Thinking of buying a house?
How to drum up a down payment.
The price of a house can be intimidating, especially to first-time homebuyers.
The national median listing price set a record of $310,000 in April, according to Realtor.com. At the same time, most first-time buyers are searching for a home priced at $150,000 or less, according to a recent survey from LendingTree.
That kind of discrepancy could chase many would-be homebuyers back to the rental market, scared there’s no way they can buy a home.
But there are many factors in your control that can help you afford a home purchase. Some may require advance preparation, such as saving and improving your creditworthiness.
In other cases, you just need to be open to more options when it comes to mortgages and houses.
Here are ways to afford your new home.
Find a down payment
The more you contribute to the purchase of your home, the smaller your monthly mortgage payment will be. If you’re able to cough up 20% of the purchase price, you’ll also avoid private mortgage insurance that can add to the monthly cost.
Before you start your house hunt, add up what you have for a down payment, including a job bonus, your tax refund, savings and gifts from family. If you don’t have a lot – or even anything – for a down payment, all is not lost. Some home buyers can qualify for no- or low down payment options from the Veterans Administration, Agriculture Department and more.
Reduce your DTI
Another key factor to qualify for a mortgage – and afford your home – is the debt-to-income ratio, or DTI. Lenders add up your monthly debt payments including your future mortgage payment and calculate how much that makes up of your monthly gross income.
The higher the ratio, the riskier the borrower. If your DTI is too high, you might not qualify at all. Every lender sets its own DTI requirement. If your DTI is getting close to the edge, you need to reduce your monthly debt obligations. Refinance car loans and consolidate other debts to lower monthly payments.
When it comes to credit card debt, forget conventional personal finance wisdom of paying down the debts with the highest rates first. In this scenario, you want to pay off debts that have lowest balances and highest monthly payments to immediately reduce your DTI.
“This allows you to get the biggest bang for your buck in bumping up your borrowing power,” says Scott Sheldon, branch manager for New American Funding in California.
Raise your FICO score
Before shopping for a home, it pays to
work on improving your credit score before the big purchase. Why? Because it translates into savings.
First, lenders give lower mortgage rates to borrowers with higher credit scores. That means you’ll pay less interest over the life of the loan and your monthly payment will be smaller.
For instance, if you have a credit score of 760 or higher, you qualify for a 3.86% rate on a $216,000 30-year, fixedrate mortgage, according to FICO. That’s a $1,014 mortgage payment. But if your score is 650, then your rate goes up to 4.9% with a monthly payment of $1,147.
Similarly, your credit score affects the premium you pay for private mortgage insurance, or PMI, which is required if you put down less than 20% of the purchase price.
For example, on a $250,000 home with 10% down, the monthly PMI payment would be $71.25 if your credit score is 750.
But if your score is 650, then the PMI payment is nearly $100 more at $170.63 per month, according to John Stearns, senior mortgage originator at American Fidelity Mortgage in Wisconsin. “If you have a bad credit score, you’re dead in the water,” Stearns says.
The fastest way to improve your credit score: Set up automatic bill payments so you’re never late. Reduce or eliminate the balances on your credit cards to 30% or less of the credit lines. And get rid of any errors on your credit report.
Explore all loans
Don’t fixate on a specific mortgage loan program. Instead, find out all the options available to you from a professional mortgage professional before you even start your search. In fact, it might not be a bad idea to know you qualify for more than one mortgage as you shop around, says Sheldon.
Adjust expectations
The home you can afford may not be one that checks all the boxes, especially if you’re a first-time buyer in a market with limited entry-level homes. It’s smart to prioritize your absolute musthaves from your would-like-to-haves.
Other quick tips
Interest rate: Another way to lower your mortgage rate – and reduce your monthly payment – is to buy down the rate, says Pava Leyrer, COO of Northern Mortgage in Michigan. You can do a permanent buydown, where the lower interest rate lasts the life of the loan.
Or, you can do a temporary buydown where the lower rates lasts a couple of years. Both require upfront payments at closing. In some cases, the seller will pay for the buydown as a concession.
❚ PMI: You can also eliminate the monthly PMI premium by prepaying the mortgage insurance upfront. The prepayment can be financed into the loan, but results in a lower monthly payment than one with monthly PMI.
❚ Insurance and taxes: What you pay in taxes and insurance can differ by zip code and county, so a house one street over may make a big difference to your monthly payment.
Compare insurance rates online and local property taxes. When budgeting, bet that these costs will go up in the future, says Leyrer.