First-Time Buyer's Series: Preparing Your Finances to Make You "Bankable"
Whether you plan to buy soon or are looking ahead to buying a few years down the line, it is never too early to prepare your finances so that you are in a solid place when the time comes.
In fact, I think the number one mistake first-time buyers make is that they just want to buy a place so bad (I can relate) that they will do almost anything to get a hold of the house that has tugged at their heart strings... even if buying that house right now means they are stretching their finances too far and they are buying before they are actually fiscally ready.
It's hard for me to tell you to pump the breaks because I get it. I struggle with this feeling each time I close on an investment property and I am already wanting to go buy my next one. It takes a tremendous amount of self-discipline and brutal honesty with yourself to recognize when you just aren't fiscally there yet. Plus our society does not do a great job encouraging us to say "no" to purchases that are beyond our means in general. I say this to illustrate you are not alone in feeling this way, but don't let that lead you down the road to over-leveraging yourself.
How do you know if you are really financially ready to buy? The benchmark is really to ask yourself are you "bankable," meaning would a bank see you as a candidate who would qualify for their loans? If you are, then you are ready to move forward with purchasing. If you are not, I recommend you read this entire post to learn how you can become "bankable."
Here's how a bank determines whether or not you are "bankable":
1) They want a low debt-to-income ratio (your total monthly debt payments divided by your gross monthly income). Most banks look for that ratio to be lower than 36%.
2) Excellent Credit Score: 720+ gets you the best rates.
3) Proof of Funds: Documentation to show you have enough money for the deposit, closing cost and prepaids for the next year (taxes and homeowner insurance).
4) Proof of Employment (Recent paystubs to prove steady work or if you own a small business, usually 2 years of tax returns for the business).
Keep in mind that these are the basics but every bank's idea of who is "bankable" varies slightly. These are general criteria they look for though. If a bank won't lend to you, then you are probably not ready to buy. While their rules tend to be more conservative to ensure that they reduce risk on their end, that is a good sign for you because that means they believe you are a safe bet to loan to. Now that doesn't mean you have to go with a conventional lender - there are many other options - but it does give you a clear idea as to whether or not your finances are in order enough where buying a home now will not be significantly risky for you. It's a good litmus test to set you up to successfully take on more leverage.
Photo Credit @ Sydney Rae
So what do you do if a bank doesn't view you as "bankable" yet? Roll up your sleeves and put in the work to get there! Don't give up, it just means it will take a bit more time to get there.
Here's what I suggest you do in that situation. I make lists of action steps I can take right now which will help me make progress and get "in the game" while I am still working to get my finances in complete order. It helps me to get the momentum going without making a decision that might force me to over-leverage. Here are some things I focus on to prepare my finances:
Educate yourself about real estate and money
You must take the time to educate yourself on the process of buying a home. The fact that you are here reading this right now tells me you understand the value in that.
Photo Credit @ Chrstin Hume
Read blogs and listen to as many money and real estate podcasts as you can. This can never hurt. The more you know, the more prepared you are. Plus hearing about other people's mistakes will help improve the chances of you avoiding them yourself. Often times first-time buyers are the first ones in their family to buy a home. If you are in that boat, this can be incredibly helpful because it can serve as a resource for you to know what to expect. The process isn't intuitive and there are many different routes you can take to find and secure your first property. It helps tremendously to do your research and keep an open mind, especially in a seller's market where it may take more time to find your perfect deal.
