How to Prepare for a Home Loan

Since taking out a mortgage to purchase a home will likely be one of the most significant—if not the most significant—financial investment of your life, it’s important to plan for a mortgage application accordingly. This means making sure that all of your finances are in order and that your credit score is strong before going through the pre-approval process or signing on to any mortgage deal with a lender. What follows are some basic tips to help you with these preparations.

Pay Down Debt

One of the best ways to ensure that you get the best mortgage rate available is by improving your credit score, and one of the best ways to improve your credit score is by paying down credit card debt. By reducing your debt to income ratio, you can increase your credit score by as much as a hundred points, while simultaneously demonstrating to lenders that you are a responsible borrower and a sound investment for the bank. Paying off credit cards may sound like an intimidating task, and for those with a large amount of debt, it can take a while—all the more reason to start planning for a hone loan as far in advance as possible.

Avoid Additional Debt 

Once you’ve paid down credit cards and credit lines, it’s also important to avoid accruing any new debt. This may seem like a no-brainer, but it can be very easy to slip back into new debt once old debt is paid off. Individuals feel a newfound sense of wealth and stability once credit cards are paid off, and occasionally use that as an excuse to take out an auto loan or open a store credit card account. This, however, can simply send your debt to income ratio skyward again, which in turn may threaten to lower your credit score and reduce your chances of getting the best loan rate out there.

Save, Save, Save

Of course, anyone who is looking to take out a mortgage should be sure they have enough money saved for a down payment. Yet it’s always a good idea to set aside more than you think you’ll need, as there will inevitably be some unexpected expenses incurred along the way to purchasing your home. For example, you may find your “dream home,” only to discover that the sellers are requesting a few thousand dollars more in a down payment, and will not budge in negotiations. Or you might find a house that seems right for you, but which will require a number of home repairs right away.

Finally, it’s important to keep apprised of the information on your official credit reports. Occasionally, these reports include erroneous information that may be driving down your credit score—and you don’t want to discover this problem when you’re sitting in the mortgage lender’s office. Make sure to request your official FICO scores prior to filling out a mortgage application, and be sure to comb through the documents to ensure that all of the information is correct.

Should You Get a Second Mortgage?

When a family buys their first home, it’s hard to comprehend the necessity of taking out a second mortgage. After all, an initial mortgage loan can extend anywhere from 15-30 years, which can seem like a lifetime to first-time homebuyers. Yet these days, it is becoming more and more common for homeowners to take out a second mortgage before their first is paid off. While this decision should not be entered into lightly, there are some scenarios where it can be appropriate.

What To Know About Second Mortgages

The definition of a second mortgage is fairly straightforward: it is just an additional loan that is added to your initial home loan. (This should not be confused with the process of refinancing your home, which allows you to alter the terms of your initial loan). The process of taking out a second mortgage is not too different from taking out a first mortgage. You will still have to complete a thorough application process, and you will still want to decide what loan type and interest rate (e.g. variable or fixed) will be right for you. The primary difference is that in this case, you will essentially be leveraging the equity in your existing home.

When Your House Falls Apart

Even if your home is in good condition at the original point of sale, there will inevitably be a need for some repairs down the line. You could be halfway to the payoff date on the initial mortgage when you discover that your roof needs to be re-shingled or the exterior of your building needs new stucco. Such projects require fairly urgent attention, and can cost tens of thousands of dollars depending on the size of the house. Thus, the necessity for major repairs is one viable reason to consider taking out a second mortgage.

When Your Kids Go to College

The second major expense that homeowners will likely face in their lifetime is college tuition. With tuition rates continually on the rise, it is becoming less and less possible for parents to help their children pay their way through school out of pocket. While student loans are an option, interest rates are also on the rise—and no parent wants to see their child saddled with copious amounts of debt right after school. Thus, if you have children heading off to a prestigious university (which can cost upwards of $250,000 over four years), a second mortgage can be useful.

Warnings and Caveats

While a second mortgage might be necessary to cover unexpected repairs or expected college tuitions, that does not mean it is appropriate to cover other kinds of debt. In fact, there are few other scenarios where such a hefty loan would be required. For instance, avoid taking out a second mortgage to pay off large amounts of credit card debt. This does not really eliminate the unsecured debt, but simply shifts it to your home, leaving you vulnerable to racking up more credit card debt on your now “empty” cards.

Before opting to take out a second mortgage, it is important to make sure you will be able to make the payments. Most financial advisors suggest offering a 10% down payment as well, to expedite the pay-off process. After all, if you aren’t able to stay current with your second mortgage payments, the loan will ultimately do more harm than good.