How to buy your first home

The bank looks at four things

Not just the score, although the score has a big influence on whether you qualify and on the rate you are offered.

• Your credit score: it influences whether you qualify and the interest rate
• Your income: it must be documented and stable, normally 2 years
• Your debts: how much of your monthly income is already committed
• Your available cash: for the down payment and closing costs

The score they usually ask for

It depends on the loan type. These are general references; each lender may require more.

• FHA: from 580, with a down payment from 3.5%
• FHA with a score between 500 and 579: 10% down payment
• Conventional: from 620, with a down payment from 3%
• VA (veterans): varies, many ask for 620 and in many cases require no down payment
• USDA (rural areas): around 640, and in many cases no down payment is required

The point almost nobody explains: qualifying and qualifying well are not the same thing. With a fair score you can get in, but with a high score you pay a lower rate. On a 30-year loan, that difference can add up to a lot of money. That is why it pays to get your credit in order before you apply, not after.

How much money you really need

The down payment is not the only expense:

• Down payment: between 0% and 20% of the price, depending on the loan.
• Closing costs: normally between 2% and 5% of the price. They include appraisal, title, insurance, prorated taxes, and lender fees.
• Earnest money deposit: it is paid when you make the offer and applied at closing.
• Inspection: it is not mandatory, but you should not skip it.
• Reserves: some lenders want to see several months of payments in the bank after closing.

Many states and counties have assistance programs for first-time buyers. Ask your loan officer about the programs in your area.

The debt-to-income ratio

The bank adds up all your monthly debt payments, including the new mortgage, and divides them by your gross monthly income. A limit many lenders use as a reference is 43%, and some accept more with a good score or strong reserves.

In practice: with high car or credit card payments you can qualify on score and still not qualify on debt. Paying those balances down before applying helps twice: it improves your score and lowers your debt-to-income ratio.

The steps, in order

• Get your credit in order first. Review your report and take care of anything wrongly reported or past due.
• Lower your debts, especially credit cards.
• Gather your documents: two years of taxes, W-2 or 1099, recent pay stubs, and two or three months of bank statements.
• Get a pre-approval. It is not the same as a pre-qualification: it is stronger and tells you your real budget.
• Look for a home within your budget. The maximum approved amount is not the amount you should spend.
• Make the offer and close, without opening new credit between approval and closing.

The most important warning

Between approval and closing day, do not open new credit accounts, do not finance furniture, do not buy a car, and do not change jobs. The bank checks your credit again right before closing, and some loans fall through because of an installment purchase made the week before. Wait until you have the keys.