a “good” credit score? That depends on the loan. Qualifying minimums range anywhere from 580 to 640, but a score of 700 or higher is ideal. If your score is below 580, your best bet is to take some steps to raise your score before you apply for the loan.
Do You Have the Required Documents?
Applying for a mortgage means paperwork - lots of it. Before the bank can approve your mortgage application, they need to feel confident that you’re the kind of borrower who will pay the loan back. This requires documentation of your financial situation, including your income, assets, and debt.
To speed up the process, you should have a few documents ready to go: the last three months of pay stubs and bank statements, W2s and tax returns for the past two years, and a list of your assets and debts. If you’re not currently working, be prepared to provide an alternative form of proof of income.
How to buy a Home when your credit is less than perfect
Many people believe that it is only possible to purchase a house if you have an excellent credit history. However, this is absolutely not the case. There are lots of ways to buy a new home for your family with less than perfect credit, such as:
Use Applicable Government Programs
The Federal Housing Administration (FHA) has more flexible loan requirements for people with low credit scores. Usually, your credit score must be 580 or above to qualify for a loan with a 3.5 percent down payment. If your score is between 500 and 579, the down payment will be 10 percent. If it’s less than 500, you are probably ineligible.
If you have a non-traditional credit history or if your credit score isn’t quite where you would like it to be, an FHA loan is usually the best way to get on the property ladder. Before you start applying, you should check your FICO credit score on sites like Credit Karma or Credit Sesame.
Fix Reporting Errors
It is not at all unusual for the credit reporting bureaus to make mistakes. These errors can often have a negative impact on your credit score. As such, you should thoroughly review your reported data to ensure that it is accurate. If you notice any mistakes, you should then take the time to reach out to the reporting agency and have it corrected. You might just be surprised by how much your score increases after you do.
Increase Your Down Payment
Banks and financial institutions tend to be much more willing to lend money to homebuyers who can make a large down payment. This is because making a large down payment reduces your loan-to-value ratio - making the loan less of a risk to the mortgage provider. If you can put down at least 20 percent, lenders will pay much less attention to your low credit score.
Though having a great score can certainly help when trying to buy a home, it is absolutely not a necessity. By following the tips and advice outlined in this article, you will be able to close on a new home even with less than perfect credit. If you have the income to afford market-and-above rents, then there’s no reason you can’t be earning equity with those payments through a mortgage and living in a proper home of your own.
Here are two of the primary mortgage options available to you if you’re in this situation:
This type of mortgage starts you out with a lower initial rate, gradually raising it over time. There are a couple of scenarios where this can be beneficial to you. One is if you expect a significant increase in income prior to your rate increase. The other is if you expect a significant improvement in your credit situation, giving you the possibility of refinancing before the rate goes up. It is generally a little easier for buyers with imperfect credit to be approved for this type of mortgage.
Federal Housing Administration (FHA) Loan
The Department of Housing and Urban Development operates the Federal Housing Authority’s mortgage insurance program. The FHA was created in the 1930s to promote home ownership. Its programs allow lenders to take risks on borrowers with lesser credit so more people have the opportunity to purchase a home. If a borrower defaults, the lender may claim reimbursement from HUD to recover its losses.
Usually referred to as the FHA program, the program is available to borrowers who have a FICO score of at least 500 if they can put down 10 percent of the purchase price up front. If you have a score of 580 or better, you are only required to put 3.5 percent down.
These aren’t the only possible options, but they’re two of the best and should be among your initial considerations.
FHA mortgage tips for first time home buyers
If you are a first time home buyer you may be thinking about an FHA mortgage
for the purchase of your first home. These mortgages are guaranteed by the U.S. Federal Housing Administration and are designed with low-to-moderate income home buyers in mind. FHA mortgages feature less stringent income requirements for buyers.
Hallmarks of FHA Loans
The main reason that first time home buyers opt for an FHA loan is that qualifying is easier, and the down payment is only 3.5 to 5 percent. A credit score in the 600s will typically suffice. Compare these requirements with those of a conventional loan, and you’ll easily see why many first time home buyers find the FHA route to be attractive.
A conventional loan requires buyers to put down at least 20 percent of the home price and requires credit scores around 700 (different lenders have different requirements).
