When applying for a mortgage, you shouldn't do anything that will cause a bank to question your ability to repay the loan. You don't need perfect finances to get a mortgage, but it's in your best interest to have a basic understanding of loan requirements. The more you know, the less likely you are to make mistakes that can ruin your application. (See also: Make These 5 Money Moves Before Applying for a Mortgage)
Here are a few missteps to avoid if you're thinking about buying a house.
1. Paying for everything with cash
Using cash for everyday purchases is one way to avoid debt. But just because cash is king in your world doesn't mean you should cast off credit cards.
Unless you're fortunate enough to pay cash for a house, you'll need to apply for financing, which requires a credit history. And the only way to build credit is to use credit. Without any type of credit profile, a mortgage underwriter can't assess whether you're capable of responsibly managing a home loan.
In the lending world, no credit can be just as damaging as bad credit. So before applying for a home loan, establish credit by getting a credit card or another type of loan. You don't have to drive yourself into debt with it, but you should demonstrate a pattern of timely payments and responsible borrowing.
2. Carrying too much debt
While it's in your best interest to have a responsible credit profile, if you start spending money on stuff you don't need and get in over your head, you could hurt your chances of a mortgage approval. Maxing out credit cards can raise your credit utilization ratio and lower your credit score. Credit utilization is the percentage of your credit card debt compared to your credit limit.
If you go overboard and accumulate too much debt, there's also the risk of falling behind on payments. Late payments are another credit score killer that can destroy any chance of qualifying for a mortgage.
To avoid problems with a mortgage approval, get into a habit of paying off credit card balances in full every month. If you carry a balance, keep it small — ideally below 30 percent of your credit line.
If you've already been approved for a mortgage, don't make any major purchases before closing on the home purchase. This includes buying furniture or financing a new car. New debt increases your debt-to-income ratio, which can affect your approval.
Since you won't know your actual mortgage costs until a few days before closing, hold off spending money on new furniture or appliances to ensure you have enough cash on hand.
3. Co-signing for someone else
Co-signing a loan for a friend or relative is a noble deed (one that I do not personally recommend), but it's imperative that you're fully aware of the consequences of this decision. Co-signers are not silent partners on loan documents. By signing your name, you become a joint debt holder; as such, a co-signed debt appears on your credit report and counts toward your debt-to-income ratio. This is because you're responsible for the loan if the primary signer stops paying. (And if this happens, you could be in big trouble financially!)
Once you are ready to apply for a mortgage, your lender takes a co-signed debt into consideration when calculating your debt-to-income ratio. Unfortunately, with a co-signed debt on your credit file, a lender might say you owe too much to take on additional debt and deny your mortgage application.
4. Not saving enough cash
You need cash for a home purchase — a lot of cash. Nowadays, many mortgage programs require borrowers to bring cash to the table. This includes a down payment between 3.5 percent to 5 percent or higher, as well as funds for closing (between 2 percent and 5 percent of the sale price). It doesn't matter how much you earn: If you can't show enough assets, you can't get a mortgage. Build up this cushion first before diving into the homebuying process.
5. Quitting your day job
Don't quit your day job if you're planning to buy in the near future — at least, not yet.
Qualifying for a mortgage involves demonstrating long-term financial stability. This is why lenders require a borrower's most recent paycheck stubs and the previous year's tax returns. Self-employed people can purchase a home like anyone else, but they have to provide one to two years of profitable business tax returns, where their income either increases from year to year or remains roughly the same.
It doesn't matter how much you're making today as a self-employed borrower. If a lender has reason to believe that your income isn't consistent or stable, you might not get a loan. So if you're thinking about buying, stick with your job until closing, and then become your own boss. (See also: Denied a Mortgage? Here's How to Fix It Fast)