Here are some of my favorite podcasts to listen to that may help you out as well:
Pay down debt
The next step is to pay down your high-interest debt. Credit cards are considered extremely high interest and should be demolished first. Be aggressive. Take any and every extra penny you have and pay it off. Depending upon how far in debt you are this could take a month, a year, even a few years. Trust me when I say this should be eliminated before you purchase a home, especially if you are already worried as to whether or not you can afford to buy a home. Here's how I recommend you do it:
Photo Credit @ Rupixen
Start with the card with the highest interest and send all your extra money to that one first. Continue paying the minimum payments on the others, but every extra dollar you have there after send it to the credit card that has the highest interest. Do that until it is paid off completely. Once you have, cut the card up. Don't cancel it (I'll explain why later) but make sure you don't charge on it again. Then go to the second highest interest rate card and do the same. Pay the minimum on all your others and use all the additional money on this one to hammer it out. Continue this process until you don't owe a dime on any credit card. It's super important that you do this because:
1) It will teach you fiscal discipline (a necessary skill when owning a home).
2) It will help you to build fiscal confidence in yourself.
3) It will make you more bankable to future lenders.
4) It will raise your credit score, thus eventually giving you a better loan rate which will save you thousands in the long run.
As I said before, it is super important that when you finally have paid off those credit cards, do not close them. Keep them open, but don't use them. The reason being that part of your credit score is created based on the longevity of your credit history and how much access to credit you have. If you close a card, it removes all that history with it. It also shows you have less access to credit, which to a bank makes it seem like you are less trustworthy and therefore less bankable for a loan. While we know that is not true, that is the logic behind how it can negatively impact your credit score. So pay off the cards, keep them open and never use them again unless you can pay off the balance that very same month. If you don't think that is possible, cut them up, and pretend like they don't even exist anymore.
Fix and/or improve your credit score
Improving your credit score is crucial because it improves the interest rate at which a creditor will lend to you. This will save you THOUSANDS over the course of the lifetime of your loan. Plus, improving your credit score will reflect that you have now built good fiscal habits. It is a direct measurement of your integrity when it comes to managing and paying down your debt. Without this there is no way you can ensure yourself that you are able to truly be disciplined enough to pay back your loan consistently and not end up in a foreclosure situation.
Photo Credit @ Avery Evans
How do you improve your credit score? I touched on it a bit before, but here are the basic steps. There are tons of articles written out there that are more comprehensive than this so feel free to research them as well. But basically the process is:
1) Pay down debt (it lowers your debt to income ratio, a number lenders look at very closely).
2) Get a copy of your credit report, check it for errors. Dispute and resolve any errors that appear.
3) Do not open any more credit cards or do anything that requires credit checks or pulls. Each time someone pulls your credit, it gets noted. The more times it's pulled, the lower your credit score drops because to credit agencies it looks like you are in financial distress and need access to money right now (even if this may not be true).
4) Don't make big purchases. Now is not the time to buy a car, or buy furniture for that dream home. Wait until after you close on your home to do that.
Get your paperwork in order
If you go with conventional lending, they will be asking you for a ton of paperwork. Get ready. Most people don't realize how much actual paperwork it is. I know I sure didn't the first time around. Even the second or third time going through the process, I always find that they ask for a new document that I may not have provided before. So while you can anticipate some of the regular documents, know that they may ask you for other papers. It's part of the process so they can really be assured that you are responsible and will pay back your loan. Getting these papers together in advance helps.
Photo Credit @ Kelly Sikkema
I usually keep a file with the following things:
1) Tax returns for the past two years
2) Photo copy of your driver's license or Government ID
3) Bank statements that show you have money for the downpayment and closing costs
4) Statements from 401k
5) Pay stubs for the past 2 months
6) Proof of employment
7) Proof of insurance (they will ask for this right before you close)
8) Copy of purchase agreement (usually your lawyer sends this to them)
9) Copy of appraisal (usually they get this and share it with you)
10) Sometimes a copy of the inspection
11) Property disclosure form (some states require the seller fill this out in advance of closing and banks often like to see it)
12) Proof of any other assets that make you more "bankable"
13) Credit report (but often they pull a more recent one themselves)
Like I said before, this list is not exhaustive, but just a few commonly requested items to have on hand. And if you are married and purchasing this with your spouse or with a partner, they will need to submit copies of all these documents for themselves too. Just create a file and keep adding to it.
