Don’t Go to An Open House Until….
February 18, 2010 by Rebecca
I command you: do not go to an open house until you’ve got an ironclad handle on your finances. In other words, don’t let yourself fall in love with the home of your dreams until you’ve figured out the financial nitty gritty of what exactly you can afford.
That's right--dust off your calculator and get busy!
What the heck am I talking about? I’m talking about the sacred 4 P’s of home buyer preparation. (Ok, I think I’m the only one that calls them the 4 P’s–but hey, it works!)
Here are the 4 P’s of Home Buying Preparation. Sear them into your brain:
> Personal Finances
> Pre-Qualification
> Pick a Loan & Lender
> Pre-Approval
Let’s break it down.
Personal Finances
The first thing you absolutely must do is assemble a clear picture of your own finances. Do not rely on a bank lender to do it for you–as we’ll cover later, they have a totally different way of looking at your finances. (They do not care if you have to eat ramen for the next 30 years in order to afford your mortgage payments, but you do.)
With that said, here are a few things to focus on:
- Get your credit report, if you haven’t done so recently. You can get one per year free. Correct any faulty information ASAP.
- How much do you spend on housing now?
- How much are your monthly debt payments (anything that won’t be paid off within the next 10 months should be included here–car, student loans, credit card debt, etc)?
- What are your other “required” expenses? (Health insurance, subscriptions, any other expenses you don’t have much control over)
- What are your average monthly discretionary expenses? If you’re not sure, go back the past 3 months and figure out everything you spend money on. If that’s too difficult, then start carrying around a notebook and writing down every penny you spend.
- How much do you put into retirement savings each month?
- How much do you have in savings?
- Be sure to take into account annual expenses–not just monthly
The point of doing this is to figure out how much money you have to spend on a one-time down payment, as well as your monthly cash flow, which you’ll need to cover your mortgage payments.
To see how your finances translate to what you can afford, check out this affordability breakdown.
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Pre-Qualification
Once you have a handle on your money situation, trot down to the bank (or mortgage broker) to get pre-qualified. Pre-Qualification is an informal process where you give your key numbers to the bank, and they informally tell you what they think you can be approved for. The Pre-Qual step is useful because no one pulls your credit (which impacts your credit score)–you can basically window shop.
What you want to see here is that you and the bank are on the same page in terms of what you can afford. They almost always will say you can afford more than you really can, because they don’t know (and frankly, don’t especially care) what you spend on things like dog food and pedicures. They just care about your gross income and your current debt obligation. [Here's more detail on the ratios the bank uses, and why you don't necessarily want to use them in your own calculations.]
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Pick a Loan & Lender
Once you and the bank are grooving, your loan officer will tell you about the different types of loans available to you. These depend on your income level, assumed credit score (remember, the bank has not yet verified the numbers you gave them, so this is still window shopping).
Your lender will be able to show you estimated monthly payments and closing costs based on your loan options. He or she will give you a Good Faith Estimate, which discloses all the closing costs and fees associated with the loan.
You should talk to more than one lender and obtain GFE’s from each. That way you can be sure you’re getting the best possible loan from the best possible lender.
Here’s an illustration of why it’s important to speak with multiple lenders: Let’s say a lender quotes you an amazing interest rate–much lower than anything you’ve seen recently. This sounds great, until you realize that they’ve charged you a point at closing in order to “buy down” the interest rate. Basically, they’ve charged you up front in order to “buy” a lower rate. This could make sense for you, but YOU have to make the decision, not get pushed into it by a desperate lender.
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Pre-Approval
Now that you’ve figured out your financial picture, made sure the bank is on the same page as you, and found a great loan from a lender you like, it’s time to get Pre-Approved. Pre-Approval is similar to Pre-Qualification, except you’re no longer window shopping. The bank will pull your credit, call your employer to verify income, and thoroughly scrutinize your financial picture.
The output will be a letter from the bank stating that you’ve been Pre-Approved for a certain loan amount. You have no commitment to take out the loan, or even work with this lender (though since you’ll have gotten to know them, it’d be strange to suddenly switch lenders). But the Real Estate World will take you much more seriously once you’ve got this letter in hand. Realtors will know you’re serious about buying, and sellers will take your bid more seriously, since it is more likely that your financing will come through. (It’s not uncommon for deals to fall through at the last minute because a buyer can’t get financing.)
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And with your 4 P’s taken care of, you have my blessing to go crazy in the classified section and visit as many open houses (in your price range!) as you like. Mazel tov!
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At RSRE, we know how intimidating it can be to even consider buying a home, and we hope to help demystify the process, give helpful unbiased advice, and inspire you along the way. [
