Preparing Your Finances before Applying for a Mortgage

Preparing Your Finances before Applying for a Mortgage
By: Geoffrey J. Rejent

A home purchase is one of the most significant financial commitments you can make, and obtaining a mortgage is a very important step in the process.  It is important to have your finances in order before completing mortgage applications.  Proper financial preparation will help you ensure a relatively easy application process, avoid stress and potentially save thousands of dollars in interest costs over the life of your loan. The following steps can serve as a guide on how to prepare your finances before applying for a mortgage.

1. Evaluate Your Credit Score and Credit Report

Your credit score is a major factor that lenders consider when reviewing your mortgage application.A higher credit score will usually translate into a lower interest rate, thus saving you money over the life of the loan.  Before applying for a mortgage, you should obtain a copy of your credit report from the three major credit bureaus (Equifax, Experian and TransUnion).  It is important to take time to review the information for accuracy.  If you determine that there are inaccuracies, you can contact the credit bureaus and the creditors and notify them of the discrepancies. You can improve your credit score by doing the following:

·         Pay off outstanding debts.

·         Ensure that you are current on all installment loans.

·         Avoid opening new credit accounts or taking out new loans prior to applying for a mortgage.

·         Reduce the amount of overall debt you owe by keeping balances low on credit cards and avoiding any large-scale purchases.

2. Establish a Stable Employment History

Most lenders prefer applicants with a stable employment history. A stable employment history usually translates into less risk for the lender. Most lenders require at least two years of consistent employment in the same field and at least one year with the same employer.  Self-employed individuals may need to provide additional documentation to prove their income.  Some additional documents that prove stable income include tax returns and profit-and-loss statements.

3. Build an Emergency Fund

Homeownership comes with expenses (both expected and unexpected).  These include repairs and maintenance.  Establishing an emergency fund can provide financial security and prevent you from defaulting on mortgage payments if an emergency arises.The following are tips for building an emergency fund:

·         Focus on saving at least three to six months’ worth of living expenses.

·         Keep your emergency fund in an easily accessible account such as a high-yield savings account.

·         Contribute to your emergency fund regularly (automate the deposits if possible).

4.  Reduce Debt-to-Income Ratio (DTI)

Your debt-to-income (DTI) ratio is another important number lenders use to evaluate your ability to manage monthly mortgage payments. A lower DTI indicates that you have adequate income to cover your debts and other financial obligations.  Certain mortgages have DTI thresholds in order to conform with the lending guidelines.  You may not qualify for certain types of loans if your DTI is higher than the maximum limit.

Ways Lower Your DTI:

·         Pay off or consolidate high-interest debt to reduce monthly obligations.

·         Increase your income through additional income sources such as overtime, side jobs or career advancements.

·         Avoid making any large purchases that require installment payments prior to applying for a mortgage.

5.  Save for a Down Payment and Closing Costs

A large down payment can improve your loan eligibility and reduce your monthly mortgage payments.  Conventional loans typically require a 20% down payment to avoid private mortgage insurance (known as PMI).  PMI protects the lender in the event that the borrower defaults on the mortgage.  There are loan options available with down payments as low as 3% for qualified buyers for residential properties.

Ways to Save for a Down Payment:

·         Create a separate savings account dedicated to your down payment and closing costs.  It is best to automate the process so that a certain amount is deposited into the account each pay period. 

·         Reduce discretionary spending and deposit those funds into your savings.

·         Explore special mortgage programs and grants that may offer down payment assistance.

·         Look for properties where the seller is offering closing cost credits.

·         You can consider using gifts from family members; however, you must be aware that lenders may require a letter from the gifting family member disclosing that the money was a gift. 

You need to budget for closing costs, which typically range from 2% to 5% of the home's purchase price. These costs include appraisal fees, title insurance, surveys and other administrative expenses.

6. Get Pre-Approved for a Mortgage

Obtaining a mortgage pre-approval is a preliminary evaluation conducted by a lender that determines how much a borrower can borrow based on your specific financial situation.  A pre-approval gives you a budget to operate within when shopping for a home and strengthens your position in the eyes of the seller when making an offer.  The following are required for a pre-approval:

·         Proof of income (pay stubs, tax returns, W-2 forms)

·         Bank statements and investment account summaries

·         Current debts or revolving credit

·         Credit reports and scores

·         An employment verification letter

A pre-approval doesn’t necessarily guarantee a loan, but it is generally beneficial to have one when negotiating with sellers and real estate agents.

Conclusion

Preparing your finances prior to applying for a mortgage can improve your chances of obtaining the best mortgage with the most favorable terms for you. Following the advice in this article will improve your chances of obtaining a mortgage approval.  The goal is to have financial success as a homeowner while having an equity stake in the nation we serve as first responders. 

Geoffrey J. Rejent is a Municipal Police Sergeant in New Jersey.  He is currently in his 22nd year of service and is assigned to Special Operations.  Prior to Special Operations, he was assigned to the Detective Bureau, Traffic Bureau and Patrol Division.  He also currently serves as a Drug Recognition Expert and is a former Crash Reconstructionist.  He holds a Bachelor’s Degree from Marist College and a Master’s Degree in Administrative Science from Fairleigh Dickinson University.  He is also a Mortgage Loan Originator (NMLS 2624041) with One Real Mortgage (198414).  You can reach Geoffrey J. Rejent by email at Geoffrey.Rejent@onerealmortgage.com or by Facebook at Geoffrey J. Rejent – For All of Your Mortgage Needs.