Whether you’re starting to feel cramped in your space, or longing to lounge in your own private backyard paradise, once the home-buying bug bites, you’re almost certainly going to ask yourself “how do I get ready to apply for a mortgage?” And, “how much can I afford?”
The two questions are closely related. We’ve assembled some of the most critical action steps here, but we also highly recommend consulting your own financial advisor and mortgage lenders for personalized advice. Buying a home is a big commitment so it pays to get clear on your financial situation before you fall head-over-heels for a particular house.
- Shrink your debt and/or boost your income.
These are the two elements of the infamous DTI: the Debt-to-Income Ratio. The DTI sums up the percentage of your income that goes towards debts. Lenders use it to guide how much you can pay while still leaving room for other bills and savings.
- To calculate your DTI, divide your monthly debt payments by your monthly income—so if you make $5000/month and have $800 in payments for loans and credit cards, that’s $800/$5000 = 0.16 (or 16%).
Lenders prefer you limit the total for mortgage and other debts to 36% of your monthly income—and the mortgage alone to a max of 28%. So, in our example, your maximum monthly mortgage payment would be roughly $1000. If, as you get ready to apply for a mortgage, you know you’ll need more, you’ve got a few options:
- earn more: get a side hustle, earn a promotion or switch jobs (usually the fastest way to get a raise), or work more hours at your current job,
- cut down on existing debt: pay down credit cards, student or car loans, and/or
- save for a larger down payment: to reduce the size of the mortgage you’ll need.
- Strengthen your credit score as you get ready to apply for a mortgage
Lenders make their decisions by assessing risks: based on what they see in your financial situation and track record, how likely is it that you’ll pay back the loan consistently, over time? You’ll find a few other recommendations in our previous post on prepping for a home purchase.
To put yourself on the most qualified financial footing:
- Pay your bills on time, every time… for a long time, e.g., 12-24 months.
- Review your reports from all 3 credit bureaus; check for and dispute any inaccuracies.
- Don’t open new accounts (but also, don’t close all your old ones. Why not? Experian explains…
- As noted in #1, if you’re carrying balances, pay down your outstanding credit or loan amounts.
- Save for a generous down payment
As noted above, a larger down payment is one way to help afford a higher-cost home. But as you get ready to apply for a mortgage, having at least 20% of the anticipated price of your home on hand for a down payment also:
- reduces the size of the loan you need,
- keeps your monthly payments lower, and
- helps you avoid mortgage insurance.
- Limit loan applications
Once you’re ready to apply, it’s important to remember that mortgage applications are credit applications, so to protect your credit you’ll want to strategize your process. If you decide to comparison shop by applying with several lenders, do it at close to the same time—within a few weeks of one another—so they count essentially as one request.
- Applying for several over the course of a few months counts as multiple “hard inquiries,” which can ding your credit score.
- Remember not to finance costly items like furniture, appliances or planned renovations before closing—lenders will run another check before the final signings and it could impact your buying amount.
- Gather all the paperwork you’ll need as you get ready to apply for a mortgage
Lenders will give you a list of what they require, but you’ll save time by gathering the essentials before you start to prepare your mortgage applications:
- tax returns from the past year (or 2)
- several month’s bank statements
- pay stubs and credit card statements for several months
- statements for any loans you have out
- retirement and/or investment account statements
If you’re self-employed or have an LLC, you can still qualify for a mortgage, but will need to provide other paperwork (e.g., personal tax returns, profit & loss forms, client contracts, letter from your CPA, any licenses you hold, business insurance, LLC or DBA) to prove your income over the past 12-24 months, as well as future stability.
If you have questions as you start to get ready to apply for a mortgage, contact us. We can help connect you with great resources for every step in your home-buying journey—as well as the fun part of discovering your dream home!