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Before you make any kind of investment in a home, check your financial "pulse" to make sure you're financially healthy and able to comfortably afford both the down payment and the monthly payments. Below are common-sense guidelines to follow in this regard:
Guideline 1: Check your credit rating!
One of the first things lenders will check before loaning you money is your credit rating. If it’s good to excellent, your chances of borrowing money for a mortgage are very much improved. Currently, depending on circumstances, you need a credit score of at least 620 and the money for a down payment (the percentage varies with the type of loan).
If you have a credit score below the 620 benchmark, then additional documentation (and more time) will be required to prove to the lender that you're worthy of a loan - and even then there's no guarantee that the mortgage will be granted.
So, as you can see, it's important to know what your credit score is before you approach a lender. You can find out this information from one of the "Big Three" major credit reporting agencies shown below:
- Equifax (equifax.com)
- Experian (experian.com)
- Transunion (transunion.com)
If you're wondering exactly what such agencies do, the best explanation is that they act as a clearinghouse for lenders. That means they collect financial information. They then sell it to banks, credit card companies, mortgage companies and other lending agencies. In essence, lenders use that information to decide if you’re a good financial risk.
So, if you have a credit score of 620 or better, no problem! But what if that score is below 620? What can you do then? Follow the guideline below.
Guideline 2: Reduce or Eliminate Debt!
The only method of raising your credit rating is to pay off credit cards or any other kind of debt you have.
Now, no matter what you hear or see on television, radio or the Internet, there's no "magic bullet" for reducing or eliminating debt. It has been and always will be a matter of personal discipline on your part! You can accomplish that discipline by taking the following steps:
Step 1: Pay your bills on time—all the time.
Step 2: Don’t open unneeded credit card accounts to increase available credit.
Step 3: This is the most important step. You must figure out where you stand financially by budgeting. In other words, you have to reduce unnecessary expenditures so you can apply saved monies to your debt and improve your credit score.
In this step, you must analyze your current financial situation. The first question to ask yourself is, "How much debt is too much?"
There’s an easy formula for coming up with an answer to that question. It’s called the debt to income ratio. It’s a simple method of measuring your net monthly income against your debt.
For purposes of illustration, let's assume the following: Your net monthly income is $2,000. Your monthly debt payments are $500. Divide $500 by $2,000, and you’ve calculated your debt to income ratio:
500÷2000 =.25 (25%)
Financial experts generally agree that debt expenses should be 25% or less of your income. A ratio of 10% or less is great. Anything above 25% waves a red flag in the face of lenders in general. In that case, you definitely need to reduce or eliminate debt.
So, what is your debt to income ratio? Answer that question by doing the following:
- Review last month’s bills. Add up all the fixed expense items (rent, mortgage, car payments, child support, loan payments, etc.)
- Review your credit card bills. Add up the minimum payments owed on each card.
- Figure your monthly take-home pay (net salary).
- Now divide monthly fixed expenses by monthly income.
What percentage did you get? If it’s 25% or greater, then it's time to take action to reduce your debt. It’s time to budget!
Okay, let's assume that your credit rating is in the good to excellent category and you have the money for a down payment on a house. That's great news!
But, you still need to stay within your means! So, upfront decide what you want in a home (two bedrooms, attached garage, etc.) and then stick to those guidelines!
Don't get swayed by an ultra-beautiful home with, say, four bedrooms and a state-of-the-art kitchen. If such a house is beyond your means, it won't look very beautiful when you can't make the monthly payments!
The best approach to take is to tell your realtor upfront about your guidelines and ask him or her to show you only homes that meet them.
Believe me, I or any other realtor love to work with customers who know what they want! It not only helps you but us as well because we can locate such properties faster and easier and get you into a new home that much more quickly!
Please contact me so I can answer any more questions you might have about buying a great new home within your means!
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