Credit Bureaus

The information in your credit report is gathered by reporting agencies called credit bureaus who then offer it to potential creditors.  The three main credit agencies are Equifax, TransUnion, and Experian.  A creditor will make a decision about you with regards to your credit risk by looking at these companies’ reports.  To better analyze your credit, you are assigned a credit score, a three-digit number that takes into account all of your credit history. The numbers range from 300-850; the higher the number indicating a better credit risk.

How is your Credit Score Determined?

Points are assigned based on items in your credit history. Your resulting score is compared to those of other consumers with similar profiles.  With this information, mortgage lenders have a pretty good idea of  how likely somebody is to repay their loan on time.  There are different scoring methods out there but the most common is known as a FICO score.  The name comes from an independent company who created it; Fair Isaac and Company.  This is how the score is broken down:

• Payment history – 35%
• Amounts owed – 30%
• Length of credit history – 15%
• New credit – 10%
• Types of credit – 10%

The number and types of inquiries also play a role in determining your score.  Public inquires, including bankruptcy filings are considered as are the number of inquiries made.  If too many new credit inquiries exist, this may indicate to the lender that you are preparing to go into additional debt by taking out new loans.  Fortunately, mortgage inquiries do not fall into this category.  All inquiries from mortgage lenders within a 30-day period count as one inquiry.

Regardless of your personality type, there are specific characteristics all first time home buyers should have.  If only for the duration of the home buying process, you must consider yourself the following:

A Realist

Carefully and honestly distinguish between what you want in a home and what you need in a home. Be careful not to stretch your budget for features that you simply don’t need and won’t use much.

Analytical

Never hesitate to ask questions no matter how silly you may think they are.  Remember, this is one of the biggest financial decisions you will make in your life time; you deserve to have every bit of information you need.

A Negotiator

Negotiating plays a significant role in the home buying process.  To make sure you are getting the best possible deal on your home, it is a must.  If you are working with a real estate professional, you will have somebody to do this “dirty work” for you but you are the ultimate decision maker in this regard and it pays to be strong and decisive.

Patient

Your home buying process may end up being quick and simple or it may be a bit more challenging and take quite a while.  Be prepared for either case and remember every decision you make today should be made for the long haul.  Your goal is to get the best home for you and your family; not to get in one quickly.  Never settle for something you may regret later; your patience will undoubtedly pay off.

If you find it difficult to be the person with these traits, work with somebody who can be these things for you.  Choose somebody in addition to your real estate professional: a friend, family member or colleague.

Let’s take a look at what you will need.

• The very first thing you should do is request a copy of your credit report.  Make sure there are no outstanding problems or errors that may prevent you from taking out a mortgage.  It could take some time for discrepancies to be cleared up, so get this process going immediately.  Along the same lines, be mindful of activity that is happening with your accounts during the home buying process.  Avoid transferring large sums of money or taking out new debt.

• Now it is time to create a file of your financial records.  Here is what you will need:
  • W-2’s and tax returns for the last two years
  • Pay stubs for the last two months
  • If self employed, two years of tax returns plus a current profit and loss statement (i.e. income statement).  If your income has been irregular you may need to produce account information from the last three years.
  • Two months of checking account statements
  • Two months of statements from other accounts (IRA, savings, money market, etc.)
  • Documentation of other assets such as stocks, bonds, and CD’s
  • Records proving that derogatory credit report items are paid off
  • Social security numbers for those buying the home
  • Two years of employment history; preferably steady work in the same industry
  • Balances of other debt including car loans, store charge cards, credit cards, etc.
  • Current landlord’s contact information, monthly rental payment amount, and previous landlords for the last two years
  • If you currently own a home, have ready the address, mortgage lender, account number, payment amount, balance, and current market value of your home.
• The following are particular circumstances that may or may not apply to you:
  • If you are separated or divorced, you will need your divorce decree or separation agreement.  Include also child support payment amounts to be included in your income.
  • If public assistance is part of your income, you will need to provide the amount you receive.
  • If you have declared bankruptcy or have gone through a foreclosure or any other credit-related judgments against you in the last seven years, produce documentation of the proceedings.

The thought of gathering these items may seem tedious to you but is a critical step in the home buying process.  Make copies of all documentation or better yet scan each piece and store it on your computer to be printed or forwarded electronically as needed.  Stay organized by purchasing a portable accordion-style folder to store the originals and hard copies.

