9 Steps to Take Now That Will Prepare You for Buying a Home in 2021
Today’s competitive housing market is making it harder for buyers to find the right home. Median listing prices are more than 13% higher than in 2019, while inventory is down nearly 40%. With record low mortgage rates and high demand, homes are selling 14 days faster than last year. If you want to find a home in this market you need to be prepared and move fast.
Getting a head start can mean the difference between buying the house you want and settling for what’s available.
Get Your Financial House in Order
While scrolling listings online to find a new home is an integral and even exciting step of any home search, it won’t be the most important. Before you begin looking for that perfect home, you need to make sure you have your financial house in order.
No one ever said applying for a mortgage was fun. But by following these steps, the process can become much easier.
Check your credit score. Before taking on any new debt, checking your credit score should be your first order of business. Your score will determine if you’ll qualify for a loan and what interest rate you’ll be charged.
To qualify for a conventional mortgage you’ll need a credit score of at least 620. Different lenders and loan types may have different requirements, however. FHA loans, for example, can be obtained with a credit score as low as 580. However, to snag the best rates you’ll need a 740 or higher.
If your credit is on the edge, you’ll want to check all three credit reporting bureaus — Experian, Equifax, and Transunion. You can access your free credit reports at annualcreditreport.com. (All three will let you do so for free once a week through April.)
According to Denny Ceizyk, senior staff writer for mortgage marketplace LendingTree, lenders will look at your three credit scores and use the middle score to price your loan.
This is also a good time to see if you can improve your score. Paying down credit cards is a good way to get a quick bump. For example, if your credit card usage is more than 30% of your total available credit, Ceizyk recommends reducing that debt. It will take 30 to 60 days for a change in your credit habits to be reflected in your score, he noted, so the sooner you start the better.
Figure out your target monthly mortgage payment. Buying a home is a big investment and you want to make sure it’s an investment you can afford. A good place to start is a mortgage calculator.
By inputting information about the loan amount, interest rate, down payment, where you’re located, and loan type, you can come up with ballpark figures for how much you’d pay each month in different scenarios. Change the information you input, and you can see how different interest rates and down payments can affect your monthly payment.
There are also a couple of guidelines you can use to determine how much you can comfortably afford. Lenders will use a percentage of your monthly gross income to determine how much you can afford to borrow for a home loan, taking all your monthly debts into consideration.
One of the standards used is the 28/36 rule. In this case, the lender calculates that 28% of your monthly income can go to a mortgage payment, with 36% going to pay total monthly debts. You can do this calculation yourself by multiplying your monthly income by .28.
Another common lender benchmark is your debt to income ratio. To calculate your DTI, add your potential monthly mortgage payments to all your other monthly debts and divide by your monthly gross income. Multiply the result by 100 and you’ll get your DTI. Most lenders prefer you have a DTI of 36% or less. However, some lenders will allow DTIs of up to 50% or more depending on other elements of your application.
Don’t forget maintenance costs. Keep in mind that as a homeowner you’ll also be responsible for keeping your property in good shape. According to Amanda Pendleton, communications manager at online listing site Zillow, maintenance costs average about $3,000 per year.
In a tight housing market, you may have to compromise for a home in less than ideal conditions, notes Pendleton. Remember to consider repairs when determining affordability, and how urgent these repairs are. “If you think about it, kitchen countertops obviously can wait but a leaky roof really can’t,” she noted. Make sure you have a cushion for unexpected expenses.
According to Realtor.com, you should budget between 1% and 4% of your home’s value for maintenance and repair costs each year. Exactly how much you should budget will depend on your home’s age. Newer homes may need fewer repairs than older ones.
Get your down payment squared away. Saving for a down payment is one of the biggest obstacles to homeownership. The ideal down payment target is 20% — you not only qualify for a lower interest rate but you’ll also avoid having to pay for private mortgage insurance.
But depending on the price of the home, 20% could easily equal tens of thousands of dollars or more. Depending on your income, saving up for such a large amount can take anywhere from a few years to a few decades. Fortunately, many lenders offer loans with as little as 3% down, making homeownership much more affordable. FHA loans also allow for lower down payments.
