Each homebuyer is different, and the next wave of first-time home buyers has the potential to drastically change the way mortgage lenders operate.
With a wave of freelancers and contractors marching toward self-employment, and companies like Uber and Airbnb offering new, unprecedented ways to make money, income streams are less consistent and more diversified. After the financial crisis in 2008, many people rejected the use of credit cards and worked to eliminate debt altogether.
These shifts in how people can earn a living create great new opportunities, and you could take advantage of them if you are so inclined. Refusing to get trapped into a credit card debt cycle is admirable. But mortgage lenders aren’t known for dealing with change well, and many have not adapted to the new economic realities.
Being self-employed or lacking a credit history can make getting a home loan complex – but don’t worry. If you do your research, there are steps you can take to make the process work for you instead of against you. Here are some common roadblocks to home buying and what you can do to address the issue.
My credit score is low
Do you know your credit score? If not, you should check it soon. There are many ways to check it for free online that won’t affect your score, and you will get a nice summary to help you understand where you stand.
Many mortgage lenders require a minimum credit score to lend money. Every lender is different, but we can tell you that the minimum score for FHA loans is 580 to qualify for their low down payment loans. The higher your score, the less risky you are as a borrower, and the better interest rate you’ll generally get.
Anything above 780 will usually get you the best rates. If you have a low credit score credit, don’t worry – working with a credit counselor can help you take the right steps. The Justice Department has a useful list of approved counselors that you can check out here.
Also worth noting: different types of lenders use different calculations to determine your credit score. Your FICO score for your auto loan is different than the score for your credit card or your mortgage. Often times the score you’re given online is using a different calculation, and the mortgage score tends to be lower than the rest. Don’t be surprised if the score a mortgage lender uses to quote your loan is different than what you expected.
I don’t have enough for a 20% down payment
You are not alone. A Google Consumer Survey found the average person in the U.S. has less than $1,000 in savings. A conventional loan requires 20% down, but there are many products that ask for far less – from 10%, 5%, and in some cases 0% cash down.
Still, a down payment is not the only thing you’ll need cash for when buying a home. Many first time home buyers don’t realize there are closing costs that must also be paid. But don’t fret! There are many options to deal with these as well – from having the seller cover the costs or having the lender cover them.
If you’re interested in buying a home at some point, one great thing you can do is be diligent about saving money. One option is to open a dedicated “house fund” and auto transfer money every month. Setting a goal is important here, and automating that goal makes the process painless.
- Pro-tip: Instead of opening a savings account with your existing bank, choose a different bank altogether. If you make your house fund difficult to access, you will be less likely to dip into it.
My parents / family friends / rich oil baron uncle is helping me with my down payment
The use of gift funds can seem like a natural solution for borrowers with limited access to cash. In many cases, family (or some really supportive friends) can gift money to a borrower to help cover the down payment or closing costs. These are called “gift funds,” and while they are perfectly acceptable, they can make lenders nervous.
All lenders will require a letter from the person gifting the money that states the money is not a loan and does not need to be repaid. Getting this letter ahead of time is a great proactive step.
The finer points: budgets, emergency funds, and debt management
There are a number of steps you can take right now that can make things easier when it comes time to get a loan, and they can also help you qualify for a larger loan or specialty programs.
Build a budget
Budgeting in general is important, but new home buyers will need to budget for home-specific expenses like furniture, decorating, renovating (interior), yard improvements, etc.
Having an emergency fund is also important. If your car breaks down or your AC unit goes out after you move in, you’ll take comfort in the fact that you have the cash on hand to take care of the situation.
Also, some types of mortgages have a reserve requirement for you to close your loan. A proper emergency fund can help show you have cash in the bank in case the lender requires 3-6 month’s worth of monthly mortgage payments in reserve.
Manage other debt
Outside of your income and down payment, your monthly debt payments are the next biggest thing that affect affordability. Eliminating even $100 in monthly payments can increase your affordability by tens of thousands of dollars.
- Reduce debt – There are thousands of articles online about lowering your overall debt. We like the debt snowball approach, but there are many strategies to pay off debt.
- Consolidate debt – Before you sign up for home loan debt, you might consider consolidating or even eliminating other debt first. Refinancing variable rate student loans, consolidating credit card debt, or paying off other loans can have a major positive impact when the time comes to buy a home. Balance transfers on 0% interest cards can be a great tool too, especially when they give you cash back or travel rewards. Just make sure you pay the debt off before the interest rate takes effect!