Credit, Mortgages and Your Ability to Buy a Home: It Doesn't Have to Be Scary
Lenders want you to be able to buy a house, but first, they want you to understand what you sign.
The subprime mortgage crisis is still a wound that hasn't fully healed for many Americans, serving as a cautionary tale against buying a home. The fact that millions of people lost their homes is hard to forget, and many who witnessed the tragedy are leery of entering the market for fear of another housing bubble just waiting to burst.
Margaret McNeal, a housing counselor for ClearPoint Credit Counseling Solutions, a national financial counseling organization based in Atlanta, says many homebuyers didn't understand their mortgages, which became a major contributor to the housing crisis. “Primarily, people weren’t educated,” she says.
While the economy has largely returned to pre-recession levels, and the real estate market has recovered, many consumers are still a little gun-shy to close on a home.
John Sulzbach, a financial and housing counselor for LSS Financial Counseling in Minneapolis, likens lending to a pendulum, swinging back and forth over time, reacting to market events and borrowers. “It went from greed in 2007 to fear in 2008, ’09 and ’10. Now I see that pendulum is coming back to a more neutral position,” Sulzbach says, adding that lenders are doing their due diligence when considering a loan and want borrowers to do the same.
Buying a home shouldn't be scary. The key is understanding your financial situation and what you are able to afford, as well as the kind of lending you sign on for. Following the steps below will not only make buying a home possible, but a positive financial move.
Know your credit score. Potential homebuyers should know their credit score and any problem areas in their credit history, which can be obtained through a number of free providers like AnnualCreditReport.com.
With your credit report, you can spot errors and areas that require additional effort to improve your credit score, which could help get you better mortgage rates.
While a mortgage may have seemed hard to come by unless you had stellar credit during the recession and immediately following it, that’s not the case today. Those with credit scores below the good rating of 700 can potentially show their creditworthiness through nontraditional credit scores, which factor in nontraditional lines of credit, such as utilities payments and rent that aren’t included in a FICO score.
Sulzbach recommends using a nontraditional credit score to see what actions might best improve your credit history, rather than to actually get a home loan. He says he advised one interested homebuyer with little credit history who couldn't receive a FICO score. In that case, the buyer used a nontraditional score to see what credit areas he should work on.
Though less common, nontraditional lines of credit are used by some lenders to determine the best possible loan for a borrower, like with BECU, a credit union based in Seattle that primarily serves residents and workers in Washington. Lorraine Stewart, vice president of mortgage lending at BECU, says nontraditional sources of credit can be helpful for finding the right type of financial assistance for a member with a weak credit history.
“Many people out there today – especially first-time homebuyers – a lot of them haven’t established a lot of credit, and so we have to look at alternative sources of credit,” Stewart says.
Educate yourself and get organized. All homebuyers, whether it’s their first house or fifth, should take the time to educate themselves on their finances and changes to government regulations on lending.
McNeal says homebuyer workshops are a great way to learn the process step by step. Many local state and city governments set up free or low-cost workshops that include conversations with real estate professionals so consumers can better understand each group they will work with, from loan representatives to home inspectors.
Banks want you to be more educated as well, McNeal says. "They’re in some cases requiring that you go through some type of workshop – whether it’s online, over the phone, in person – so that you have some knowledge of what’s going to happen throughout this process,” she explains.
Stewart adds that all homeowners should have the necessary documents in order to give the lender during the application process. “You’re going through the biggest transaction in your life – buying a home, especially for the first time – and then there’s someone asking for a bunch of information on top of it,” she says. Pay stubs, W-2 forms and bank statements are among the required documents. You should also be prepared to explain any anomalies in your past, like a significant gap of time between jobs.
Shop the loan before the home. Meet with multiple loan representatives the same way you would meet with multiple real estate agents before choosing one. Explain your needs and get a feel for how well you fit with the lender, especially when you might be tied to the lender for up to 30 years.
When it comes to deciding between a major bank and a smaller, local lender, it ultimately comes down to personal preference. The smaller you go, the more personal experience you could have over a larger lender that might offer more online features to meet a consumer's immediate needs quickly.
Whichever lender you choose, know that their goal is to make "sound credit decisions," Stewart says. "All lenders are now tasked with the responsibility to determine if a borrower has an ability to repay the mortgage," she says.
Buy the home you can afford. While everyone has their own version of a dream home, it’s imperative you stay realistic while house hunting – going after a home you can’t afford or would struggle to keep up with financially can turn that dream into a nightmare.
Before actually stepping into the world of owning a home, Sulzbach recommends that you pretend you’re buying a house. If you think you can afford a certain amount in monthly mortgage payments, and the amount is more than your rent now, put the difference into savings each month. Take into account the cost of utilities and maintenance that are currently included in your rent and put that away, too. The exercise will give you a realistic view of the cost of owning a home before taking the plunge.
The additional savings will be put to good use, Sulzbach says: "Now you’re saving up for that down payment.”