Before you progress too far into the home-buying process, it's a good idea to talk with a lender about pre-qualifying for a loan. Pre-qualification will let you know how much money you will be able to borrow, so that you know your price range for your home search. Having a pre-qualification letter also assures sellers that you are a serious potential buyer.
What you can afford will depend on your income and your debt. In general, lenders don't want borrowers to spend more than 28 percent of their gross monthly income on a mortgage payment (your "housing expense ratio") or more than 36 percent on all debt payments combined (your "debt-to-income ratio.") They will define your total mortgage payment as the sum of your principal, interest, taxes, and insurance (known by the acronym PITI), and they will define your long-term debt as any monthly payments which will take ten months or more to pay off.
Low housing expense and debt-to-income ratios do not guarantee that you will qualify for a loan; neither do high ratios always signal a denial. In addition to your gross income and your current debt, potential lenders will consider these factors to determine how much you can borrow:
Follow these steps to get a general idea of how you will pre-qualify:
Line 6 is the maximum monthly principal and interest you can afford. The following table will show you how the monthly payment relates to your loan amount.
We said earlier that potential lenders will consider six factors to determine how much you can borrow:
To verify your current debts and your credit history, your lender will order a copy of your credit report. Even if you don't anticipate any problems, it's a good idea to order a copy of your report before you begin the loan application process. This will give you time to clean up any errors or problems that may show on the report.
You can obtain a copy of your credit report from one or all of the three credit reporting agencies:
You can also look in the yellow pages under "Credit Reporting Agencies" for a location near you. The reports should cost under $10 each, and it's a good idea to get a report from all three companies since they may not be exactly the same.
Your first credit problem may be lack of a credit history. You can approach this problem in a couple of ways. First, you can begin to build your credit by getting a credit card and charging small amounts on it. By paying it off each month, you will be establishing a positive credit history without incurring finance charges. Second, you can ask your lender to establish a non-traditional credit history which uses payment information from monthly obligations other than loans: utility bills, rent payments, telephone bills, etc.
If you have a credit history, the credit report will list all of the consumer credit that has been extended to you in the last seven years. For each account, it will show:
Sometimes problems will crop up on a credit report because there has been a misunderstanding or error. If you find such a problem on your report, contact the billing department for that account and have them correct it. Keep written copies of your correspondence and keep notes of phone conversations which include the names of the people with whom you have spoken, the dates of the calls and the outcome of each call. Write a letter explaining the error to the lender and attach it to the credit report. Submit copies of your written correspondence and notes from conversations with the creditor as further documentation. If a poor credit rating is the result of past problems, you need to be aware that there are no quick fixes for a poor credit history. Be patient, and improve your credit rating by:
Additionally, lenders are much more concerned with how you have handled your credit recently than with what happened several years ago. If you had problems in the past but have paid your bills on time since, you may qualify for a loan after as little as two or three years.
Some lenders have begun offering risk-based pricing. In other words, even if you have slightly damaged credit, you may still be able to get a loan; you'll just pay more for it.