How to Avoid Lending Pitfalls that Will Prevent You from Buying a House

By Tali Wee with Erin Lantz of Zillow

Buying a home for the first time is a major decision that buyers should prepare for in order to make educated choices to protect their investments.  Because home values have bottomed out in most areas of the country and interest rates are near record lows, it’s an affordable time to buy.  Before buyers rush to make a purchase, they should be aware of the unexpected pitfalls that may hinder or halt the buying process.
1. Set Reasonable Expectations
The best preparatory action for first-time home buyers is to review available homes in their market to get an idea of the market’s value.  Buyers can research their dream homes within their ideal neighborhoods to check current costs.  Next, buyers should get an idea of how much they can afford using Zillow’s mortgage calculator.

Once buyers have an understanding of how much money they are capable of paying each month, they can balance it with the must-have features of their dream homes

A common pitfall is that many first-time home buyers have unrealistic expectations for their future homes and how much they can afford.  They often miss several opportunities by making low offers or no offers because of minor home details they don’t love.  An experienced real estate agent can advise their clients to prevent this pitfall.  However, buyers who have a grasp on their market’s value have healthier expectations of competitive offers and are better able to compromise on features of the affordable homes.
2. Reduce Debt-to-Income Ratio
Another item that should be reviewed prior to making an offer is the debt-to-income ratio of the buyer.  The debt-to-income ratio (DTI) is the amount of monthly income regularly paid toward debts such as a car payment or student loan.  The DTI maximum requirements vary by loan program and by lender:

Conventional: Monthly debt not to exceed 36 percent of income
FHA: Not to exceed 43 percent of income
VA and USDA: Not to exceed 41 percent

These maximums are general guidelines, but in some cases lenders will permit higher DTI ratios when certain compensating factors are present such as very high credit scores or large amount of cash reserves.  The DTI percentage is calculated by adding up all of the buyer’s recurring debt, dividing that total debt by the buyer’s gross monthly income and then multiplying the quotient by 100.

(Total Debt ÷ Gross Monthly Income) × 100 = DTI

For example, Bob has a $300 car payment, $50 credit card minimum payment, $400 student loan and a $750 rent payment each month totaling $1,500 of recurring monthly debt.  Bob makes $45,000 before taxes each year, or $3,750 each month.  The total debt of $1,500 divided by his monthly income of $3,750 equals 0.4.  Multiply 0.4 by 100 to get a DTI of 40 percent. Because Bob’s DTI is 40 percent and assuming there are no compensating factors, he likely would not qualify for a conventional loan.  This is something to keep in mind for buyers who are expecting to use a specific loan program or who select a property with loan program limitations.
3. Source All Funds
One pitfall that may catch first-time home buyers by surprise is that all of their funds must have a paper trail or source.  Lenders will evaluate buyers’ bank statements to specify the source of their income and how their money is managed before approving a loan.  Three red flags for lenders are large cash deposits, regular transfers and gift money.

Buyers should expect their lenders to inquire and should be prepared to provide sourcing for all deposits and transfers, whether it’s a side job, reimbursement or transfer from a relative.  If someone has offered a gift of money to apply toward the down payment, then it must be accompanied by a signed letter stating the money is a gift instead of a loan and must include a bank statement proving the source of the funds,