Can we talk about buying a house for a minute? Ideally, it’s the pinnacle of the American dream, a place to establish roots and continue traditions. Regrettably, the process is as daunting as it is exciting but there are steps that you can take to ensure you’re ready to take the plunge and that the transaction goes smoothly.

Steps that will help prepare you to buy a home.

Check your Credit and clean it up.

The first item on your list should be to check your credit. Not only because you need decent credit to qualify for a mortgage, but also because it takes time to improve your credit score if it needs work.

Start by getting your credit reports from all three bureaus from annualcreditreport.com. Dispute all errors or discrepancies that you find and do the same for old entries that should no longer be showing on your report (seven years for most negative entries).

If you have late payments on your accounts, start making payments on time and be consistent. It will take time to build up a good payment history, but it’s worth the wait because it is the most significant portion of your credit score.

It’s beneficial to have at least two active accounts in good standing. Be sure to have at least one revolving and installment account type. For example, having an auto loan (an installment account) and a credit card (a revolving credit account) would be ideal.

Many people make the mistake of thinking that if they don’t use their credit cards, it will benefit them to close it, but that would be a mistake. It’s important to leave old credit lines open so that you can show a lengthy credit history.

Pay off debt.

This one is self-explanatory. Not only will lenders look upon you more favorably if you have little to no debt, but also the less debt you have, the more house (and unexpected house expenses) you can afford.

Determine how much house you can afford.

So how do you know what you can realistically afford? The truth is, it’s going to be highly individual, but a general rule of thumb is that an ideal house price is one that costs two to three times your annual salary. So, if you make $75,000 on average, you should be able to afford a $225,000 home. Of course, this is a broad estimate, and it varies depending on additional expenses and debt.

A more customized way of determining what you can afford is called the 28/36 rule, and it’s a commonly used measurement in the mortgage lending industry. The first number is the front-end ratio, and it means that your total house payment, including mortgage, insurance, and taxes should not be more than 28% of your gross monthly income. For example, if your gross monthly income is $4000, you multiply that by 0.28, and you get $1,120 which means your house payment should equal that or less.

The second number is known as the back-end ratio, and it means that you want to see a 36% or less debt to income ratio. A debt to income ratio is simply the money you make compared to the debt you owe. So, if you make $4000 a month but spend $600 paying on debts, you divide $600 by $4000, and that would give you a 15% debt ratio, which is excellent! However, when determining how much house you can afford, you should add the estimated house payment to your debt amount. Let’s try it with the previously calculated $1,120 house payment.

If you make $4000 a month, have $600 in debt and add a $1,120 house payment to that debt, it makes a total of $1,720 debt. Dividing $1720 debt by your gross monthly income of $4000 will show you a 43% debt-to-income ratios; far too high. Adjusting these numbers by paying off your debts or lowering your acceptable house payment until you hit the 36% (or less!) sweet spot will help you determine how much house you can afford.

Learn about mortgage types and determine what fits you the best.

While most borrowers go with a conventional 30-year fixed rate loan, there are many types of mortgages out there, some that may be better suited to your specific situation.

Some mortgage choices are:

15-year or 30-year – Going for the 15-year loan will always mean that you pay less interest over the life of your loan, but sometimes people just can’t afford the monthly payment that a 15-year mortgage brings. As the names imply, these are merely the timeframe in which you pay your mortgage back, 15 or 30 years.

Fixed-Rate or Adjustable Rate (ARM) – A fixed rate loan, means you pay the same interest rate over the entire life of the loan, which is typically 15 or 30 years. An adjustable rate mortgage usually starts with a honeymoon period where the interest rate is lower than that of a fixed-rate, loan for a time. Once that period is over, the interest rate then adjusts according to current interest rates.

Conventional or Non-Conventional – A conventional mortgage is merely any mortgage that is not sponsored by a government body while a non-conventional loan, sometimes known as a government loan, is backed by the government. Government-backed loans give assurances to the lender that they will be paid back even if you can’t pay it back yourself. That is why many of these loans require minimal down payments.

