Buying a house will be the largest purchase most people will make in their lifetime, and mortgages allow people to afford real estate without paying in full up front. Much like a car loan, a mortgage is a type of debt instrument where the borrower pledges the real property to the lender as security for payment of the debt. The lender holds onto the title of the home until the borrower completes their payments or until the home is sold or transferred.

 

Preparing to shop for mortgages is a critical step in the home buying process, which is especially true for first-time home buyers. Borrowers are often unprepared once they begin shopping around for mortgages not knowing how thorough lenders examine their financial profile. To better prepare first-time buyers like yourself, we put together a helpful blog post to help you before you begin shopping for a mortgage. We work with mortgage brokers, credit unions and banks and are happy to introduce you to highly recommended local professionals to get pre-approved for a mortgage.

 

To determine how much you can afford, lenders will examine four requirements before approving you, the first-time home buyer, for a loan: Cash, Credit, Capacity, and Collateral.

 

To lenders, Cash includes the size of your down payment, and if you can afford a few months worth of living expenses (including mortgage payments) similar to an emergency fund, plus how much your closing costs will eat into your savings, and the origin of your cash flows (employment history, windfalls, gifts, etc).

 

Down payment: Lenders will want to know how much you are able to put down. Most conforming loans require at least 20% down, yet there are multiple loan programs available to you (including 3% down FHA loans) which can help if 20% down is not feasible. Adjusting the size of your down payment and reducing your debt-to-income ratio are two ways to secure better loan terms.

 

Closing costs: When you close on your dream home, you will typically incur closing costs equal to 2 to 5 percent of the purchase price of your home. The type and number of fees will depend on multiple factors, so it’s important to speak to a real estate professional who specializes in East Bay real estate. Lenders will want to know if you can cover closing costs.

 

Reserves: Lenders will want to know how much savings you have left after the down payment and closing costs. If you have little saved up, lenders may worry about your ability to make mortgage payments if you have an unexpected financial emergency. Demonstrating your ability to save is equally as important as the depth of your savings.

 

Gifts and loans: Lenders will want to know if you’ve received any cash gifts from friends and family to help out with your down payment. Although the presence of a gift won’t harm your chances of securing the right mortgage, undisclosed gifts can. Lenders will want to know about sudden windfalls to make sure you are following the law.

 

To lenders, Capacity means your ability to make payments based on your take home income versus your debts, including the mortgage. Although borrowers give Capacity more weight over the other three factors, lenders consider your take home income just as seriously as Cash, Collateral, and Credit.

 

Housing-to-income ratio: Lenders will want to know how much of your monthly income will be spent on your total housing costs, including your mortgage, property taxes, HOA fees, and any other housing-related expenses. The golden rule for the housing-to-income ratio is 30%.

 

Debt-to-income ratio: Your mortgage may not be your only financial obligation, which is especially true for first-time home buyers who may have student loans. Carrying other types of debt will not scare lenders, yet lenders will want to know the right mortgage you can carry without financial burden.

 

A mortgage is a debt instrument where the real property (your house) will be used as collateral if the worst happens and you default on your loan. To lenders, Collateral means ensuring the home’s value matches with the loan amount, so if the worst occurs, the lender knows the debt can be settled.

 

Independent appraisal: The house will be inspected and appraised based on a set of factors, including recent sales in the immediate area, the location, fixtures and features, and income potential from rentals to name a few.

 

Health and safety: Lenders will want to know that the house in question is both habitable for your use and in sound condition if the property needs to be sold if you default on your loan.

 

Lenders will build a holistic view of your credit history to better understand your financial volatility as a potential borrower. Credit is your ability to repay debts in a timely manner, which is important considering you’ll be on the hook for a large loan lasting years.

 

FICO: To a lender, your credit score is like your financial/adulthood GPA. It helps institutions gauge how well you can handle lines of credit, and ultimately how well you can handle debts. There are many factors to consider with your credit score, and lenders will want to see a benchmark of 580 for most FHA loans and 620 for most conventional loans. 740 is the threshold most finance experts agree gives you a good chance for a good rate, and any score 780 and over gives you the best possible position for the lowest rates.

 

Additional tips for first-time home buyers searching for real estate in Berkeley, Oakland, El Cerrito, and Albany:

 

Mortgage terms will vary depending on the market, and the Bay Area is no exception! Although it may seem like securing the right loan may be impossible, there are plenty of ways to better prepare today for a mortgage in the future:

 

• Save up for a larger down payment. It’s common for family members to gift funds for a down payment, especially in the Bay Area.

• Reduce debt-to-income ratio by paying off higher interest debts. Whereas student loans have lower interest rates, credit cards (including store cards) should be tackled first.

• Consult with a local market expert. Speak to a real estate professional who specializes in East Bay real estate to learn what closing costs to expect.

• Establish an emergency fund independent from your savings account. Show lenders that you have enough saved that won’t be affected by closing costs.

• Fuel your savings. Demonstrating your ability to save is equally as important as the depth of your savings, too.

• Focus on your FICO today. Demonstrate proper debt handling by making timely, structured payments on all your debts.

• Follow the Golden Rule. The ideal housing-to-income ratio is 30%, so consider the size of your mortgage payments versus your gross income.

When you’re ready to start your home search, contact a Marvin Gardens real estate agent who specializes in East Bay real estate. We’ll guide you through the home buying process.