Improve Your Credit
As you investigate FHA mortgage programs, it will become evident that even though someone with a credit score in the low 600s may qualify for a home mortgage, a better credit score will allow for a better financing deal. There’s a misconception that many home buyers who rely on an FHA mortgage have bad credit.
That’s simply not the case. While their credit might not hit the 700 mark, most FHA mortgage holders have a credit score around 680. If you have some time before purchasing a home, it’s always best to improve your credit as much as possible in order to secure better rates.
Hold Some Down Payment Money Back
If you’re planning to buy a home with an FHA mortgage be sure to take advantage of its reduced down payment requirement.
Sellers can also contribute up to 6 percent.
Say that you have enough to put down a 10 percent payment. It’s still less than the 20 percent required by a conventional mortgage, but within a few months you experience a home emergency that isn’t covered by your home owner’s insurance.
For example, your sewer line going out to the main lines could suffer a broken tile. This type of repair could run you about $5,000. Leaving yourself with a cushion allows you to more easily handle major home repairs that come up.
FHA Mortgage Limits Change
Keep in mind that if you research FHA mortgage limits one year, they may change the next, and FHA programs may be different in different parts of the country.
You’ll want to look closely at FHA program comparisons from state to state.
FHA Gotchas to Be Aware of
Are there any gotchas to be aware of when opting for an FHA loan? There are pros and cons to nearly any type of mortgage you opt for when purchasing a home. The main FHA mortgage gotcha is the required Private Mortgage Insurance (PMI) until you reach below 80% Loan To Value (LTV) threshold.
While FHA insures its’ loans, borrowers pay part of this insurance. FHA private mortgage insurance can sometimes add up so make sure to use an amortization calculator that displays that info clearly and easily. Make sure to set the down payment to 3.5% for an accurate mortgage payment amount and PMI estimate.
So, while buyers have to put down less up front for their home purchase, they do have to pay a monthly FHA insurance fee that’s typically included with their monthly mortgage payment.
How Do FHA Direct Endorsements Work?
A lender funds a new home loan after reviewing the borrower’s application and determining the risk is acceptable. Once the lender is finished with the file, it sends the information to HUD for review and approval. HUD will return the file to the lender if it is incomplete, deny the endorsement due to fraud, or approve the request and endorse the loan. If the request for endorsement is approved, HUD will issue a Mortgage Insurance Certificate to the lender.
The direct endorsement underwriter takes on the duties of HUD prior to the loan’s approval if applicable. This includes the initial inspection and appraisal of the property. To qualify for an FHA loan, the property’s appraised value must be equal or greater than the total loan amount. FHA does not endorse loans with variable interest rates. The borrower must meet FHA’s minimum qualifications with regard to credit, income and employment. When dealing with FHA direct endorsers the borrower’s down payment must be at least 5% (instead of the typical 3.5% FHA loan minimum) of the property’s value.
To obtain HUD direct endorsement privileges, a lender must have at least five years of experience as an originator of single-family mortgages and demonstrate professional expertise in the industry. The underwriter who will be analyzing applications must go through a HUD training course, work for the lender full-time and have at least three years recent experience appraising property and evaluating credit applications.
HUD may deny an insurance endorsement request if it finds fraud or misrepresentation by the lender or borrower. If lender fraud or misrepresentation is found after the loan is endorsed, HUD may revoke the insurance at a later date. This leaves the lender unprotected if the borrower defaults on the loan. HUD will not pay out any claims related to that loan in the future.
HUD also reviews the loan history of direct endorsement lenders to evaluate their performance. The lender may lose its authorization if there is a pattern of defaults or other complications with the loans originating from this particular source. HUD can also review past loans for compliance issues if it discovers problems with the current loans.
Buying a Home is a Big Deal
If you’re thinking of going with FHA, you’re not alone. This loan has allowed millions of people to buy a home since it came into effect during the 1930s. Keep this information and various tips in mind as you research the best mortgages for first-time home buyers.
Picking out your new home is exciting, but applying for a mortgage can be a huge headache. Going into the process prepared and well-informed will not only lower your stress level but also expedite the time between pre-approval and clear to close. Before you know it, you’ll be picking up the keys to your beautiful new home!