Get Your House in Order: 3 Things to Do Before Applying for a Mortgage

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My wife and I are just starting the journey of buying our first home together. We're both excited and nervous, because a lot can and does go wrong.

One of the first steps I took was to figure out exactly how much house we could comfortably afford to buy. While there are a variety of affordability calculators out there, I wanted to get pre-approved before we ventured out to find our dream home. Turns out, the fact that we don't plan on moving until next summer made it too early to consider getting pre-approved.

That said, the effort wasn't completely wasted. I learned three things that every prospective home buyer should know in order get their house in order, so to speak -- things that will make for a smooth process when applying for a loan.

1. Get Your Credit House in Order

Home buyers need to do everything in their power to boost their credit score before applying for a mortgage. This means paying down credit cards and making sure your credit is as squeaky clean as you can get it.

It's a good idea to check out your credit reports well in advance of applying for a loan to make sure there are no issues you need to address. You can pull reports from all three major bureaus for free at annualcreditreport.com. (Everyone whose income is going to be considered in qualifying for the loan needs to do this.)

If there are any issues, start fixing them immediately. Some red marks -- even if they are due to inaccurate reporting and not because of your bad credit management -- can take a while to clean up.

When I pulled my credit report I was pleased to find that my credit score is still in healthy shape. However, it could be better. I have too many accounts carrying balances. To get my credit house in order, I plan on paying off the one card that's holding a balance from our last vacation, despite the fact that it charges zero percent interest.

2. Protect Your Credit Reputation

Once your credit house is in order, protect it. According to John Laymac of CBC National Bank, there are several things we can do between now and when we buy our new home:

%VIRTUAL-article-sponsoredlinks%"Do not let anyone pull your credit, pay everything on time, do not close any accounts you may pay down to zero, do not apply for any new credit (besides the mortgage), do not buy a car, do not make other large purchases on credit and do not carry a balance on any revolving account that is more than 25 percent of the card's limit. Use a mix of cards if you have more than one and pay the balance off or below 25 percent of the limit when the bill arrives."

That pretty much sums up what you need to do to avoid accidentally dinging your own credit before you start shopping for a loan.

What's probably most surprising is that closing accounts or paying off a term loan are actually a very bad idea, especially before applying for a mortgage. Closing a major credit card can actually do damage to a credit score. Lenders look at the balance on revolving credit accounts in terms of its ratio to total available credit. Closing an account can have the unintended consequence of raising the ratio. Paying off a car is the same story; lenders want to see a long-term credit history. So, it's actually better to put any extra money toward a down payment rather than paying off the car.

One other thing Laymac recommended we do is go to OptOutPrescreen.com and register to electronically opt out of electronic offers (spam and junk mail) of credit for five years. He said that "this is similar to the do-not-call list and the credit bureaus see it as a positive." Bottom line: Prospective homeowners should do all they can to protect their credit before applying for a mortgage.

3. Open a Separate Account to Hold Your Down Payment Funds

It goes without saying that a new homebuyer will be forking over money, and lots of it, at the closing. What you might not know is that the funds set aside for a down payment and closing costs shouldn't be kept under the mattress, nor should those funds be in your main checking account.

Instead, homebuyers should open a separate account specifically for the down payment. I asked Laymac to explain why the separate account, and he said:

"To avoid delays, establish a dedicated account for the down payment and closing costs and have all transfers into that account final at least 60 days before you start the process. Any non-payroll deposits into asset accounts must be explained in detail and any cash deposits can cause a loan to be declined. Banks typically only ask to see the two most recent months of account statements, so transactions prior to two months are not scrutinized. If you have no transactions in the account over two statements, there is nothing to explain and no additional documentation to provide."

So, sell that stock or get grandma to send the Christmas money early. (If a money gift comes in later, you may have to provide your lender with a note from the gift giver stating that the money was a gift and no repayment is expected.) Then sock it away in a separate account that has been designated for the down payment.

Final Thoughts

Following these three steps should make the mortgage application process less painful and intrusive. Buying a house comes with enough issues of its own, so why complicate matters with a mortgage mishap?

12 PHOTOS
Which Is the Best Mortgage for You?
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Get Your House in Order: 3 Things to Do Before Applying for a Mortgage

With the subprime mortgage mess unfolding all around us, there's never been a better time to make sure you make the right mortgage decision.

Of course, no single loan is best for all circumstances, but the following eight loan types work better than most when matched to your individual situation and lifestyle.


Next: For the Long Haul

Loan to consider: 30-year fixed rate

Why: Financial peace of mind can be worth the higher interest rate that won't change for three decades.

Next: Refinancing
(15-20 yrs before retiring)

Loan to consider: 15- or 20-year fixed or ARM

Why: You can retire the loan before you retire from your job. A fixed rate generally costs more than an adjustable, but will give you more certainty in budgeting. However, if ARMs are a lot cheaper and your income can handle possible payment increases, you could save with the adjustable rate.
Next: Recent Graduate
(With strong potential for increased earnings)
Loan to consider: 1-year ARM Why: Stretch your dollars with low interest rates during the years when your income is at its leanest. Your rate can go up (or down) each year, but rate caps will limit that change to a predictable amount, and your rising income should be able to handle it. Watch out for loans that cap your payment instead of your rate. They could cause your indebtedness to grow.
Next: Self-Employed

Loan to consider: No- or low-documentation loan

Why: Though you'll pay a higher interest rate, not having to produce paycheck stubs or employer references, as you would be expected to supply when applying for a traditional loan, can be a huge help to those with variable incomes.



Next: 4-5 Year Plan

Loan to consider: A 5/25 hybrid loan

Why: If you won't keep the loan longer than five years, why pay extra to lock in an interest rate for a longer period? If you do end up staying longer, you can either refinance or live with an interest rate that adjusts every year.


Next: Good Income, but ...
Loan to consider: Option ARM
Why: With these very risky loans designed for people with incomes that vary monthly, each month you have a choice of payments: the full amount needed to pay off principal and interest, an amount that covers only the interest, or an even smaller amount that doesn't even cover interest owed. Over time, however, your required payments could rise significantly if you often choose the smaller payments.
Next: Job Relocation
(With good income, savings)
Loan to consider: Interest-only
Why: While these loans can be risky for novice borrowers or those stretching to afford a home, they can be a smart tool for savvy borrowers who already have assets built up. Monthly payments are low because you're not repaying principal, so you can afford a larger loan. If you sell the home for less than you paid, however, you have to come up with the difference.
Next: Military or Veteran
Loan to consider: VA loan

Why: The U.S. Department of Veterans Affairs offers loan guarantees that allow qualified military personnel and veterans to take out mortgages for as much as $417,000 with zero down payment. In Alaska, Hawaii, Guam and the U.S. Virgin Islands, that loan amount goes up to $625,000.


Next: More on Mortgages
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Motley Fool contributor Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends Zillow. The Motley Fool owns shares of Zillow. Try any of our newsletter services free for 30 days.
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