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Am I Financially Prepared?

 

Are you really ready to make the financial commitment necessary to buy a home? There are three key factors that creditors will use evaluate your financial preparedness:

  • Character — your stability and how you handle your credit obligation
  • Capacity — your ability to assume additional debt
  • Capital — the financial assets you have to draw on if you don't honor your loan commitment or the value of the collateral used for the loan

Take a hard look at your personal finances and spending habits to help you decide if you are ready to buy a home. Here are some specific questions for you to consider:

Is Your Employment Record Solid?

Lenders want to know that you will have the ability to pay back a mortgage loan. One factor they look at is your employment history. Lenders consider working consistently for the last two years to be a solid employment record. Now that doesn't mean you have to have been at the same job for two years - only that you have been working consistently without any large unexplained gaps in employment. In fact, job moves are looked on favorably if the result has been better pay.

Do You Have A Good Credit Rating?

Lenders can also get an idea whether you will pay your mortgage back based on your history of paying other bills. Lenders will obtain your credit report, which contains a detailed history of your credit and debts, your payment history, court records (like bankruptcies, liens and judgments), current and former employers and a record of credit inquiries.

There are three major credit bureaus that provide information to lenders when you apply for credit. Usually you can get a copy of your report free or for a nominal fee. If any information is missing or inaccurate, you can take steps to have the report corrected.

  • Equifax
  • Experian
  • Trans Union

In addition, lenders often use a credit "score", called a FICO Score, that ranks your score with others and establishes a measure of future credit risk. This helps them determine if they'll lend to you and if so, what interest rate you can qualify for. You can find out how credit scoring works, what your score is and tips on improving it at www.myfico.com.

Do You Have Enough For a Down Payment?

Nearly all homebuyers have to take out a mortgage loan. However, few loans are for the full purchase price of a house. Usually a lender will insist you make a down payment as part of the deal. However, you may qualify for a no-money-down loan option.

Regardless of the loan you choose, you also will need to pay a number of additional costs, called closing costs, that cover the legal transference of a property to your name and other costs associated with your taking out a mortgage. Closing costs generally range from 3-6% of the sale price of the home. So, if you were to buy a $100,000 house with a 5% ($5,000) down payment, you could expect to pay between $3,000 and $6,000 in closing costs.

Here are some sources you can consider when you're trying to come up with the money for your down payment and closing costs. Your lender will require verification of where you got the money so you'll need to be able to document your sources:

  • Your personal savings and investments
  • A gift from your parents or other close relative. If you use gift money, you will need a letter for your lender that states the amount of the gift and that repayment is not required. The letter must be signed by the giver(s), and notarized.
  • Many employer profit-sharing, thrift or 401(k) plans allow you to borrow against your savings; however some lenders consider this a loan and factor it into your debt-to-income ratio. Some plans also allow you to take money out of your plan to buy a home. Depending on your situation, it may make sense to take the tax penalty to withdraw the money instead of borrowing against the funds.
  • Your IRA savings. You can withdraw up to $10,000 penalty-free, once in your lifetime, for the purchase of your first home (you and your spouse can each make a withdrawal of $10,000). Roth IRAs allow you to withdraw up to 100% of your contributions without taxes or penalties.
  • Other personal down payment sources may include pension funds, real estate holdings and life insurance policies.
  • Special down payment assistance from your employer - some employers have special programs to help employees buy a home.
  • Get a Federal Housing Administration (FHA) or Department of Veterans Affairs (VA) loan, which require lower or, in some cases, no down payment.
  • Special state programs for low and moderate income families.

Getting private mortgage insurance (PMI) from your lender is often required when you make a down payment of less than 20%. This can be expensive but it may be worth it for you to be able to make a smaller down payment.

Can You Swing A Monthly Mortgage Payment?

Generally, lenders limit the amount of a monthly mortgage payment to a percentage of your gross monthly income (including principal, interest, real estate taxes and homeowner's insurance). They also look at your outstanding debts and the amount of your monthly payments. This includes financial obligations like car payments, credit card balances and student loans. Check with your lender for specifics.