Everything You Need to Know About Relocating (Part 1)
Quick! Name something that’s chaotic, scary, exhausting and sometimes sad. If “moving” didn’t come to mind first, you’ve been spared from one of life’s major
First Time Home Buyer: Steps to Success
It may not seem like it, but there is a process to buying a home and taking certain steps in the proper order just about guarantees success. Taken out of order – putting the cart before the horse – the steps are inefficient and counterproductive, and the process becomes chaotic.
Remember when you were learning algebra? If you tried to take a shortcut, you would get the wrong answer. The steps are there for a reason, and they simply must be followed, in order, if you’re to be successful.
Over the next three posts, we’ll take a look at the three steps you must take before looking at even one home for sale.
Today we look at the first step: Figuring out where you stand financially. If you’ll need a mortgage loan, this is the most critical step in the process and it can make or break your house budget.
Step 1: Check Your Credit
When faced with a loan application, the first task on a lender’s to-do list is to order the applicant’s credit reports and determine his or her credit score. This score is produced by Fair Isaac Corporation – and is known as your FICO® score. This score not only reflects your credit risk but will be used in the determination of the interest rate you’ll be offered.
Calculated from the data in your credit reports, FICO® credit scores range from 300 to 850 and FICO® uses five categories in the calculation:
- Payment History: FICO bases 35 percent of its score on your payment history.
- Account Balances: 30 percent of your score is based on your current account balances, listed in your credit reports.
- Length of Credit History: This category is used to determine 15 percent of your credit score.
- New Credit – 10 percent of your credit score depends on new credit obtained.
- Types of Credit – the types of credit you use accounts for the final 10 percent of your FICO® score.
This formula is not set in stone. People who have short credit histories – young people for instance – are weighted differently than those with long credit histories.
You are entitled to a free copy of your credit report from each of the three major credit reporting agencies once a year. Make sure you order the reports at AnnualCreditReport.com, the only site authorized by the federal government.
Next time, when we take a look at Step 2 in the home-buying process, you’ll learn how to clean up your credit and raise your score.
First Time Home Buyer: Steps to Success (Step 2)
Last time we looked how lenders determine your rate and your creditworthiness based on your credit score. We suggested that you order your credit reports from the “big 3” credit reporting agencies.
When you receive your credit reports look for mistakes or anything else you can challenge. According to a CBS News report, about one out of every five credit reports contain errors. The study also found that one out of 10 of these errors are serious enough to diminish the consumer’s chances of obtaining credit.
Common errors found in credit reports include:
- Other people’s accounts listed as the consumer’s.
- Incorrect personal information, such as birth date and social security number.
- Closed accounts listed as open, with outstanding debt.
- Accounts in good standing aren’t listed in the report.
Dispute anything in your report that appears to be a mistake. The credit reporting agencies, by law, must investigate your dispute and correct inaccurate information within 30 days.
Your FICO® Score
Thankfully, your credit score isn’t etched in stone but rises and falls according to how you use credit. There are several ways to boost your FICO®.
Start by paying off accounts that you’ve fallen behind on. Late pays count heavily against mortgage borrowers. Here are a few other ways to help clean up your credit history:
- Pay down other debts, starting with the one with the highest balance.
- Pay down credit card balances that are at the credit maximum and keep the balances low.
- Don’t close old credit accounts – they’re good for your score.
- If you don’t have a credit card, apply for one, use the credit sparingly and pay the balance every month. Applying for the card will lower your score but if you use the card responsibly, your score will rise.
Although these tasks may seem time consuming, if they raise your credit score a few points, it will be worth it when you go to apply for a mortgage.
Even after a bankruptcy, “it’s not uncommon for people to see their credit scores skyrocket up into the 700s if they have absolutely no late payments or collections,” says Chris Bridges, former credit and identity theft consultant with Vision Credit Services in Washington, D.C.
Please join us next time for Step 3 in the home-buying process.
First Time Home Buyer Steps to Success (Step 3)
Unless you’ll be paying cash for a home or you are applying for a loan backed by the government (such as a USDA or VA loan) or a Fannie Mae or Freddie Mac loan, you’ll need at least 20 percent of the loan amount in cash. This is the down payment, required by the lender.
The larger the down payment, the more attractive the interest rate will be. The down payment may also determine whether or not you’ll be required to purchase private mortgage insurance (PMI).
You’ll also need cash for closing costs, which can add up to a significant amount of money by the time we get to closing. Some fees are negotiable and the total amount due varies. I counsel my clients to save at least 3 to 4 percent of the loan amount, just to be safe.
If you’re not a saver ― and millions of Americans aren’t ― it’s time to get into the habit. Not only will you need savings for the cash layouts of buying a home, but for its ongoing maintenance as well.
Set Up a Budget
Setting up a budget is challenging but sticking to it is worse. If you have personal finance software with budget-making tools, creating the budget will be a snap. Financial guru Dave Ramsey EveryDollar® Budget Tool online and its free. Otherwise, use a spreadsheet.
The first step is to know exactly how much money you bring in every month. You’ll then need to list your fixed expenses – those that remain the same every month. Examples of these expenses include your car payment, insurance and rent or fixed mortgage payment.
Variable expenses, such as what you pay for electricity, groceries and your phone, come next. Keep track of your spending every day and enter the numbers into the budget on a weekly basis.
This budget is a snapshot of where you are spending your money, where money is being wasted and whether you are spending more than you can afford. With this knowledge you can direct your resources so that you keep up with bill payments and start saving money toward the goal of purchasing a home.
Make Lifestyle Changes
After a few months of budgeting you’ll find areas where you can cut back. Some of these might include taking the bus to work instead of driving, bringing your lunch from home instead of eating out, shopping at discount stores and using coupons.
Everywhere you can make cuts in the budget allows you to put more money toward paying down debt and saving money, thus putting you one step closer to solvency and the purchase of your new home.
Save Money
When your debts are paid off you can use the money that you had been using to pay them down to start building a savings account for those cash layouts involved in the home purchase.
As you build your savings, avoid the urge to add to your debt. Keep that house you want top-of-mind to motivate yourself to stay out of debt and remain solvent.
Congratulations on taking the initial steps toward ensuring you receive the most amount of money, at the lowest price, from a lender.
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