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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, and lenders may have other documentation requirements for gift funds.
Buyers who don’t manage their money well may have several overdraft charges or funds that cannot be sourced. Lenders may turn down such loans in the underwriting process. To prevent cancellation, buyers should manage their money carefully for at least a few months prior to house hunting in order to meet their lender’s requirements.
4. Select a Lender Before Making an Offer
To safeguard against losing an offer, buyers should select a lender at the launch of their house hunting process. By selecting a lender early on, the buyer can establish how much they can truly afford to borrow. Lenders will pre-approve the borrower for a maximum loan amount, which encourages buyers to not waste time shopping for homes out of their price range. During this time, the lender and borrower can agree on a loan program that will work best for the borrower.
Once the borrower is ready to make an offer, the lender is equipped with documentation to facilitate a faster underwriting process. This preparation makes the buyer’s offer more competitive because it’s pre-approved by the lender and should process quickly without error. Buyers who wait until they find their perfect home to select a lender run a few risks. They will likely not yet be pre-approved, making them less competitive than other buyers. They will have to scramble to find a lender at the last minute, making them less likely to feel confident with their selection.
Lenders on Zillow Mortgage Marketplace quote interest rates online and display past client reviews for borrowers to makes educated, quick selections. If a buyer is unable to solidify a lender who can approve a loan in time, the buyer may be forced to cancel the offer and lose the home.
5. Understand Owner Occupancy Percentage Requirements
Before buyers decide to make an offer on a condo, they should be aware of the owner occupancy percentage requirements for the property. It’s not often evident until late in the closing process that the homeowners association (HOA) of a property only allows a small percentage of the owners to rent their properties.
The reasoning behind this renting limitation is to ensure that future buyers will have all loan options available to them. Sometimes, loan requirements restrict the number of units in a property that can be rented to protect the overall value of the complex.
Generally, owner occupancy is more desirable because the condition of the complex will likely be better-maintained than if it were rented. Also, fewer payment defaults on mortgages and HOA fees are expected in owner-occupied properties. Although the maximum investor concentration may vary by HOA and lender, typically conventional loans allow 30 percent investor concentration, meaning the remaining 70 percent of the units must be owner-occupied.
FHA loans allow 50 percent investor concentration. For owners who plan to occupy their condos, this HOA rule protects the value of their homes and will make it easier to sell because more loan programs can be approved. A low owner-occupancy density can prevent buyers from getting a loan.
Buyers who are unaware of the owner occupancy percentage requirements may expect to rent their condo immediately after purchase or eventually, without realizing their HOA will not allow them to do so. This is an important consideration for buyers whether it will restrict their current purchase or inhibit their future plans to rent or sell.
6. Make Competitive Offers
When a buyer has selected a lender, an agent and a great home, it’s time to make an educated offer. A first-time home buyer may expect to offer the asking price of the home and then sit back expecting acceptance. In some markets that may be acceptable. However, in competitive markets, the sellers will have multiple offers to choose from, so the buyer will need to stand out.
Buyers who feel they’ve found their “dream homes” have some risky decisions to make. If the market is competitive, then real estate agents can advise their clients on the type of offer and loan program that will compete for a chance to purchase. Those who can offer a higher price, more cash upfront, a quick 30-day close or offer to skip the inspection will likely end up with the home. Buyers should be prepared to compete for their perfect home without feeling like they’ve overpaid.
If the market is slow, it’s possible to offer less than the asking price, but buyers should turn to their agents to make educated offers. It’s not uncommon for first-time home buyers to lose a few homes they love before landing an offer.
7. Hold Back on Celebrating Until After the Inspection & Appraisal
When an offer is finally accepted on the perfect home it can feel like a victory, but it’s before the finish line. Buyers should refrain from the emotional celebration until all of the documents are officially signed. Even if a buyer is pre-approved and an offer gets accepted, the offer can be canceled.
One pitfall is the home inspection, which estimates the condition of the property. If the inspector finds structural or mechanical system damages, such as excessive dry rot or electrical hazards, the purchase may be jeopardized. Pest problems such as rodent nesting or termite damages can also harm the sale. The buyer may not be interested in taking on all of the damages, or the lender may turn down the loan.
Depending on the extent of the damages, the agent may be able to negotiate a reduced price acceptable for all parties. Another important step is the appraisal, which estimates the total market value of the property. An appraiser will take into consideration all of the features of the home, including any damages, and indicate how much it’s worth.
Generally, the lender will not finance a home worth less than its price, which is also in the best interest of the buyer’s investment. Home buyers should save their celebrating until they become official homeowners.
In conclusion
Home buyers should begin their house hunt with research. Understanding the process, the market and the personal list of home priorities in addition to acquiring an educated team of agents and lenders should fully prepare a first-time home buyer for the exciting experience of purchasing the perfect home. Buyers with more knowledge can better protect their investments and experience a more agreeable buying process.