Preparing For Home Ownership
Preparing for homeownership can be a daunting proposition. Many individuals, couples and families may not believe they’re financially ready to purchase a residential property, and knowing where to start can be a challenge. A combination of saving and building good credit can help prospective homeowners prepare their finances to absorb the cost and scrutiny of securing financing for a new home.
Two major categories of preparation are savings and credit scoring. Without adequate savings, paying for expenses associated with the purchase of a home can be impossible. Good credit ensures that you’ll be an attractive and trustworthy candidate for a mortgage. Here are some of the financial considerations you should make as you prepare to purchase a home:
The first step to home ownership should ideally begin well before you purchase a home – with saving. There are several things you may want to save for, including:
- The down payment: In the past, homebuyers needed to put down at least 20% of the purchase price to get a mortgage. If your down payment is less than 20%, you may be required to purchase private mortgage insurance or get a second mortgage at a higher interest rate.
- Closing costs: Closing costs are the fees required to obtain a mortgage and transfer ownership of the home, such as attorney costs, an appraisal, title insurance, a recording fee, points, and a loan origination fee. You may have to pay the fees yourself, although sometimes the seller will pay them.
- Post purchase reserve funds: You may need to show the lender that you will have savings left over after you purchase the home. This provides assurance that the mortgage can be paid even if you are experiencing cash flow problems. At least three months’ worth of mortgage payments is a good amount to have in reserve.
- Extras: If you plan to buy a fixer-upper, appliances or new furniture, include these costs in your savings plan. Additional funds may also include an emergency reserve to cover the deductible on your homeowners’ insurance policy if something should happen to your home.
In order to get a mortgage, especially one with a low interest rate, you usually need to have a good credit score. The most common scoring model is the FICO score, issued by Fair Isaac Corporation. Scores range from 300-850 – the higher, the better. Your score is calculated using data from your credit report, which is compiled by three bureaus: Equifax, Experian, and TransUnion. A lender may check your score from all three bureaus or only one.
The following are the factors used to calculate your credit score:
- Payment history (35%): If you make a late payment, your score will take a hit. The more recent, frequent, and severe the lateness, the lower your score. Bankruptcies, judgments, and collection accounts have a serious negative impact.
- Amounts owed (30%): Carrying high balances on revolving debt (like credit cards) and personal loans, especially if the balances are close to the credit limits, will lower your score.
- Length of credit history (15%): The longer you have had your accounts, the better.
- New credit (10%): Having recent inquiries and opening new accounts can lower your score. However, all mortgage or auto loan inquiries that occur within a short period of time are considered just one inquiry for scoring purposes, and you accessing your report does not affect your score.
- Types of credit used (10%): Having a variety of accounts, such as credit cards, retail accounts, and loans, boosts your score.
Reviewing your credit report regularly is a good idea, but it is particularly important to do so before seeking a mortgage. Even if you always make your payments on time and have a low level of debt, your credit report could contain score-lowering errors. Check your report at least 60 days before you plan to apply for financing, as it can take some time to resolve issues.
You can obtain your free credit report from Experian, Equifax, and TransUnion once a year through the Annual Credit Report Request Service. Additional requests for reports come with a fee. If you notice errors on your report, send a dispute letter to the relevant credit bureau(s) indicating which information is incorrect. They must investigate your claim and remove unverifiable information.