More so than ever before, buyers are finding themselves up against an array of obstacles that must be overcome prior to obtaining the keys to their new home; the first of which is saving for that down payment. Outstanding debt, checkered employment histories, and a lack of documentation are other substantial obstacles that will hinder your dreams, yet none of these hurdles are insurmountable if managed properly.
Saving for a Down Payment
The first step to establishing the amount you will need for a down payment is determining the price point of your desired home. Those looking at homes with a $150,000 price will need a much smaller down payment than those looking in neighborhoods or markets where the average home sells for $650,000. It is also important to determine how you plan to finance the house. Though it is typically best practice to save twenty percent as a down payment, there are arrays of loan programs, such as Federal Housing Administration (FHA) and Veteran’s Administration (VA), that allow homebuyers to put down a more modest amount. Typically, the higher the down payment, the lower the interest rate a person will be able to obtain.
Once the price point and mortgage program are established, you will have a better understanding of the amount needed as a down payment. When there is a gap between savings and the amount required, a person has a number of options:
- Automatically deposit money from paycheck into a checking, savings, or money market account. Money market accounts have a few drawbacks, such as minimum balances and higher fees, but often provide a higher rate of return than traditional savings accounts.
- Draw from other investments, such as IRAs, 401(k)s, and stock market accounts. Tax laws allow a person the ability to withdraw $10,000 from an IRA on a one-time, penalty-free basis. Married couples can leverage up to $20,000 this way.
- Explore city and state programs for first-time homebuyers; they many offer eligible buyers down payment assistance. Usually these take the form of forgivable loans.
Grappling with Debt
There are any number of reasons why a person may have significant debt, often times the debt is through no fault of their own. Whatever the reason may be, paying this debt is a critical step toward buying a home. Many mortgage programs have strict debt-to-income ratios. If a person has debt that exceeds these ratios, obtaining a loan approval may be challenging unless the loan is approved by an automatic underwriting system by FNMA or FHLMC. A conforming loan will be even more challenging.
There are a number of scenarios to the homebuyer who has a high debt-to-income ratio. First, a buyer may consider a smaller down payment in lieu of investing other free cash towards the repayment of existing debt. Second, a person may accept the penalties for doing so and withdraw money from retirement accounts to pay off existing debt. Another option is to seek a co-signer for the loan, someone with a higher credit score and a lower debt-to-income ratio. Be sure, of course, to consider the implications of having a co-signer and what this means for your long-term investment strategy.
Establishing a Stable Job History
When banks issue mortgage notes, they want to know that the borrower will be able to repay the loan. In order to do so, many lenders require borrowers to have at least two years of employment with the same employer to establish stability. If you are considering purchasing a home in the near future, it is not wise to suddenly change jobs. Of course there are exceptions. For example, if a job offer presents itself that pays significantly more than what you are currently earning, this will be looked upon favorably if it is in the same line of work.
Make sure that you have the job offer in writing and at least 30 days of pay stubs to back up the offer letter for the bank to confirm the new earnings. Lenders will average your earnings over the course of the past twenty-four months, even if a person is now earning substantially more than previously (Sheldon, 2014). It is also important to note that overtime, commissions and bonuses are not typically taken into consideration when establishing a person’s earnings unless these additional sources of income have an established history of at least two years.
Compiling Proper Documentation
Today, lenders require prospective borrowers to compile a range of documents in preparation of issuing a loan commitment. In addition to the pay stubs noted above, a person should be prepared to submit 2 months of bank statements, 2 years of Federal tax returns and 2 months of statements regarding additional assets, such as retirement accounts and stock portfolios. All funds that will be used toward the down payment and closing costs must be established and in a readily-accessible account prior to the bank issuing a loan commitment.
As is often the case in life, the most difficult things to accomplish are often the most worth working towards. While there are certain financial realities that come with buying a house, the outcome is worth the effort needed to overcome the hurdles identified here. Owning a home provides financial stability, long-term equity, and an investment that can be passed on for generations to come.
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Eric Lawrence Frazier, MBA
President and CEO
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FHA Requirements: Debt-to-Income Ratio Guidelines, FHA.com (2015). Retrieved September 8, 2015 from https://www.fha.com/fha_requirements_debt.
Sheldon, Scott. Why Your Job Matters When Buying a Home, Credit.com (16 July 2014). Retrieved September 8, 2015 from https://blog.credit.com/2014/07/why-your-job-matters-when-buying-a-home-88105.