Before you begin shopping for a home (or a mortgage), it’s vital to evaluate your personal financial situation, how much debt you carry, how much money you make, how much you spend, and how much you pay out in living and lifestyle expenses each month. To do a complete evaluation:
- Analyze your personal financial situation.
- Determine your maximum mortgage amount.
- Review your credit score.
- Gather and organize the information lenders will require.
Analyze your personal financial situation
Lenders analyze and evaluate your overall financial situation – not just one factor (such as your credit score). Lenders will look at four main aspects of your personal finances:
The money (or its equivalent) that you receive each month including earned income from work, passive income from your investments, and/or alimony, though you aren’t always required to list alimony. The question is: do you have enough income to cover your mortgage payments and all of your other expenses?
ALL debts, including credit card bills, medical bills, car loans, personal loans from friends, family, or other individuals, tax liens, as well as any other existing mortgages. Lenders are very concerned if a potential borrower has a debt to income ratio over 40 percent. Most prefer a ratio below 35 percent. Your debt to income ratio is calculated by dividing your monthly debt payments by your monthly pre-tax income and multiplying by 100. For example, with a monthly income of $4,000 and debt payments totaling $1,000, you would have a debt to income ratio of 25 percent … well within the range most lenders prefer.
Anything of value you own, including cars, homes, land, precious metals, stocks, bonds, receivables, and other investments. Lenders aren’t too keen on using things like furniture, furs, and jewelry in their calculations since these items are sometimes difficult to convert to cash at their appraised value (watched Pawn Stars lately?). If lenders are wary of your debt to income ratio, they may consider whether your existing assets overshadow their concern about lending you the money for a mortgage. For example, if you have a lot of liquid assets — cash or other assets that can easily and quickly be converted to cash, such as stocks and bonds — lenders may be willing to loan you money even if your debt to income ratio doesn’t meet their normal criteria.
Other expenditures you pay monthly in addition to your debts. These expenses include utilities, car insurance, alimony, and medical, transportation, and entertainment expenses. If lenders find that your monthly income doesn’t cover your expenses, they’ll likely refuse to offer you a loan unless you have very significant liquid assets.
Create a monthly budget worksheet
By creating a monthly budgeting worksheet, you’ll see an inventory of all of your monthly income and expenses. It may help you understand what mortgage lenders see and allow you to make some adjustments in preparation for getting your mortgage. Creating a personalized monthly budgeting worksheet will also help you:
- Understand how much money you have left over each month for your mortgage and other bills that might result from buying a home.
- Organize all the documents and information you and your lender may need in order to evaluate your financial situation.
To create your own budgeting worksheet, download and use this template (Microsoft Excel format) FREE from The Wisdom Journal at: http://www.thewisdomjournal.com/Blog/go/Budget_Worksheet.xls
Once you have your personal budgeting worksheet filled in, you can more easily anticipate where lenders might find concerns with your financial situation and then fix those problems before applying for your mortgage.
For example, if your expenses exceed your income just slightly, you might be able to cut back on all but your most essential expenses, thereby making your situation more appealing to a lender. Lenders LOVE to see borrowers that put aside money each month in a savings account (it’s another asset in your favor). They also love to deal with borrowers that have an emergency fund. Bear in mind however, that though you might be able to make these changes right away, you’ll need to keep them up since most lenders want to see a trend of improving financial history over more than just a few months in order to feel comfortable approving you for a loan.
How are your finances?
Are you in fiscal shape, ready, willing, and able to make sustained, consistent, timely payments on a mortgage loan? If the answer is yes, congratulations! Stay tuned to check out the next installment of Are You Ready For A Mortgage?