There is a great chance that buying a home will be the largest item you will purchase within your lifetime.  It is extremely important to consider the matter carefully before making the decision to become a homeowner.  Ask yourself these questions:

• Do you take in enough income to cover the cost of owning a home?
  It is not just the monthly payments you need to consider.  The other costs involved with the purchase of a home include:
  • Origination fee
  • Inspection fees
  • Survey
  • Appraisal
  • Credit report fee
  • Tax services fees
  • Attorney’s fees
  • Title insurance
  • Homeowners insurance
  • Taxes

In addition to the closing costs above, think about what you might spend to fix up the home and yard after you move in.

• Is your credit history in good enough shape to allow you to get a mortgage? These days it can be especially difficult to get a mortgage with bad credit.  Obtain a free credit report immediately, review it carefully, and clear up any problems before you begin the mortgage application process.
• Do you have enough cash to cover the down payment on the home as well as the closing costs we discussed above?
  Ideally, you will want to put down as much as 20% of the purchase price for the home.  While, some buyers can get away with putting down less, often times the mortgage fees and higher interest rates that come along with a low down payment will outweigh the benefits.
• Are you mature enough to take on the responsibility of owning your own home?
  As exciting as it can be to move into your own place, you will also be your own landlord and will need to take care of your own repairs and maintenance, or find the money to hire somebody to take care of them for you.
• How long do you plan to stay in your new home?
  A good rule of thumb is to not buy a home if you plan to live there for less than two years.   There are very few areas that appreciate fast enough to cover the fees that are involved in the purchase of the house.

By answering these questions honestly and thoroughly, you’ll know if you are truly ready to buy your first house.

For example, if you buy a home for $100,000 with a down payment (investment) of $20,000 and the value of the home then increases to $140,000, you can sell your home and make $40,000 from your $20,000 investment.  Although you will most likely use a chunk of that for the fees to sell your home, you can see how using other people’s money can be a great way to invest.

• Groceries
• Utilities
• Telephone
• Insurance (Auto and Health)
• Medical Payments
• Car Payments
• Car Maintenance and Repair
• Public Transportation
• Alimony
• Child Support
• Children’s Expenses (Clothing, Activities, School)
• Childcare
• Dining Out
• Entertainment
• Big-Ticket Items (Furniture, Electronics, etc.)
• Vacations
• Hobbies
• Memberships
• Charitable Donations
• Savings
• Gift Giving
• Miscellaneous
• Add 5% for Items Overlooked or Unexpected Expenses

For budgeting on a monthly basis, it is a good idea to break down these categories into sub-categories. But for purposes of getting an accurate home affordability picture, using the above numbers will put you on the right track toward responsible homeownership.

No two home buyers will be looking for the same features in a new home.  A newlywed couple will be looking for different things than a couple who is close to retirement.  Let’s take a look at the neighborhood-specific factors a young family should evaluate.  It should not be surprising that many of these items are school-related:

• School quality in the area
• Comparative standardized test scores of the school district and schools
• Status and background of the superintendent and school principals
• Number of children in each classroom
• Student/teacher ratio for each classroom
• Age of the schools
• Safety in the neighborhood and the community
• Proximity to parks and community centers
• Proximity to libraries and religious institutions
• Traffic patterns in the neighborhood
• Time away from your children due to a long commute

If you do not have children yet, it may be difficult to fully grasp the importance of these factors, but you absolutely must take them seriously if you plan to raise a family in this home.  You will be so very glad you did.

It is a good idea to have the following information ready to go when you are heading to a mortgage lender for preapproval.  This information can be gathered well before a purchase agreement is signed.

• Recent paycheck stub.
• If you are self-employed, last two years of income tax returns.
• Proof that you have the funds for a down payment on a home.  Two or three months of current bank statements may suffice; though in some cases, the lender may want verification directly from your bank.
• Employment verification showing how long you’ve been employed at your current employer. In many instances, your lender can verify this information with a phone call.  Your employer may also need to indicate the chances of your continued employment with them.
• Credit report fee.  This is the only fee a lender should request during the pre-approval process.  If the lender asks for more at this point, find another lender.
• Supporting documents that clear up any issues or discrepancies that may be present on your credit report.
• If you are refinancing, you will need to provide a recent mortgage statement.
• Bankruptcy papers, if applicable.
• Divorce degree papers, if applicable.

Begin gathering this information as soon as you decide to start looking for a home.  Review the benefits of mortgage pre-approval here.

A popular rule of thumb states that it is worth looking into refinancing your mortgage if the going rate is 0.50 percent lower than your current rate.  For example; if you have a 30-year $200,000 loan with a 6% interest rate you could indeed cut your monthly payment by $125 if you can find a new rate of 5.5 percent.

However, you will also need to consider the cost to refinance.  When you do, you may find this 0.50 percent is not enough of a savings to cover the cost of refinancing which can be 2 – 4 % of the new loan amount.  But if you can find an interest rate that is a full percentage point lower than your current rate, you can certainly come out ahead.

