The 3 most important must haves when attempting to apply for a home loan.
harpprogram.org, Copyright: 2014
A lender will not approve you for a mortgage until they gain a solid confidence you won't default on the loan. They need to see that you have enough incoming money to pay your mortgage. Also that you have enough current money on hand to pay the down payment and any potential closing costs. Finally, they need to know you have a good credit history capable of qualifying for the loan. Especially since your credit profile will effect what interest rate you qualify for as well as how large your down payment will be.
Lenders generally break it down using the three Cs of credit history, capacity, and collateral. Credit history not only looks at your credit score but also the history of your debt repayment. Your income, investments, and savings make up "capacity". Collateral is your down payment as well as the value of the home your trying to purchase based on appraisal. Lenders will also want to know your employment history for the previous two years so they can estimate the likelihood you will maintain your job. Your spouse can help offset any deficiencies you may have in one area; For instance if they have a strong credit score and history whereas yours is weak.
Lenders estimate the mortgage amount you can afford by applying payment to income ratios. Fannie Mae and Freddie Mac (GSEs or Government-Sponsored-Enterprises that guarantee the loans made by credit unions and banks) purchase most mortgages that lenders originate and therefore must follow the rules of Fannie Mae and Freddie Mac. An important thing to think about is your monthly mortgage payment shouldn't be more than 28% of your gross monthly income (remember gross is before taxes). This 28% will need to take care of principal and interest, homeowners insurance, real estate taxes and any dues to homeowners or condo associations. Adding together all monthly payments for all your debts shouldn't rise above 36% (this includes deferred student loans) of your gross monthly income either. The FHA (Federal Housing Authority another loan guarantor) jumps those number up to 31% and 43% and does not include deferred student loans.
"The bigger issue for most perspective home owners is the down payment. Fannie Mae and Freddie Mac require a minimum of 5-10% down on the home's purchase price. To put that into perspective in the beginning of 2014, 10% of the average priced home would have cost almost $19,000 down. Furthermore if you fail to come up with a 20% down payment you are then required to carry private mortgage insurance as well. Once again the FHA is slightly more forgiving, allowing for down payments as low as 3.5%. However, they also require you to pay annual insurance premiums upfront.
If you can come up with the down payment whether you cash out your 401k, withdrawing money from a traditional IRA, or by some other means. It is important to understand the requirements you will be subjected to in purchasing a home. That way you can be better prepared and have a better understanding of your options as they present themselves.