Home buying can be a thrilling — and complicated — experience. Get insights from financial advisors with the free Personal Capital Home Buying Guide.
The housing market is booming.
The typical home value in the United States is $298,933 as of July 31, according to Zillow online real estate marketplace. It’s up 16.7% compared to a year prior, and Zillow forecasts that it will increase by 12.1% the same time next year.
It’s a very competitive market for buyers, with half of homes selling above the listing price.
That doesn’t mean you shouldn’t buy a house right now, especially if you’re planning on owning it for a long time. If you are thinking about purchasing a home, here’s what you’ll need to make that purchase.
Credit requirements vary depending on the type of loan.
Typically, the minimum credit score you need to qualify for a mortgage is around 580 for an FHA loan, which is regulated and insured by the Federal Housing Administration, or a VA loan, insured and regulated by the U.S. Department of Veteran Affairs.
It’s unlikely you’ll qualify for a conventional mortgage, which is not guaranteed by the federal government, with a credit score below 620.
But the lender can decide to be more flexible depending on the size of your down payment.
There are no minimum credit requirements for a USDA loan. USDA loans are backed by the U.S. Department of Agriculture and make homeownership more affordable for rural homebuyers.
There are other mortgage types to consider as well, and each has its eligibility requirements and conditions. Here’s a useful resource for the most common mortgage loan types to help you determine which one is right for you.
Like with any other credit purchase, the higher your credit score, the more advantageous your interest rate and lending terms will be. In recent months, the average fixed rates on 30-year and 15-year mortgages have been historically low, reaching 3.04% and 2.3%, respectively, in August. If you have a low credit score, consider taking the time to improve your credit so you can qualify for lower interest rates.
Do you need a 20% downpayment? No, you can put less money down, especially if it’s your primary residence.
With a good credit score, you can get a conventional mortgage with a down payment as low as 3% of the purchase price if you’re a first-time homebuyer. But, when you put less than 20% down, you have to pay private mortgage insurance or PMI on a conventional loan, which is usually around 0.5% to 1% of your loan amount every year.
The minimum down payment for an FHA loan is around 3.5% of the house price, but you might be required to put at least 10% down depending on your credit score. You’ll have to pay a mortgage insurance premium or MIP on an FHA loan regardless of how much you’re putting down. It includes a monthly premium of 0.45% to 1.05% of the loan amount per year, as well as an upfront premium fee of 1.75% of the loan amount, which can be part of the closing costs.
A USDA loan does not require a downpayment. But, similarly to an FHA loan, there are mortgage insurance fees: one upfront of up to 1% of the loan amount and an annual fee of 0.35%.
A down payment is not required for VA loans, and there’s no private mortgage insurance. However, that option is only available to Veterans, Service Members, and select military spouses.
Putting less than 10% down in this current market where house prices are increasing rapidly is risky. You would run the risk of being upside down on your house (owing more than the home is worth) if home prices decrease in the near future. It’s important to weigh the pros and cons of having a lower down payment before deciding what’s best for you. One thing that can help mitigate the risk is to ensure that before purchasing a home you have a fully funded emergency fund.
There are fees above the purchase price known as closing fees, which are usually between 3% and 6% of the home purchase price. Closing costs cover loan origination, appraisal, survey fees, title insurance, escrow and attorney fees, and other miscellaneous fees.
For the average home price of $293,349, closing fees can be between $8,800 and $17,600. First-time homebuyers are not always aware of that significant expense associated with buying a home. You should include closing fees in your budget, or it might significantly impact how much house you can purchase.
Most sellers require to see a mortgage pre-approval letter to consider an offer. A mortgage pre-approval letter lets the seller know that you meet all the requirements to get approved for a loan up to a certain amount. It gives a benchmark of how much a buyer can afford to spend to purchase a home.
Before issuing a pre-approval letter, a lender will require to see evidence of assets, income, good credit, employment verification, and possibly additional documents. A mortgage pre-approval is different from a mortgage pre-qualification, which estimates how much credit a potential buyer can afford based on numbers provided by the borrower without verification by the lender.
Finding a Mortgage Lender
When looking for a loan, there are several options to consider, from conventional banks to credit unions or online lenders.
Most lenders today give you the option to apply online before being assigned a mortgage loan officer. A good lender should help you find the best option for you instead of only providing quotes.
You might be more inclined to use a traditional bank or credit union if you already have an account at the institution.
A credit union might offer more competitive rates than a traditional bank and more personalized service. Though membership might seem intimidating, you usually need to have a common bond with other credit union members to be eligible. There are many credit unions, and finding a suitable one shouldn’t be too much of a hassle.
In my experience, online brokers have provided the best offers and a more convenient way to shop around for the most competitive rates. But, you should be prepared to receive many phone calls from companies offering to work with you on your mortgage or other services. If you have a secondary number, consider using it instead of your primary number.
A nonbank mortgage lender does not offer traditional banking services but can provide various loan options, possibly at a quicker turnaround than a conventional bank.
You can also work with a mortgage broker to review offers from various lenders and find the best option for you.
Employment & Income Requirements
To determine if you qualify for a loan and how much you can borrow, a lender will look at your income and employment history. The typical documents that a lender requests to verify employment and income are:
- An employment verification letter.
- Two years of tax returns.
- Proof of income for the past two years.
Depending on if you are an employee or a contractor, you will need to provide two years of W-2s or 1040s. If you’re self-employed, the lender will likely ask for additional documentation and possibly contact your Certified Public Accountant to help determine if your business is stable enough to grant you a loan.
Lenders will also review your income. According to the 28/36 rule, you shouldn’t spend more than 28% and 36% of your gross monthly income on your housing expenses and debt payments, respectively. You might still qualify for a loan if you don’t meet the 28/36 rule, but it’s a good reference point as you assess how much house you can afford.
The debt-to-income ratio is a metric lenders use to determine whether to grant you a loan. The debt-to-income ratio, or DTI, is the percentage of your gross monthly income that you spend towards paying off debt. To determine your DTI, you divide the total amount of your recurring debt (car payments, rent, student loan debt) by your monthly income. For instance, if your debt is $2,000 per month and your monthly income is $6.000, your DTI is 0.33 or 33%. The higher your DTI, the riskier of an investment you are for a potential lender; very few lenders will issue a mortgage loan if your debt-to-income ratio is higher than 43%.
The Bottom Line
Buying a house, especially for the first time, can be a stressful experience. Being informed about the process and gathering the information you need to provide to be approved for a loan can help make the experience less overwhelming.
For more insights, check out the free Personal Capital Home Buying Guide. When you download the guide, you also gain access to Personal Capital’s free and secure online financial tools. You can use these free financial tools to:
- Track all of your financial accounts in one place
- Set and monitor your home-buying savings goals
- Analyze your investments and uncover hidden fees
Personal Capital compensates Anne-Lyse Wealth (“Author”) for providing the content contained in this blog post. Compensation not to exceed $500. Author is not a client of Personal Capital Advisors Corporation. The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.