Financial Planning for First Time Homebuyers
Banks and other mortgage lenders don’t hand out home loans to just anyone. To secure a mortgage, a borrower needs to prove to the lender that they’re on solid financial footing and capable of meeting the terms of the loan. And the more solid that footing is, the more favorable their loan terms are likely to be. Thus the upfront effort you put into making yourself a more attractive borrower can save hundreds, even thousands of dollars, in costs.
To strengthen your borrowing position:
- Reduce the amount of debt you’re carrying. Most lenders take a hard look at a borrower’s debt-to-income ratio — how much debt a person or household carries in the form of loans, credit card balances, etc., compared to total household income. Most lenders look for a ratio that’s below 38%, and preferably in the 25-35% range. The lower a potential borrower’s ratio, the more favorably a lender tends to view them. That often translates into better loan terms, including a lower interest rate.
- Increase your credit score. Lenders look closely at a person’s credit score when weighing whether to loan them money to purchase a home. Generally speaking, the higher the credit score, the more favorable the loan terms. A score of 750 or higher is “ideal” for potential borrowers, according to certified financial planner Leon C. LaBrecque, managing partner at LJPR, a wealth management firm in Troy, MI. One way to boost credit score is by lowering the ratio of debt-to-credit limit on credit cards, says LaBrecque. Essentially that entails paying down the balance on credit cards while at the same time preserving the credit limits on those cards. “Don’t close credit card accounts, because that can impact your credit score negatively,” he advises. “Instead keep the accounts open, just don’t use them as much.” He suggests targeting a debt-to-credit limit ratio of 10% or less.
- As the old song goes, “You better shop around,” because subtle and seemingly insignificant differences in the fees and costs associated with a mortgage (from the actual interest rate to closing costs and other fees) can translate into hundreds and sometimes thousands of dollars in savings, at the time of purchase and over the life of the loan. “I suggest looking on the Internet first, then talking with at least two other lenders,” says LaBrecque. “Be sure to get the full [annual percentage rate] from them, so you’re comparing apples to apples.” The APR includes not just the interest rate but other costs and charges and fees, some of which may be negotiable. With prevailing mortgage rates from a wide range of lenders as well as loan calculators for side-by-side comparisons, www.bankrate.com makes a good starting point for your online research. For info and tips on finding a mortgage see our article: Shopping for a Mortgage