Figure out where your down payment is coming from. Do you have enough in a savings account or could you sell a car or other assets? If you have a Roth IRA, you can withdraw from the principal without paying a penalty, although always be cautious about pulling money from a retirement account.
Wherever the money is coming from, make sure you have it deposited in an account well before applying for a mortgage. According to Ceizyk, “lenders want to see money that’s been sitting in a bank for at least 60 days.”
The same rule applies to gifts. According to Pendleton, 52% of first-time homebuyers depend on gifts or loans from family or friends for the down payment and these are usually obtained just before closing. Getting those gifts earlier in the process and deposited into an account shows your lender that you have the necessary funds to complete the purchase.
Remember to calculate your closing costs as well, which can run anywhere between 2% and 5% of the loan total, and include items like taxes, appraisal fees, and homeowners insurance.
Get your paperwork in order. Let’s face it. Applying for a mortgage entails a lot of paperwork and gathering paperwork isn’t fun. But having all the information a lender requires ahead of time will make the application process much smoother and save you some time.
Typical information required will include W-2’s for the last two years, pay stubs, bank statements, and credit and income statements.
If you were unemployed or furloughed at some point during the year due to the pandemic, prepare a letter explaining the gap in employment. If you’ve been recalled to your previous job, a letter from your employer confirming that you’re back to full-time work and at the same pay won’t hurt.
If you’re about to start a new job, you can still apply for a mortgage loan as long as it starts within 90 days of closing (and you provide documentation, of course).
Shop around for a lender. Mortgage rates vary from day-to-day, place-to-place, and lender-to-lender. Demand for home loans has been so high that some lenders are raising rates just to slow down the loan volume until they can clear their application pipelines. This is why it pays to shop around, comparing rates from at least three lenders on the same day.
Some lenders also specialize in certain types of loans, such as those for borrowers with lower credit scores or VA loans. It may pay to look at lenders who have expertise in your specific circumstances — but don’t assume they will be the cheapest.
Get a preapproval. According to Pendleton, 80% of homebuyers get pre-approved before starting to shop for a home, so if you want to make a competitive offer in today’s fast-paced market, a loan pre-approval is a must.
To a seller, a pre-approval letter signals that you are a serious buyer who will be able to close on a deal. To limit the number of people entering during the pandemic, some sellers are asking to see pre-approval letters before allowing prospective buyers to tour.
Once you do get that approval, however, be careful with your credit. Ceizyk notes that one of the more common mistakes homebuyers make is racking up larger credit card bills or applying for loans for home furnishings or other household items after getting pre-approved. Your lender will pull another credit report when you officially apply for your mortgage. Buyers who go too far “can back themselves out of qualifying if they take on debt after they’re pre-approved,” he says.
The Search Process
Get to know your taste and what’s available at your price range. Once you have all the financial stuff taken care of, the fun starts. It’s time to start looking for a home. Online listing sites like Zillow and Realtor.com can help you browse through any number of homes available for sale. But to get the most out of your search, remember to keep an open mind.
According to Pendleton, more than half of all buyers who stay within their budget have to compromise on some of the features they’re looking for in a home. Set your priorities and establish which features you can and cannot live without. Limit your search to properties that have those must-have characteristics.
Set a budget and stick to it. By looking at homes above your price point you could be tempted into spending more than you can comfortably afford.
Take advantage of digital tours to check out the features of each home. Make sure to check not only the interior but also the exterior, especially if you’re buying a home with a yard.
Check out the neighborhood. What’s the crime rate? If you have to go into a workplace, how is the commute? What are the schools like? Make sure the area fits with the lifestyle you want.
Finally, don’t just settle on one property. Pendleton notes four out of ten buyers don’t get the first home they make an offer on. Make a list of options in case your first choice doesn’t pan out.
Find a real estate agent. While there are plenty of online resources that can help you in your search, your best bet is often to find a local agent who is experienced in the ins and outs of a highly competitive market, knows how to handle multiple offer scenarios, and can help you make your offer stand out.
“Someone who can negotiate in that kind of environment is going to be a huge asset for you,” said Pendleton.
More from Money:
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How to Get Preapproved for a Mortgage: A Step-by-Step Guide for Homebuyers
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