Create and live on your anticipated budget well before you have to
Practice living like you are paying the mortgage already. This will give you a clear sense of what you can afford, and if you are pushing your budget a bit too far. For example, if you think you can afford a $2,000 dollar a month mortgage, but you currently pay $1,550 in rent, practice paying that $1,550 for rent and then regularly paying that extra $450 at the same time to a savings account. If you are struggling to put that $450 in savings each month at the same time you pay rent, then you may be over-stretching yourself by getting a mortgage that large. Better to learn this now, while that extra $450 isn't mandatory, than later when your mortgage will be.
You may be wondering right now, how much an I afford? If so, don't worry I will cover that in this series in a later post. It's a great question and I promise you I will help you through figuring that out next. :)
There are several different type of loans you can get and again, I'll go deeper into this in a future post. But you want to research your options out there. The main options are conventional and non-conventional.
Photo Credit @ Precondo CA
Conventional loans are loans from private lenders. They tend to have less fees, but also have stricter qualification rules and require a lot of documentation.
Non-conventional loans are government-backed with the aim to broaden homeownership to more individuals who may not qualify for traditional lending. These efforts were largely put in place to offset harmful practices in the past like redlining and whatnot. The benefit is that many require lower down payments the drawback is often times they have higher fees and only people in specific categories can qualify for them.
Like I said, if you are feeling overwhelmed, don't. Just start to research loans a bit more and I will go into this topic further in-depth soon in a future post.
Develop criteria for your home purchase
This one is tough but super important. The reason it is so challenging is because oftentimes as a first-time buyer we tend to have champaign taste on a beer budget, if you know what I mean. It's just how it is. We want it all and we want it now. That's just part of human nature. It's critical to remember that you aren't buying your forever home straight away, it's a starter home most likely. Which means you will have to make temporary compromises in some way. It's important that you figure out what is most important in a home to you now before you begin your search.
Photo Credit @ Stil
How do you do this? Start by creating a list of the things you need in a home. Those are your must-haves. And let's be clear, I just said need, not want. Once you have this short list start to look up homes with those quality in your target area. What are the prices going for? Are there a lot of turnkey houses with those items available in your price point? Or are houses with those qualities in your price point more like fixer-uppers? How many are there? Is there ample supply or relatively short supply? How many days are they on the market? What are the taxes roughly?
This research will help you to get a realistic idea of whether or not you need to shift your expectations or change your criteria checklist. You most likely will find that you can't get everything you need for the price that you actually have to spend. I say this because this is a common realization in all price points, not just smaller budgets. This process will enlighten you that if you aren't flexible in either adapting your budget or pairing down your must-have list, then you may be in for a very long and possibly disappointing search looking for that diamond in the rough. Better to work through this realization now, in the comfort of your own home, than when you are out viewing house after house. Save the gas, the energy and the time of your real estate agent to do the self-work now to become acquainted with the market and develop realistic expectations for your house search.
Once you have paired your must haves down put them into writing. Carry them with you whenever you evaluate a property. Stick to that list and it will ensure you get what you most want out of a first home.
Locate and build a relationship with your real estate agent
I have a whole upcoming blog post dedicated to this topic, so I'll keep it brief here too. Now is the time to shop the agent market and find one that you really click with. Don't just go with the first agent that responds to your email (although that's usually a good sign they are responsive). Have a few conversations with many. See who you jibe with. See who is willing to put in the time to answer your questions. See if they think your search criteria and budget is reasonable. Make sure it is someone you enjoy being with and feel confident that they are competent. You will be spending a lot of time with them in the future so take the time now to locate the right person for the job.
Photo Credit @ Jeremy Dorrough
So while you are busy stacking the cash for your down payment, there is lots to be done in the meantime. The more research you put in beforehand, the more likely you are to end up feeling really good about your first purchase on the property ladder. Plus when working towards larger, more long term goals, it helps to take little actions each day. It keeps you motivated and connected to where you want to go.
I hope you found this helpful! More to come soon!