Preparing For Home Ownership
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.
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 a 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 credit report from Experian, Equifax, and TransUnion free once a year through the Annual Credit Report Request Service. Scores can be purchased for a fee. If you see any 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.