Financial Readiness

Buying a new home is typically the largest single purchase an individual will make in his or her lifetime. Before you start shopping for your dream home, and certainly before you sign a contract to buy, be sure you are prepared for the financial obligations home ownership brings.

Build Your Green File. A “green file” contains all of your important financial documents and information. You'll need it to secure financing for your home. A typical green file might contain:

• Financial statements;
• Bank account statements for the last 2-4 months;
• Investment account information;
• Credit card information (balances, spending limits);
• Auto loans (monthly payments, number of payments remaining, balances);
• Information concerning any other sources of income (e.g., alimony, trusts, child support, etc.);
• Information concerning any other debts, including personal loans, student loans, etc.;
• Recent pay stubs (usually a lender will require at least the 2 most recent pay stubs); and
• Tax returns and W-2 forms for the immediately prior two years.

Know Your Credit Rating. Your credit score will have a significant impact on what type and what amount of financing you can receive to purchase your home, and therefore, is a key to buying the home of your choice. Credit scores range from a low of 300 to a high of 850. A credit score of more than 620 is considered good, more than 760 is excellent. Simply put, the higher your score, the better the terms of your loan. A score under 620 will likely mean you will receive less than the best lending terms and rates. You can check your credit score and credit report with each of the following three agencies whose business it is to track and report on credit histories:

Equifax www.equifax.com 1-800-685-1111
Experian www.experian.com 1-800-312-1122
TransUnion www.transunion.com 1-800-888-4213

Each of these agencies are independent and have different reporting and scoring criteria, so your score may vary from agency to agency. There are some on-line services that provide your credit score and credit report from all three agencies for a fee (see www.privacyguard.com).

I recommend investigating your credit score at least 6 months to a year before you plan to get serious about finding your new home and applying for lending. If the report shows that you have a healthy score and there are no adverse conditions on your report, then you can use the time to make it even better by paying down any debt or saving for your down payment or closing costs. Be careful not to fall behind on debt payments and it is a good idea to hold off on making large purchases or opening new credit accounts prior to applying for a mortgage, since these events can adversely effect your credit score.

If your report shows a lower than optimal credit score, and depending on what is involved, you may determine that it is best for you to delay purchasing a home until you can resolve your credit issues, pay down debt, and improve your overall credit score. Often, improving your score can come with the passage of time, during which you pay your debts on time, you do not add new debt or open new credit lines, and you have no adverse reports on your account (e.g., no bankruptcy filings, no judgments or liens, etc.).

In addition to learning your credit score, you should review the detailed information provided in your credit reports to ensure it is accurate. Be proactive. If you find inaccurate information, contact each reporting agency and the named creditor to clear up the issue. Each agency offers good advice on their websites about how to improve your credit score -- follow that advice to more quickly improve your credit standing. There are also credit advisors and financial advisors who can provide guidance and assistance in resolving any credit issues and helping you on to a path that will lead to a better credit score and home ownership.

Secure Pre-Approval for Financing. Before starting your home search, and certainly before signing a contract to purchase a home, consult with reputable, direct mortgage lenders to determine the amount of a loan you will qualify for and on what terms. A lender will take into account your income, your available savings, your other debts, your credit score (see above) and other financial elements to determine the loan amount you will qualify for; however, the amount of the loan you may qualify for may be far in excess of what you may be comfortable spending, so be sure to understand what the loan amount translates into in terms of a monthly payment.

Mortgage options and loan programs vary widely, so it is important to consult with at least 2 or 3 lenders, since each one will have different products and requirements. The goal is to find the mortgage product that best suits your circumstances and your financial goals. When discussing lending options, let the lenders know your expectations for your new home, your risk tolerance level, the amount of the monthly payments you would be comfortable with, and the amount of a down payment you would like to make (if any). The lender should explain all of the various loan options that may best work with your circumstances and needs. Options may include fully-amortized loans with a fixed rate for the life of the loan (e.g., a 30-year fixed mortgage), adjustable rate mortgages (ARM) that are fixed for a certain initial period and then adjust in accordance with a specific economic indicator (e.g., the LIBOR rate or the prime lending rate) after the initial period expires, or interest-only programs where you are not required to pay principle, only interest, for a fixed period of time. Ask for written rate quotes and the lender's loan fees and charges (which may include charges for appraisals, underwriting fees, application fees, etc.) so you can compare among the various lenders to find the best one for you.

Be sure to complete the application process (actually submit your application with the lender and provide the supporting documentation required, such as pay stubs and tax returns) so that you can receive a Pre-Approval Letter from your selected lender. This is different from (and better than) a pre-qualification letter, which only indicates that you may be approved for a loan once you have completed the application process and the lender has verified your income, assets, and debts. A pre-approval letter will let a seller know that you are fully qualified to purchase their property because you and your lender have done the work required to approve you for a loan.

I also recommend receiving approval from a direct lender rather than a mortgage broker. Mortgage brokers can be helpful in identifying different loan options and programs and helping you to work with a direct lender, but an approval letter from the broker may raise a red flag with the seller that you have yet to be actually approved for financing by the lender who is being requested to provide the funds.

As a buyer's agent, I often assist my clients in identifying lenders that offer excellent loan programs. I also work with my clients' selected lenders between contract signing and settlement to ensure that the loan is delivered on time and without complications.

Cash Requirements. Before signing a contract to purchase a home, it is important to you must assess how much cash you have available to apply to your home purchase and how much more may be needed. Cash is required for a down payment (if you are making one) and for your settlement costs. Whether or not to make a down-payment, and how large of a down payment, should be part of your discussions with your lender and financial advisors. Settlement costs generally can range from 2% to 3% or more of the purchase price of the home and will cover such things as lender fees, attorneys' fees, title searches, title insurance, tax and insurance escrows, loan origination fees, advance interest payments, transfer taxes and recordation taxes, etc. So, add the amount of your down payment and up to 3% of the purchase price for a “ball-park” estimate of the cash you will need to come up with in order complete your purchase. Be sure to also budget in the costs of moving, making repairs, purchasing home-owner's insurance, paying for inspections, painting, etc.

If you don't have sufficient cash to cover the anticipated expenses related to making a home purchase, but are otherwise a qualified purchaser, your lender and your agent may have suggestions on how you can minimize your cash outlay requirements. The range of lending options has expanded tremendously over the past several years, so you may qualify for, and select, a loan program that requires no money down or one that allows you to roll the settlement costs into the loan. Alternatively, if you don't have sufficient cash available to you, you may decide to postpone your purchase to give yourself time to save more money.

Also keep in mind that when you make an offer to purchase a home, you are expected to give a "good faith deposit" which is an indicator to the seller that you are a serious buyer. This deposit money is refundable to you if you have a legitimate right to cancel the contract (as specified in the contract). However, this money is at risk of being forfeited to the seller if you default on the contract to purchase the home. The amount of the deposit can vary widely and is loosely tied to the purchase price with some buyers using a rule of thumb that the deposit should be around 3% of the purchase price. Your good faith deposit is usually held by the title company or settlement agent and is credited back to you at settlement. So, even if you select 100% financing and the seller paying all of your closing costs, you may still need at least enough cash available to cover your good faith deposit check until settlement when it gets credited back to you.

Be Careful With Your Finances. As noted above, once you are approved for lending, it is not a good idea to make sudden career changes or large purchases. You want to approach home buying from a position of financial stability. A change in jobs or a large purchase made after you are approved for financing by a lender may cause the lender to revise or even withdraw your loan approval which can impact your ability to complete the purchase of your new home.

For more information and for any additional questions, please feel free to contact me at any time.

© Nadia Nejaime, 2006