One of the best ways prospective home buyers can empower themselves when purchasing a home is to improve their buying power. The numbers may seem daunting but identifying ways to strengthen your financial standing will help you each step of the way.
When visualizing your dream home, it’s common for buyers to focus on the physical characteristics. But to mortgage lenders, a home is a numbers game. The following categories related to your buying power demonstrate how lenders identify your financial standing and determine your eligibility for a home purchase. Improvements in these areas will increase your buying power, propelling the strength of your offer when you’re ready to put it on the table.
Increase savings for your down payment
As the saying goes, cash is king. The down payment—often 20% of the home’s sale price—can sometimes be the deciding factor between competing offers for a particular home.
Try stashing away a little of each paycheck to build up your savings over time. Set a savings goal, commit a dedicated amount to each pay period, and watch the savings build as time goes on. If you prefer to keep your money separate, open a new account to which you can dedicate the added savings. Another way to save for your down payment is to generate additional income. If you have interest or experience in an area outside of your current job, explore opportunities for part-time work and dedicate the income earned to your down payment savings.
There are numerous benefits to offering a serious down payment. Putting 20% or more down can help your offer stand out, it may allow you to negotiate a lower interest rate on your mortgage and could remove the need for private mortgage insurance (PMI).
Improve your credit score
Plain and simple—a better credit score leads to better interest rate on your mortgage. Your payment history, amounts owed, length of credit history, credit mix, and new credit all factor into your credit score. Although improving it will not happen overnight, a higher credit score will pay dividends in the long run.
To improve your credit score, focus on paying down your credit cards, especially those with high interest. Refrain from opening new lines of credit that aren’t necessary and stay away from large purchases leading up to the time when you are preparing to make an offer. Keep in mind that student loans factor into your financial picture. Paying them off consistently will improve your financial standing in the eyes of lenders.
Stabilize your debt to increase buying power
When assessing what you can afford, banks will examine your debt-to-income ratio. Lenders want to know that you’ll be able to pay your mortgage on top of your remaining debt.
They do this by looking at your housing ratio, or front-end ratio, to determine what portion of your income will go to paying your mortgage. Your front-end ratio is calculated by taking your monthly mortgage payment and dividing by your monthly gross income. The higher the ratio, the higher risk of default.
Next, your back-end ratio, or debt-to-income ratio, is used to determine how much of your monthly income goes toward paying your debts. Your back-end ratio is calculated by taking your monthly debt expense (the principal, interest, taxes, and insurance of your mortgage payments, credit card payments, student loans, and any other loan payments), and dividing it by your gross monthly income.
Similar to your credit score, paying off credit cards, and making steady, consistent progress on your loans will help to decrease your debt and improve your debt-to-income ratios, which will increase your buying power.
Although these aspects of your finances don’t cover everything that goes into the purchase of a home, they do play a significant role in how lenders assess your financial standing and thereby eligibility for approval. Increasing your buying power takes time and strategy. Plan accordingly so that when you find your dream home, you’re in the best position possible to buy it.