Nolo's Essential Guide to Buying Your First Home (14 page)

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Authors: Ilona Bray,Alayna Schroeder,Marcia Stewart

Tags: #Law, #Business & Economics, #House buying, #Property, #Real Estate

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Repairing Your Credit

Rome wasn’t built in a day, and credit history can’t be repaired in one, either. If you or a coborrower have a poor credit history, Fair Isaac suggests you start cleaning it up six to 12 months before applying for a loan. If your credit history is really messy, it may take even longer.

But here’s some good news: Even if you have a long, ugly credit history, your score will be weighted in favor of your latest performance. Turn over a new leaf by following these strategies:

•
Pay on time from now on.
Don’t miss due dates for credit cards and other bills. Setting up automatic payment plans can help, and your lender may reduce your interest rate in return.

•
Pay the worst first.
Start by paying off high-interest debt, like on credit cards. Also, keep your balances low on revolving lines of credit. Don’t just move the debt around—that won’t fool the credit scorers, nor will it free up cash for a mortgage payment.

TIP

Check out FHA loans.
Some low down payment federal loans are less strict about credit background. See Chapter 7 for details.

What’s Your Monthly Budget? Understanding Your Finances

Now that you’ve seen what lenders look at to decide how much you can spend, it’s time to think about what
you
believe you can spend. The point is to avoid taking on so much debt that you lose sleep or have to give up sushi for ramen noodles.

In fact, if you look closer at that debt-to-income ratio, you’ll realize that it has a built-in problem. It’s based on your
gross
income—the amount you theoretically make before your paycheck gets eaten by taxes and other withdrawals. Your mortgage payment could end up being at least half of what you actually take home. Depending on your lifestyle, spending that much on a house might sound either just fine or ridiculously impossible.

The easiest way to understand your current spending and savings pattern is to do a budget worksheet. You can do this using either special budgeting software, a spreadsheet like Excel, or the good old-fashioned way, with a pencil and paper. List all your expenses, including food, entertainment, clothing, transportation and car-related expenses, health and dental care, child and pet care, student loans, and utilities. Hold onto your receipts, and if you use an ATM card or make electronic payments, look at your bank statement to see where it’s all going each month. Include automatic monthly withdrawals on your budget worksheet—for your DSL line, online DVD rentals, or gym membership. Of course, you can leave your current rent and any rental-related expenses out of your calculations.

CHECK IT OUT

These websites have free budget worksheets you can print and fill out, or budgeting software to purchase:
•
www.vertex42.com
•
www.planabudget.com
•
www.quicken.com
.

Next, compare your monthly expense total to your monthly net income—what comes home, not what you make before taxes and the rest. The difference between that take-home pay and your expenses is the amount of disposable income that you can use for new house-related expenses.
From paperclip to house

Kyle McDonald set himself a challenge: to trade his way from a red paperclip to a house. He succeeded by bartering on Craigslist, working his way up through a pen, a doorknob, and a camp stove. It took McDonald only 14 trades (one with actor Corbin Bernsen) and about one year to reach his goal of homeownership. (He’s now ready to trade the house, too.)
Read his story at
www.oneredpaperclip.com
.

Most people try to modify their spending habits if their disposable income isn’t enough to cover the PITI. Having all your expenses in front of you helps you decide where to make such cuts. It also prepares you to draw the line if a lender or mortgage broker encourages you to pay more than your true budget allows. Remember, the lender mainly cares that you can pay back the money you borrow—not that you do it while living the life you want. If Pilates classes or Friday happy hours are important to you, then stick by your own budget and plan.

Getting Creative: Tips for Overcoming Financial Roadblocks

After running the numbers, you may feel that you can’t afford a decent house, or maybe any house. But no matter your financial woes, there are steps you can take to ease them, including:

•
Reduce your debt.
This will free up cash for monthly house payments and reduce your debt-to-income ratio.

•
Make a new budget.
Revise your monthly budget, keeping your homebuying goals in mind. If you have targets, you’re more likely to control your spending habits to meet them.

•
Reduce spending.
You may be able to get a roommate until you’re ready to buy a place, apply an expected work bonus toward your fund, go back to basic cable, or shop more at thrift shops. Check out local freecycle groups (
www.freecycle.org
) for free items.

•
Consider different financing strategies.
Check out low- or no-down payment loans or the variety of adjustable rate mortgages with low initial payments (covered in Chapter 6).

•
Borrow from a nontraditional source.
Consider different and creative options for borrowing money, from your family to the seller of the house you buy. For details, see Chapter 7.

•
Get a buying partner.
Perhaps you know someone who has cash and would be interested in jointly owning a property. Keep in mind that owning together doesn’t have to mean living together, or even owning equal shares.

•
Cash out other investments.
Consider cashing out money invested in stocks, bonds, mutual funds, or other property to come up with a down payment, thus also reducing your monthly payment.

•
Consider other home types, sizes, conditions, or locations.
Remember that condominiums are often cheaper than houses and old houses generally cheaper than new.

•
Wait.
If you expect prices and interest rates to remain stable, your income to increase, and to save more money, you might delay your house purchase. With increased income, you may be able to borrow more; with an increased down payment, you may not need more.

The Power of Paper: Getting Preapproved for a Loan

Knowing what house-related costs will be laid at your feet, roughly how much a lender will let you borrow, and how much you’ll really want to spend based on your income, lifestyle, and other factors, you can think about getting
preapproved
for a loan. Preapproval means you get a letter from a bank or lender committing to lend you a certain amount. It’s often expressed as a monthly amount, because interest rates may vary, but the amount you can afford to pay each month does not.

Preapproval does two important things: It gives you some certainty that you can afford the houses you’re considering, and it makes you more attractive to sellers. You’ll know exactly how much you can borrow, and sellers will know that if you’ve put an offer on their place, you can actually come through with the cash.

TIP

You don’t need to use the lender that preapproves you.
It would make matters easier if you did, but there’s no need to feel bound. You (or your mortgage broker) might find a better deal by the time you’ve chosen a house.

Why Preapproval Is Better Than Prequalification

You may have heard of loan
prequalification
, but don’t get it confused with preapproval. When you get prequalified, you give a lender some basic information about your income and debts, and the lender estimates what you’ll likely be able to borrow. But the lender doesn’t commit to lending you that money, so prequalification mainly helps you ballpark the price range you should be looking at and readjust your expectations if need be. Prequalification certainly won’t wow any sellers. On the plus side, prequalification is free and easy to do (in person, over the phone, or on the Internet).

Preapproval is a different story. It will actually cost you a little money (in the $30-$40 range), because the lender will check your credit history. (This cost may be negotiable.) But preapproval will also give you more—a written commitment to lend you money. Don’t accept a verbal preapproval.

Of course, the lender will attach a few conditions to that commitment. If, for example, you lose your job, the bargain is off. And make sure your preapproval letter doesn’t contain too many conditions. For example, if the letter conditions the loan on a credit check, it means the lender hasn’t really done its homework, and you’re not really preapproved.

What You Need to Show for Preapproval

To get preapproved, you’ll need to provide the lender with some financial data. This is actually a blessing in disguise—it’s all stuff you’ll need to dig up to get a loan anyway, and it’s about the last thing you’ll want to be thinking about later, when you’ve found a place to buy and are juggling other tasks.

Here’s what you’ll need to pull together and photocopy. If you’re buying with someone else, both of you will need to give the lender every item on the list.