Are You in Need of Extra Cash?

Home equity loans and lines of credit are increasingly harder to come by.  If however, you have a significant amount of equity in your home; cash-out refinancing can be a great alternative.  Essentially, you refinance your home but take out a larger loan than what you currently owe and pocket the difference.  For example; if you owe $80,000 on your $200,000 mortgage you could refinance for $100,000 and walk away with $20,000 in cash.

Typically banks set a limit to how much you can pocket when you refinance.  They normally want to retain 30% equity in the new loan which translates into being able to borrow only 70% of your home’s current value.  Be careful though as it isn’t uncommon for the closing fees for these transactions to be quite high; ranging anywhere between 0.25 and 3.0 percent.  Find yourself, or better yet negotiate yourself, a loan with low closing costs and you might be on your way to doing that kitchen remodel or paying off those high interest credit cards.

Do you want to Say Goodbye to your Adjustable Rate Mortgage?

If you have no plans to sell before your adjustable rate resets and you would like to turn that adjustable rate into a fixed rate; the time to do it is now, while the fixed rates are still low.  Remember, as the economy recovers, there is only one way for the interest rates to go.  Be aware however, that the adjustable rate mortgages are also quite low right now; so don’t be tempted by those rates and lock yourself in to that adjustable rate (again).  You may not want to miss out on that year of super low interest, but by grabbing a low fixed rate you will benefit for years to come.

It typically takes up to two years for you to break even when refinancing your home.  With that, if there is a chance you will be selling within the next two years, do NOT refinance.  Additionally, you’ll want to use this two year benchmark as a guide to whether the refinancing deal you are being offered truly is a deal.  If you run the numbers and find that it takes longer than these couple of years to break even; find another offer.

Create a Home Insurance Inventory

It is highly recommended that new home buyers compile a home insurance inventory very soon after they move into their home.  If you have been in your home for a while and haven’t done this yet; make it a priority.  Let us take a look at why it benefits you to have this list before loss occurs or disaster strikes:

• Adequate Coverage – Preparing this list is the only way to be sure you have enough personal property coverage on your home.  This is not something you want to learn after it is too late.
• Memory – In a time of crisis, it will be very upsetting and difficult to remember each and every item that was in your home.
• Claims – The insurance claim process will be sped up significantly if you have your home insurance inventory prepared and ready to submit.
• Tax Deductions – Uninsured loss is tax deductible.  If you have this list available, it will be much easier to determine this uninsured loss tax deduction come tax time.

Making a List and Keeping it Updated

There a couple of methods you can use to make your inventory list.  There are quite a few home inventory software packages out there now; many are built into home finance software. You can certainly go this route or perhaps even easier is to create your own simple spreadsheet.  For ideas of the items to put on your list, browse the internet as there are quite a few samples available.

In addition to listing each major item, be sure to record any supporting information about your items.  These could be serial numbers, brand names, appraisal values, how much you paid, etc.  You can gather this information from product manuals, receipts, and appraisals.  If the idea of transcribing all of this information into your list is leaving you overwhelmed, here is a trick.  Scan this information or better yet, take digital pictures of it all.  It costs you nothing; so simply snap pictures of those receipts and manuals.  This is certainly less time consuming than typing or scanning and you’ll immediately have a digital copy of it all.  Just make a note in the list next to the item that there is a supporting photograph with more details.

By having your home insurance inventory list on your computer, you will be more apt to update the list regularly.  When you buy something new, open up the list and type it in.  Or snap a picture of it if your camera is at the ready.

Pictures and Video

The easiest way to record all of the smaller items in your home is to take pictures and/or video.  Both are beneficial.  As we have seen pictures are a great way to get record the details of an item.  Video is a good backup as you are certainly not going to take a picture of every single item; the video will capture it all.  The video will also give you and the insurance company a better perspective with regards to the size of your items such as furniture, the size of your curio cabinet, how big your closet is, the size of your rock collection, etc.

Speaking of closets, remember to include all closets, drawers, contents of storage boxes as well as attics, and basements when taking your pictures or video.  Transfer these pictures and videos to your computer for easy access to them and be sure to back it all up.

Backing Up Your Inventory List

The final step in this process is extremely important.  That is to not only backup your inventory list and supporting pictures and video but to store a copy of that backup somewhere OTHER than your home.  Otherwise in the unfortunate event your house is destroyed, your list will be lost.  Places off site you may want to consider are a safe deposit box, at work, or at a friend or relative’s house.

Make your home insurance inventory list today.  When you have the completed list in front of you, take a few minutes to take a look at your home insurance policy.  Make sure you are adequately covered and make it a habit to review your policy every year.