Some examples of non-conventional loans are:

• FHA loans
• VA loans
• USDA loans

In addition to these choices, there are many types of less common mortgages out there, including construction-to-permanent mortgage, for building a home and a streamlined-K mortgage for homes that need a little TLC. Talking with lenders to learn about all of the mortgage options available is the best way to find a mortgage that best suits your needs.

Save for a down payment.

Once you know what mortgage you’re after, you’ll have a better idea of the minimum down payment required. Typically, down payments can range from 3.5% to 20%. While 20% will always give you access to more favorable financing and save you money, with today’s house prices, it can be a stretch to expect to save that much. Shoot for as much as you can realistically save. If you can get 10% down, great! However, if you put less than 20% down, your mortgage will likely incorporate Private Mortgage Insurance. PMI is an insurance that protects the lender if you default on your loan and while it’s typically a premium added to your monthly mortgage payment, it can also be a one-time up-front premium.

There are some government-sponsored mortgages that require nothing down and do not incorporate a PMI. The most common of these being a VA or USDA loan. There are employment, income, and geographical guidelines you must meet to qualify and while there is no money down and no PMI associated with them, there is an upfront premium for USDA and funding fee for a VA loan.

So now you’re Prepared. Your credit is good, you have a healthy savings account and you know what mortgage you’re looking for. What next?

Shop lenders for the best mortgage rates.

If you like saving money, looking at different lenders is essential because different lenders may quote different prices and have different fees. Finding the lender that gives you the best deal isn’t the only thing to consider; because you also want a lender that is easily accessible, knowledgeable, and organized; all things that are required to ensure a smooth close.

Once you find a promising lender, get pre-qualified. Getting pre-qualified is a big picture idea of what you can get approved for, and it can quickly be done over the phone or online. Don’t confuse a pre-qualification with a pre-approval, which is more in depth, requires a lot of documents and comes at a later time.

Most first-time homebuyers are so excited when they get pre-qualified that they forget to keep looking at lenders, but that could be a mistake because the real estate professional that you’re going to hire may have additional options. You are not obligated to go with the lender you get pre-qualified with. You can continue your search until you feel good about your choice.

Find a real estate agent, broker or Realtor you trust.

So now that your prequalified, and have a few lenders in mind, it’s time to seek out a real estate agent, broker or realtor. So, what’s the difference? While all are licensed to sell real estate, the difference between them is that a broker has additional education and has passed a broker’s license exam and a Realtor is a member of the National Association of Realtors and are held to a specific code of ethics. As with all professions, you will find great and subpar individuals in every group. So how do you find a good one?

The first step is to search for agents that are local to the area you are looking to move. Finding a local professional is important because they will be able to point out the pros and cons of a neighborhood, discern appropriate price ranges, and they are knowledgeable of nearby school districts, businesses, etc.

Once you have a list of local agent names, do a license check to make sure they have all the appropriate state licensing. While each state should have an online search tool available, you can also use the Association of Real Estate License Law Officials search tool  to look up a real estate practitioner’s license.

Once you’ve narrowed down local professionals that are appropriately licensed, it’s time to meet and interview each one.

Things to ask in an interview:

• Ask them how long they have been selling real estate and how many homes they typically sell in a year. If you really want to dig deep, ask them how often they negotiate home prices below list price. These answers will help ensure you find an agent with experience that successfully completes sales regularly.
• Ask them if they have any awards or accommodations, although it’s likely something they will want to highlight long before you ask.
• Ask them how much commission they charge and what services they provide for that commission. Hiring an agent that works for 1% less than all the others may sound like a great idea until you find out they offer 50% fewer services.
• Ask for a list of recent clients that you can call as references.
• Ask about any extended periods of time they may be unavailable such as planned vacations, weddings or other commitments. This is important information because you don’t want is an agent that is unavailable at critical times.
• Make sure they are readily available for questions that may arise. They should be proactive and responsive, returning calls promptly. Ask them about their availability.
• Make sure your personalities work well together. While this isn’t a question you would ask in an interview, it’s an essential aspect of the interviewing process. On paper, everything may be perfect, but if you find your jaw clenching involuntarily during your interactions, it’s probably better to move on.

