Buying a home is a significant milestone, and understanding the financing landscape is crucial to a smooth journey. As for every journey, there is a beginning, and in this journey the first step is understanding financing options, as it pertains to buying a home. In this guide, I’ll delve into the importance of connecting with a lender, obtaining pre-approval, and navigating key financial considerations.
Connecting with a Lender:
- The first step to your home buying journey is to connect with a trusting mortgage lender. A lender will serve as a guide for you, ensuring you obtain the right financing for your purchase needs. Often, if you are already connected with a real estate agent, they will have strong recommendations for lenders in your area.
Once you connect with a lender, they will typically set up a phone consultation along with sending you an application for lending. Some information in the application will highlight things like, income, tax returns, assets, debts etc.
The consultation and application are designed to assist the lender in getting a clear understanding of your goals and financial health. After they have obtained and analyzed all the proper information, along with considering your goals, they will create what is known as a “Pre-approval” letter.
What is a Pre-Approval:
- A pre-approval is a preliminary evaluation of your borrowing power by a credible lender. All pre-approvals highlight a specific amount of money the lender is willing to loan you, based on the health of your overall financial situation. Once you obtain an official pre-approval, you’ll know exactly how expensive of a house you can purchase, along with the interest rate.
Why Pre-Approval Matters:
1. Empowers Your Home Search:
- The most basic utility of a pre-approval letter is that it signals to sellers that you're a serious buyer, who has gone through a pre-liminary evaluation of financial capabilities, with the support of a reputable lender. This can also potentially strengthen your negotiating position. The pre-approval also streamlines your home search by setting a realistic budget and narrowing down options within your financial comfort zone.
2. Understanding Different Loan Types:
- A second benefit to going through the pre-approval process is that it helps you clearly understand different loan types and potential programs for your financing needs. Below I highlight the most basic types of loans:
Conventional Loans: Offered by private lenders, these often require a higher credit score but can offer favorable terms. As low as 3% down.
FHA Loans: Backed by the Federal Housing Administration, these loans are accessible with lower credit scores and down payments. As low as 3.5% down.
VA Loans: Exclusively for veterans, active-duty service members, and eligible spouses, these loans offer competitive terms. No money down.
USDA Loans: also known as the USDA Rural Development Guaranteed Housing Loan Program, is a mortgage loan offered to rural property owners by the United States Department of Agriculture. These loans are restricted to specific geographical locations. No money down.
3. Key Financial Metrics:
- During the home buying process, there are a lot of financial terms thrown around. In this section, I will highlight terms you should be aware of, along with tips, before putting in an offer for a home.
Debt-to-Income Ratio (DTI):
- DTI is essentially a formula comparing your gross income to your current monthly expenses. Lenders evaluate your DTI to gauge your ability to manage monthly payments. If you have a DTI that is too high, it essentially means you have too many expenses relative to your gross income. Aim for a DTI below 43%, including all debts such as credit cards, car loans, and student loans.
- A higher credit score often translates to better interest rates. Before looking into applying for a loan, it’s recommended you check your credit report for accuracy. Aim for a score above 700 for optimal financing options. With that said, there are loan programs that will work with a credit score as low as 580.
- The down payment is an upfront payment you make towards the loan when the loan is originated. There are common miss conceptions that suggest you need a big down payment of 10-20% to purchase a home. As we saw above, there are loan programs (and grants) that require little to no down payment, if you qualify. Keep in mind, the larger the down payment, the cheaper the monthly mortgage will be.
- Just like anything in this world, it pays to do business. Many first-time home buyers overlook closing costs when it comes to preparing for a home purchase. Along with your down payment, there will be costs associated with purchasing a home. These costs can include but aren’t limited to lender fees, title fees, recording fees, taxes, transfer fees, notary fees, etc. It’s important to work with your lender and agent to clearly understand what closing costs might be. Typically, closing costs range anywhere between 2-4% of the home’s purchase price. The down payment and closing costs will make up a total sum, known as a “cash to close” – which is the total amount of money it will cost you to complete the transaction.
- Depending on the terms of the purchase contract along with the market, sellers can provide a credit to buyers towards the purchase of their home. A credit always goes towards the closing costs of the house, saving the buyer cash at settlement. Work with your agent to understand the opportunities are for receiving a seller credit.
Navigating the financing landscape is a crucial step on your homeownership journey. By understanding loan types, financial metrics, and the importance of pre-approval, you empower yourself to make informed decisions. Connect with a trusted lender early in your home buying process, paving the way for a seamless and confident venture into homeownership.