Thanks to the Dodd-Frank Act that took effect this year -- requiring more proof from consumers that they can afford a home, along with helping to protect them against bad lending practices -- getting a home loan is more difficult than ever. Getting your financial house in order before buying a home is always a smart move, but tighter credit makes it almost a necessity.
The total number of purchase mortgages originated in 2012 is down 44 percent from 2001 levels, according to a recent report from the Urban Institute. A large portion of the drop -- as many as 1.2 million loans -- can be attributed to low credit availability, researchers found, disproportionately
"Getting a loan right now is a lot easier than it has been. Getting a home right now is brutally different."
Getting a home loan with tighter credit restrictions in today's home loan market can be more difficult, but it's a lot easier if you're prepared financially. Here are four things home shoppers should do before attending every open house they can get to on a Saturday afternoon:
1. File your taxes. With tax filing day around the corner, this is a must because a lender will want to see your most recent tax returns to show your income, says Wendy Cutrufelli, sales and marketing administrator for the mortgage division of Bank of the West in San Francisco. Even if you owe taxes and are making a payment now, but are filing an extension with the IRS to file a return up to six months later, you'll need to show a lender alternative documents to show your income, Cutrufelli says. But ultimately, the bank will want a copy of your federal tax return.
2. Gather other financial documents. These include anything that can show your full income for the past two years, such as W-2s, old tax returns and tax forms such as a 1099 IRS form to show self-employed income. If your family owns a business together, you'll need a corporate tax return for two years, Cutrufelli says.
To get a "qualified" mortgage under the Dodd-Frank rules, you'll have to prove you can afford the home with enough assets and show an ability to repay the loan, along with mortgage insurance.
"In the current world, the more assets you can show, it's more helpful," Cutrufelli says.
A borrower's debt-to-income ratio can't exceed 43 percent, and they must have enough reserves for two months of mortgage payments and insurance. A firm bid for homeowner's insurance must also be in hand, she says.
"The last thing we want anybody to do is wipe out themselves to buy a home," Cutrufelli says of the importance of having two months of reserves after buying a home.
3. Check your credit report. Doing this six months to a year before buying a home is smart, partly to check your credit score and try to improve it. But the main purpose should be to check for errors and fix them, Cutrufelli says.
"Credit report errors do happen. It's important to repair those errors," she says.
For example, a credit agency may say you've missed a payment, but you can prove you weren't late. Errors can take 90 days to fix, Cutrufelli says. Get a free credit report at AnnualCreditReport.com.
4. Research the housing market. This is the final step before the fun of house hunting begins. Bank of the West, which does business in 19 states, has seen home prices rise in every market it's in, Cutrufelli says, requiring borrowers to research their local housing market and know how much home they can afford.
"Understand where you need to start to get your house," she says of knowing home prices and how much of a loan they qualify for before shopping. Whatever that qualifying level is, bid at 20 percent less so you have room to raise the offer if other buyers come in with cash offers or multiple offers are made, Cutrufelli says.
"Getting a loan right now is a lot easier than it has been. Getting a home right now is brutally different," she says.
For too many first-time homebuyers, the joy of looking at pretty homes is a lot more enticing than doing the hard work of preparing their finances.
"They don't actually deal with all that hard work until they see a home they like," Cutrufelli says.
Be a smart home shopper. Eat your veggies.