As mentioned earlier in this article, it’s likely that your agent will have preferred lenders, and while you’re not obligated to use one of their preferred lenders, they likely have a good reason to prefer them, so ask questions, take heed and make an informed decision.

Get a mortgage preapproval.

So now you’re armed with good credit and money in the bank with your real estate agent by your side; you’ve got a perfect mortgage option through a great lender. It’s time to get pre-approved! Getting pre-approval from your lender show sellers that you are a serious contender and helps them feel confident in accepting your offer.

When you get pre-approval, you will get a dollar amount that you are approved for, and it may be more than you have already determined you can afford. Proceed with caution and stick to the plan. The last thing you need is a home that puts you into so much debt that you default on your mortgage. You know your finances better than anybody, including your lender.

The documentation you may need for pre-approval:

• Social security number
• Proof of employment
• Proof of income: W2’s, 1099’s and any additional income you earn.
• Bank statements: usually 60-90 days’ worth of bank statements.
• Tax documents: typically, the two most recent federal and state tax returns.
• Assets: retirement accounts, CDs, stocks, bonds or any other assets you may own.

Another item of note, make sure that any numbers you provide to your lender are accurate because you will have to verify any and all information you give when you apply for the loan. While going through this process, it is also important to leave your finances stable and predictable. Do not move large amounts of money, make large deposits, buy large ticket items or open/close new lines of credit. Lender’s do not want to see any unpredictable transactions in the time between pre-approval and closing.

Shop for your dream home.

Start by making a list of needs; what are the things your new home must have? Then make a list of wants; what elements would be nice to have? Is there one particular neighborhood or school district you must be in, or are you open? Share these things with your real estate professional. Make sure you look beyond the property you’re purchasing when shopping around, observe the neighborhood and research the school district. If the house looks like a contender, introduce yourself to the immediate neighbors. All of these elements are important, after all, a dream home can quickly turn into a nightmare with bad neighbors at your side.

Make an Offer.

So, you’ve found the home of your dreams and now it’s time to make an offer. You will likely go back and forth until you have an agreed upon price. Depending upon how desirable the home is, you may be bidding against other offers. Your real estate professional will structure the offer with appraisals, home inspections and other contingencies taking place during this phase. It’s overwhelming but a good agent will lead you through it with ease. Once the terms are approved by both parties, a purchase agreement is signed, and you are on to the next step of finalizing the loan.

Submit Mortgage Loan Application.

Now it’s time to finalize the loan. While your pre-approval process got you off to a good start, your loan officer will now ask for additional documentation. All of the information will be gathered, and within three days you will get a loan estimate that describes the terms and estimated cost of your loan.

Loan Processing and Underwriting Begins.

All of your documentation and that of the property is gathered and sent to the underwriter. The underwriter is the person that closely evaluates all the information for accuracy. The underwriter will verify the information and approve or reject the loan. Some approvals may come with conditions, such as a written explanation for a minor credit infraction, etc. After initial approval, you’ll receive a locked interest rate and get title insurance.

Close on Your Home.

Whew! You’ve finally made it! You should expect a three-day period to review loan terms and a final walk-through of your property to ensure any requested repairs are complete etc. Bring your checkbook, two forms of I.D. and a wrist brace to the closing meeting, because you will be signing impressive amounts of paperwork.

Want more? Click here for a more detailed guide of what to expect between pre-approval and closing.

We hope you have enjoyed this edition of Dollars and Sense. If you need help improving your credit or paying off debt, we can help. Our My Credit Plan and Accelerated Debt Payoff can help get you on the path to homeownership. We also offer a free financial consultation if you call 877-789-4172.