So, you want to buy a condo. Where do you start?
The first step is a thorough assessment of your assets, income, debt and spending.
Lenders will want you to document your earnings and expenditures for at least the past six months. They will pay special attention to your scheduled monthly debt payments, including credit card and car payments.
The numbers go into a formula, the debt-to-income ratio, which measures your financial fitness.
Follow these steps to get ready.
Calculate your income
Compile your income history with your current position, the longer back the better. This will give lenders hard proof of your monthly income that they will use to calculate a mortgage application. They also will help document your tenure at your position and any raises you may have received.
Ideally, lenders will want to see that your monthly housing costs — principal, interest, taxes, insurance and, if necessary, mortgage insurance — remain no more than 28% to 30% of your gross monthly income.
To a lender, an applicant with a steady work history is less risky than someone who changes jobs (and earnings) often. Your pay stubs will also verify your income and the amount of monthly mortgage payments you will be able to make on a home.
Calculate your debt
Next, sit down with your recent bills to determine how much you spend on monthly recurring payments, including rent, credit cards and car loans. The amount will be used to calculate your debt-to-income ratio. It's your monthly debt payments divided by your pre-tax income.
For example, your monthly salary — before any deductions are taken for taxes — is $5,000. Your small studio apartment costs $1,500 a month. You drive a new Ford and pay $500 for your car loan. You have two credit cards, each with a monthly minimum payment of $100.
Total monthly debt = $1,500 + $500 + $100 + $100 = $2,200
The ratio of your debt to income — $2,200/$5,000 — is 44%.
Ideally, lenders want applicants to spend no more than 36% of their pre-tax income on all monthly debt. Lenders also want to see less than 28% of monthly pre-tax income going to housing expenses separate from other expenses. Why? This gives applicants the financial wherewithal to deal with sudden costs during the month while continuing to have the money to pay for monthly debt.
What if you are self-employed so that your income varies each month? Lenders often will ask for two years of personal and business tax returns, according to Fannie Mae. They also will ask for profit and loss statements to back up the information. Lenders may require a copy of your business license, or correspondence from a personal accountant, to verify your employment and income.
Assess your credit
The next step is to determine your creditworthiness. Lenders use three main credit bureaus — Experian, Equifax and TransUnion — that calculate this as a number.
The bureaus pretty much use the same criteria: your habit of making payments, how many new credit accounts you've opened in the last six months to a year, how much you owe compared to your income, the mix of credit accounts you have (cards? car loans?) and your past credit history (if you've filed for bankruptcy or defaulted on a loan). A habit of making payments and amounts owed are generally the most influential.
The score ranges from 350 to 800, the higher, the better. Lenders at banks typically want to see an applicant have at least a 620 credit score to qualify for a loan. Applicants with lower scores can still get a mortgage if they use programs funded by the federal government that insure loans for people with marginal credit. One of the most frequently used is the Federal Housing Administration, which will charge successful applicants a monthly or a one-time fee to offset the costs.
Be sure to verify that the information used by credit bureaus is accurate and up to date. A change to your credit history, such as paying off a credit card, may take several weeks or months to appear. Americans can receive a free credit report by contacting a bureau and requesting a report. The report will show what their current credit score is, why it's high or low and what they can do to raise it.
Assess affordability
Lenders will also want applicants to show they have additional financial resources that may be necessary to make a purchase affordable.
They will want to see an emergency fund of three to six months of housing expenses, in cash. This will reassure them that you can continue to make monthly mortgage payments if you lose your job and monthly income.
They also will want applicants to have the cash for a down payment and closing costs. Loans that are not insured by the federal government — called conventional loans — usually require a down payment of 20% of the cost of the house. Lenders can be flexible for lower amounts but will charge a premium — called private mortgage insurance — that will be added to the monthly mortgage payment.
Federally insured loans have lower down payment requirements, since the government will step in and pay if you default. But you will still need to pay a monthly private mortgage insurance premium and possibly a one-time payment at closing.
Factor in condo-specific items
Applicants who want to buy a condo have a few additional considerations.
Condo residents share common areas of the community. They also have repairs and yardwork performed for them. They pay for this with monthly homeowner association fees. The fees typically are set — and raised — by the HOA. They can be substantial. Lenders will automatically tack this on to a monthly mortgage payment.
Paying the monthly fee entitles residents to the use of amenities offered by the condo community. These frequently include large swimming pools that are professionally maintained and staffed. Other popular amenities are workout facilities, parks, playgrounds and business centers that residents can use as a home office.
Lenders also will want to know about the community you plan to live in. They will investigate its physical condition and any safety concerns. Lenders will examine a condo's homeowners association for its history, financial health and whether it has an adequate surplus known as a reserve fund to pay for emergency repairs and expenses.