Many years ago, when I was starting out as a real estate agent, I was just plain desperate to get my first deal done. It’s funny when I think back because I was only 26 years old when I got the bright idea to go into real estate to hopefully make a lot of money and build my fortune there. The only problem I had — besides inexperience — was not too many people would trust a younger person with selling their most valuable asset (their home).
So, my first real quest was to just find buyers. The other agents and I did anything and everything to try to find them, starting with our own network, which was small at the time. Then, we moved to working a geographic area, holding open houses, and even answering the phone in the office to hopefully get some buyer leads.
One of my first customers was this lady who called in and was looking for a house. Bingo! This would be my first sale, right? Well, not exactly. I met her at the property she called about, and then later we started to meet each week at my office before going out to look at more houses. But, of course, I made the huge mistake of not having her get pre-qualified for a mortgage.
For the next several weeks, I served as her tour guide and taxi driver until she finally found a house that she liked. Then when we met with the lender, we quickly found out that her credit was shot, and it would be very difficult for her to buy a house at that time. I was devastated because I had wasted so much time.
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It was then that I realized real estate is a finance-driven business, and I decided that my new quest was to become an expert in the finance side of things. Otherwise, I was potentially spinning my wheels and may never have made a commission.
So, why is getting pre-qualified so important?
When starting out, many people go through a period of discovery, which today is mostly done on the internet. They decide they want to buy their first house (or their next house), and they start to investigate what’s out there. Maybe they’re tired of paying rent and want some tax breaks, maybe they want to build some equity to increase their net worth, or maybe they just don’t want to have a mortgage payment in retirement. But regardless of one’s motivation, it ultimately comes down to this: If you don’t sit down with the lender to get pre-qualified (even if it’s done by phone or computer), you are just window shopping.
Have you ever experienced sticker shock when going to buy something? For many people, it happens with larger purchases, like buying a car. When it comes to shopping for a house, most folks have an idea of what they can afford as a monthly payment, but they may get sticker shock on the cash required to close (i.e. down payment and closing costs).
You need to look at not only what you can afford from the bank’s point of view, but also the whole, overall picture.
Once, I had a lady who was looking to downsize as she was nearing retirement, but she quickly found out that she could no longer afford the modest condo she wanted because she had cosigned her son’s new truck loan.
Another time, a friend from high school wanted to buy a home with his wealthy father as a cosigner, only to find out the father was worse than he was in the eyes of the bank because he had many assets but very little extra income.
Often, people can make small, subtle mistakes just by taking on too much debt or even by paying off their debt too soon. Yes, you heard me right. I had a client once who thought it was smart to pay off a debt before buying a home, but what he didn’t realize was that the low monthly payment wasn’t hurting his back-end ratio, and he used up a lot of his cash that could’ve been saved as additional reserves.
While the bank calculates both your front-end ratio (typically 28% of your gross monthly income) and your back-end ratio (typically 36% of your gross monthly income minus your monthly recurring debt), they use the smaller of the two numbers as your maximum amount towards PITI (monthly payment, interest, taxes, and insurance). Even if this amount is higher than what you’re paying monthly in rent, you would still need to consider the mortgage interest deduction you’d be getting at tax time.
So, besides running these numbers, what else can you do to get ready to purchase your first home?
It should be quite obvious that there’s plenty one can do to prepare to buy that first property (or the next property). Things the banks consider besides just credit scores usually revolve around stability.
For example, where have you lived and worked for the last two years? Have you paid your rent on time? Have you saved up money for your down payment and closing costs yourself? Banks typically request to see two or three months of bank statements to ensure you didn’t borrow the money prior to applying for a mortgage.
Today, getting the financing for a property can be pretty involved, especially in the current heavily regulated mortgage market. Of course, the first mortgage can be one of the toughest, so be sure to ask your loan officer about any special programs currently being offered as well. Whether you’re brand-new or just new to the current market, it’s time well spent if you’re looking at where you are now and what you may need to do to prepare.
Happy house hunting!
Any other ways you’d prepare for mortgage applications?
Let me know with a comment!