From net income and credit scores to monthly expenses and more, your finances can impact mortgage payments, down payments, and interest rates on your new home.
Check out these important tips to know as you build your budget and begin looking into loan options during your homebuying search.
Understanding Your Finances and Budget
One of the first steps in any homebuying search is understanding your financial situation. Identify your monthly net income — sometimes known as take-home pay after taxes and other benefits — to see what you can afford to pay toward a mortgage each month.
A good rule of thumb, according to Chase Bank: Borrowers should follow the 28% rule, which says that your mortgage payment — including principal, interest, taxes, and insurance — shouldn’t exceed 28% of your monthly gross income.
An easy way to calculate the maximum mortgage payment you can afford is by multiplying your monthly gross income by 0.28:
- Monthly Gross Income = $3,000
- $3,000 x 0.28 = $840
With this in mind, the 28% rule is only effective if you remain conscious of your spending outside of your mortgage payment. For example, if your monthly gross income falls within the 28% rule but the remaining 72% of your budget is taken up by car payments, you'll have no wiggle room for essentials like groceries, daycare, gas, and more.
Need additional help? Start by understanding your after-tax income and track your progress as you spend. NerdWallet says that one of the most common budgeting frameworks is the 50/30/20 rule, where 50% of your after-tax dollars is dedicated to necessities, 30% to wants, and 20% to savings and debt repayment.
Different Loan Programs and Ideal Credit Scores for Each
Homebuyers have several different loan options to choose from when they’re ready to make their purchase. Some loans are administered by private companies while others are government-backed, which means that they’re insured by federal agencies like the USDA and VA.
Each of these is associated with different requirements for a buyer’s credit score and DTI ratio. A few of our customers’ most common loan types include:
- Conventional: Credit scores must be at least 620 (680+ preferred) with a DTI of up to 50% and a minimum of 5% down.
- FHA: Backed by the Federal Housing Commission (FHA), credit scores for these loans must be at least 580 (640+ preferred) with a down payment of at least 3.5%.
- VA: Administered by the Department of Veterans Affairs (VA), buyers can put as little as $0 down with lower interest rates than other loan types. Applicants must be in the U.S. Armed Forces or National Guard to qualify. Preferred credit scores should be at least 640.
- USDA: Loans through the United States Department of Agriculture (USDA) can be as little as $0 down if the buyer meets certain requirements. Preferred credit scores should be at least 680.
Avoid Large Purchases and Additional Loans
Don’t make any large purchases or take out any additional loans. This can include everything from buying a new car to financing a fresh mattress. These purchases may seem harmless, but any new loan transaction paid for in installments can impact your credit score.
As a result, a dip in your credit score can impact the interest rate on your home loan or even jeopardize your ability to qualify for the loan.
Stay on Time with Payments
As a good rule of thumb, anything that can impact your credit score should be avoided if you’re in the process of purchasing a home. This includes staying on time with payments on existing loans, including for vehicles and student loans.(see https://g.co/ng/security#xss)