Buying a home is a source of pride to many. It is also a source of agitation and angst for those who are turned down for a home loan. For many, that loan denial could have been prevented if they had properly prepared for their application. Preparations for a loan should start at least six months before you apply, but the preparations for a mortgage should start at least a year ahead of time. An eighteen month run-up would be even better. Here are several things that you should do in the twelve to eighteen months prior to applying for a mortgage.
Forming a budget at least a year before you apply for a mortgage is essential. It will help ensure that you pay all of your bills on time leading up to the application and it will help you steadily build the down payment that you will need. It should also help you fully understand how much of a payments(mortgage, insurance, property taxes) that you can afford. We have a three part series that may help you form your budget. The first post is here: The First Step to Preparing a Budget.
You can get a free credit report from each of the three top reporting agencies once a year. You would be best served by pulling your report from one agency at a time. Request a report from a different agency every four months so that you can monitor for inaccuracies or fraud throughout the year.
You are pulling these reports to check for inaccurate information, fraud, and credit accounts that are in the arrears that you may have forgotten about. You will increase your chances of approval by fixing inaccurate information, disputing fraudulent accounts, and bringing old accounts up to date. Take care that you do not start making payments on an account that is more than seven years old. It is about to go off your credit report, but making a payment will ”reactivate” it giving the creditor another seven years to collect the debt.
Buy A Credit Score
You can pay for a credit score from any of the reporting agencies at any time. In general, those scores can vary from agency to agency. The only score you should pay for is your FICO score. That will cost you $19.95 at www.myfico.com. You can also participate in their ScoreWatch program for $14.95 a month. The ScoreWatch program allows you to see your score, get an Equifax credit report, and simulate how certain factors would change your score. The one time fee should be enough for most people. IF you want to participate in the ScoreWatch program, you can use it for a few months, then cancel it in order to minimize your overall expense.
Buying your score about eighteen months before applying for a mortgage will help you see where you are and let you look for ways to improve a marginal score. Perhaps you need to pay down debt or diversify your types of credit. Buying your score and seeing your credit report should help you understand areas where you need to improve.
Pay Down Debt
Paying down debt is key to having any type of financial success. Since your debt utilization ratio (amounts owed compared to credit limits) accounts for 30 percent of your credit score, paying down debt is extremely crucial to obtaining a mortgage. You will have the most success if you attack one debt at a time. Even if you start 18 months out, you may not have time to pay off every credit card, so shoot for getting the balance on each card down to 30 percent of the credit limit.
Ideally, you want to have twenty percent of a home’s value as a down payment. Most lenders will not even consider you for a mortgage unless you have at least five percent upfront. A low down payment will cost you in two ways. First, you will have to buy primary mortgage insurance (PMI). Nothing like having an additional amount to pay every month, is there? Secondly, the lower your down payment, the higher your interest rate because you appear as a risk to lenders.
You can kill two birds with one stone as you save your down payment. Obviously, you do not want to take on too much of a payment, so set a number that you think you can afford as a house payment. Save that each month and viola, you build your down payment and verify whether you can afford that amount or not. Psst, that method works leading up to any new loan you are considering.
What Is The Point?
The difference between an interest rate of 6 percent and one of 4 percent could be as little as 30 points on your credit score. Those thirty points can be obtained just by paying down your debt. If you have had an occasional late payment your score has suffered for it. Making all of your payments on time for a year can boost your score an easy thirty points. As for the down payment. Every dollar you borrow eventually costs you $1.50 to pay back on a thirty year note. Additionally, if you do not have 20 percent equity in your home, you will have to pay for mortgage insurance until you do. Preparing for a mortgage months in advance will save you a good deal of money over the length of your loan.