Check out yourself 11 steps before a mortgage

In fact, getting a home loan or mortgage isn’t always tough. What matter is how well you can manage it. There are people who have somehow qualified for a mortgage but sooner or later they have found themselves in a mess! So, first and foremost, you need to check your home loan affordability and then look out for programs on offer.

No doubt markets keep changing, but your personal finance and credit has a big role to play here. There are 3 things lenders will watch out for:
Your credit score
Your income and liabilities
Your down payment
But prior to approaching lenders, check out yourself 11 affordability factors which will help to decide whether it’s time for you to take out a mortgage.

1. Are you debt-free?

Have you taken out credit cards, personal loans or an auto loan? If you have high interest credit cards, consider paying them down and avoid using more than 10% of your cards’ limit at any given time. However, if you are debt-free, you can possibly go for a bigger mortgage depending upon other factors.

2. Do you save for retirement and children’s education?

You may be saving for your retirement by investing into employer sponsored plans like 401k/403b as well as the IRAs. You may like to save for your child’s education (Coverdell education Savings and 529 Plan) as well. So, decide whether you’re comfortable with managing a mortgage as well as savings plan.

However, if you have too much of credit card debt, pay it off and then start saving for future. Otherwise, managing credit cards, savings and then a mortgage may be quite difficult!

3. How’s your credit?

If you’re looking for mortgage in a market where borrowing is costly and difficult, then having poor credit will cost you a lot. In such markets, a borrower with a score of 620 is no longer considered creditworthy! At least you should have a score of 680 to qualify for better rates and terms.

Although there are FHA and VA programs for those having poor credit, yet, if you want to get the best program and avoid mortgage problems in future, then wait till you repair your credit and then apply for a loan.

Often lenders take the initiative and work with borrowers in improving their credit scores prior to offering the loan. However, if your score is between 640 and 680, consider putting down 10-15% of purchase price so that some of the best programs are available to you.

As for the credit history, most lenders look for 3-5 tradelines (mortgage, second mortgage, credit cards, auto loan, student loan, store card, gas card, secured/unsecured installment loan etc) in good standing for the past 2 years.

4. Are there enough of cash reserves?

Most lenders will require you to have cash reserves/savings equal to at least 6 months of mortgage payments (PITI) apart from what you’ll pay for closing costs and down payment.

However, not all programs (such as the FHA loans) require this but it’s better to have some cash reserves so that in case there’s an emergency you don’t miss a payment and bring down your credit score.

5. Do you expect a raise in your income?

Are you a fresher at job or have you been employed/self-employed for 2 years or so? Do you think your income will increase in a few months or so? Check out how much you can borrow at your current income. If you need more, wait till your income gets higher.

6. How much of your income goes into paying off debts?

In order to take on additional debt, you’d have to calculate how much of your income (include all sources of income) is being spent on current debts such as credit cards, personal loan, auto loan etc. This is given by the debt-to-income ratio or DTI. (You also can visit here to find an online mortgage calculator to calculate monthly payment of your mortgage loan)

The DTI = (total monthly debt payment/gross monthly income)
So, the % of income put into paying off debts = DTI * 100

Check out yourself the DTI using Debt-to-income Ratio calculator.

The higher the DTI, the lower are your chances of getting a mortgage because you pose a higher risk to lenders if you’re already having a lot of debts to pay for.

7. Do you have an insurance policy?

Are you paying premiums for automobile, health or life insurance policies? Decide whether you can manage a mortgage while paying the premiums. Buying a home is no doubt an important step in your life but having a proper insurance coverage is also worth considering!

8. Are you investing in stocks?

You may like to invest in stocks, bonds, and mix and match options to build up a strong portfolio. However, investment options are subjected to market risks, so it’s worth consulting an investment expert in order to get maximum returns. An estimate of such returns will help you decide whether it’s worth investing or getting a mortgage.

9. What about home prices?

If it’s a declining market with home prices going down, you may like to wait till prices get better. This is because lenders may reduce the loan amount as investors won’t provide enough funds.

Moreover, if you cannot pay off the mortgage and decide to sell the home, you won’t get enough proceeds because the home value will turn out to be lower than what you owe. Thus, in a declining market, you can’t rely on home sales to pay down your mortgage. Rather you’d have to choose options which will have a negative impact on your credit.

However, if you’re planning to occupy the house for a long time and your finances are in good shape, you may go for a home that’s losing value now as you have the time to wait till prices get higher.

10. Concerned over inflation and Fed rate changes?

Rising inflation and changes in market rates may be some of your major concerns. The Fed often cuts down the rates thereby preventing the economy from recession. But lower rates often reduce the value of dollar thereby raising inflation. So, you need to think whether you can manage a mortgage besides maintaining your lifestyle in the midst of rising prices. If you compare inflation rate over the past few years, you’ll get an idea of how much high or low prices will be in the next 5-10 years. This will help you decide whether you can afford to take out a home loan.

11. How does the industry affect you?

The lending industry has been changing with time to keep pace with inflation and economy. With market changes and scenarios like the credit crunch (due to sub-prime mortgage crisis in 2007), lenders have come up with stricter lending guidelines in order to reduce the rising rate of foreclosures.

Due to market changes, certain programs are simply not available. For example, due to the rising concern over foreclosures (in 2007-2008 beginning) and borrowers’ inability to pay off loans, lenders have almost stopped offering 100% financing or 80/20 loans.

No doubt, inflation, home prices, fluctuating rates and industry changes have a big impact on your decision to take out a mortgage. But these are external factors on which you don’t have much control. So, instead of taking decisions with respect to the external changes, it’s better to improve factors that you can control - your personal finance, credit record, debt-to-income ratio and down payment.

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