Buying a new home is exciting – looking at all the pretty kitchens, snooping around touring open houses, planning where all your furniture will go! But before you get to all the fun stuff, it’s important to know exactly how much house you can afford. Sitting down with a lender and getting pre-approved for a loan at the beginning of the home buying process provides a clear picture of what you can realistically afford and helps prevent potential disappointments down the road.
Here’s are the key factors lenders typically evaluate when helping to determine your buying power:
One of a lender’s biggest concerns is always whether a borrower will have the income coming in and the financial resources already on hand to keep up with their mortgage payments, regardless of what else is going on in their financial life.Therefore, you will be required to provide documentation of assets showing where money for the down payment is coming from and what your savings and investments currently look like. The bigger your cushion, the more likely lenders will think you can afford all mortgage costs and fees, and all other home-related financial obligations afterward.
2. Debt-to-Income Ratio
Making a steady income and a lot of money in the bank is great, but not the sole factor in determining your mortgage worthiness. Lenders want to be reassured that you’ll be able to pay your mortgage in addition to all other outstanding debts currently in your name. To do this, they will look first at your front-end ratio, or housing ratio — your monthly housing payment (including insurance, interest, taxes, and PMI, if applicable) divided by your monthly income. The general rule of thumb is to keep this at or below 28%.
Next, lenders will consider your back-end ratio or debt-to-income ratio, a calculation that determines how much of your monthly pay services your existing debt (e.g., car loans, student loans, credit card payments, etc.). This calculation is your total monthly debt payments divided by your total monthly household income. The general rule of thumb for this calculation is to keep it at or below 36%.
3. Credit Score
Credit scores reflect your credit risk level, with a higher score indicating lower risk. Your credit score is fluid, and changes as the elements in your credit report change. For example, payment updates or adding a new account could cause your score to fluctuate. FICO® scores are your credit rating. Scores can range from 300-850, the higher the better. Your FICO® score is calculated based on your rating in five general areas: payment history, amounts owed, length of credit history, credit mix, and new credit.
While a low credit score (typically considered below 620) doesn’t necessarily mean you’ll be denied for a loan, it certainly impacts the quality of loan you’re offered. Interest rates for scores in the 580 to 699 range could be anywhere from 0.5% to 4% higher than the lowest rate available — and that will make your mortgage more expensive. On the other hand, a score of 760 to 850 could land you the best possible rate, and a score of 700 to 760 could put you just 0.25% above the lowest rate.
4. Down Payment
Regardless of how low your mortgage rate is, the ability to offer a substantial down payment improves your overall buying power.There are plenty of benefits to the often-repeated 20% rule of thumb, in which you come up with 20% of the home sale price in cash. Putting this much money (or more) into a down payment can eliminate the need for private mortgage insurance (PMI), and allow you to negotiate for a lower interest rate, and, in competitive markets, could place you above the competition. **New programs might be available regarding no money down** - we have prefered lenders who can discuss numerous options with our buyers!
Contact us at Knoxville Real Estate Group, Steve and Tonja Doty (865-599-7967) for more information on the home buying process.