The Basics of Home Financing in 7 Easy Steps

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U.S. Existing Home Sales Fell in March
Daniel Acker/Bloomberg via Getty Images
Combine low interest rates and improving household finances, and you get a housing market as hot as it ever was, especially in high-priced markets like the San Francisco Bay Area. There, it's not uncommon for a seller to receive 20 or more offers and for sale prices to end up 25 percent over asking prices.

However, since the credit crisis of 2007-09, getting home financing has become more difficult. So it pays to fully understand home financing so you can present your best offer and make sure that the loan process goes smoothly. It's also critical to find mortgage loan officers, real estate agents and financial planners you can trust.

Income, then savings. Banks qualify borrowers on income first, not savings. The general rule is that not more than 40 percent of your pretax income can go to principal, interest, taxes and insurance -- plus any monthly debt obligations such as a car loan, student loans or credit card debt. Lenders will also document that you have enough savings for the down payment, closing costs and at least two to three months of cash reserves covering your PITI plus debt obligations.

Preapproval. This process involves working with your loan officer to document your income, assets and other pertinent issues so that you don't spend time looking at houses that are out of your reach.

Credit score. As early as you can in the home-buying process, check your credit score. The general rule is that a score of 720 and over is golden. A low credit score can increase the interest rate on your loan or prevent you from getting a loan altogether. There are ways to improve your credit score such as paying down balances and checking your credit report for mistakes. Federal law gives you the right to get a free copy of your credit reports from the three major credit reporting companies by going to www.annualcreditreport.com or calling 877-322-8228. You can also pay to get your credit scores.

Gifts. If a generous relative is willing to give you cash to help fund the down payment or closing costs, you can accept it without having to worry about anyone paying taxes now or later. Each American, as of today, has a lifetime gift tax exclusion of $5.34 million, and very few will come close to maxing out. The amount over the annual exclusion ($14,000 a person, $28,000 for couples in 2014) is reported to the Internal Revenue Service on Form 709 the year the gift is given. In addition, lenders require a gift letter from the donor.

Verifying income. Self-employment income equals net-pretax income, while income for employees is gross wages, as documented on the W-2. In both cases, lenders want to see at least two years of stable income history. If you are self-employed, be ready to produce a profit & loss statement for all quarters not covered by you last filed tax return. Employees may need to supply tax returns as well if there is large variable income such as bonuses.

Documentation of deposits. Low-document or no-document loans are a thing of the past. Lenders need documentation of your income (wages, Social Security, pension). Also be ready to give an explanation and paper trail for any non-recurring deposits over $1,000 that show up in your two most recent monthly bank statements.

Down payment requirements. Most lenders would like to see a 20 percent down payment. You can put less than 20 percent down but will pay private mortgage insurance. Veterans can qualify for a zero percent down Veterans Affairs loan. Anyone can get a Federal Housing Administration loan and put as little as 3½ percent down, but fees are higher, and there is a mortgage insurance premium.


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vlady1000

Submitting all my paperwork tonight. Looks to be about 500 pages (not a typo) of info they want to see. hope the underwriter has as much fun going thru it, as I did putting it together.

April 23 2014 at 5:13 PM Report abuse +3 rate up rate down Reply
JoJo

it's a major pain in the azz but well worth it

April 23 2014 at 3:16 PM Report abuse +1 rate up rate down Reply
theycallmeroy3

Utter perfection..

April 23 2014 at 10:02 AM Report abuse -2 rate up rate down Reply