If you're in the market for a new home, you probably already grasp the importance of having a solid credit score and a decent down payment in order to qualify for a mortgage and successfully close a purchase. But do you fully understand just how critical those two factors have become in the hyper-competitive housing market we're in right now, which is characterized by housing shortages and record low interest rates?
Here's a snapshot of the current reality across the nation: The average down payment in the top 11 most competitive metros in the United States is 21 percent according to new LendingTree study. In some places, like San Jose, California; Hartford, Connecticut, and Cleveland, Ohio, down payments of 22 and 23 percent are the local average. Furthermore, a staggering 73 percent of buyers in those competitive metros have credit scores of at least 720.
In other words, this isn't your typical rodeo. If you want to be successful landing the home of your dreams (or landing a home, period), it's best to have your financials in tip-top shape.
"In today's red-hot market, bidding wars happen within hours of a home going on the market. Prospective buyers need to resort to creative strategies to stand out from the competition," says Mark Washburn, a realtor with Naples Condo Boutique.
You'll want to keep Washburn's comments in mind particularly if you live in the three metros with the most competitive housing markets, which according to the LendingTree report are (ranked in order) San Jose, California (average down payment 23.67 percent; percentage of buyers with credit score 720 or higher 84 percent); San Francisco, California, (average down payment 21.43 percent; percentage of buyers with credit score 720 or higher 81 percent), and Raleigh, North Carolina. (average down payment 20.39 percent; percentage of buyers with credit score 720 or higher 70.48 percent).
Let's take a closer look at why credit score and down payment are so incredibly crucial in the nation's hottest locations and how to get them in order before you embark upon the home buying process.
Why these two factors have taken on such importance
Essentially, it boils down to this: In a hyper-competitive market, sellers can be extra-fussy and choose the offer they're most comfortable with, which includes opting for the offer that might make them the most money and that they're most certain will close successfully without hiccups or falling out of escrow.
"In a hyper-competitive market, the buyer must do just that…compete," says Daren Herzberg, a licensed real estate broker with New York-based Babst + Herzberg. "The seller has two objectives when choosing a buyer—highest price and lowest risk."
Most home buyers obtain pre-approval for a mortgage from a lender to finance the bulk of the property purchase. And the sale contract will be contingent on the buyer ultimately securing that mortgage if their offer is accepted by the seller. In the event the prospective buyer does not get approved for that mortgage, however, they can cancel the purchase contract, leaving the home seller in the lurch.
"When a homebuyer has a strong or high down payment and fair credit score, it gives the presumption that the buyer can comfortably handle the mortgage, and if their offer is accepted, they may not fall out of escrow," says Chantay Bridges, of Los Angeles-based EXP Realty. "The last thing a seller wants is to begin with a buyer and later discover that their pre-approval never turned into an approval [and] they are unable to buy the home."
Ryan McPartland, principal and mortgage advisor with Mortgage Acuity, says amid such a backdrop it is down payment that's most critical, particularly the earnest money deposit.
"The general thought process is, the more money you're willing to put down, the more skin you have in the game, the stronger buyer you become," says McPartland. "Larger down payments are typically indicative of more qualified and serious buyers. The ability to save a large sum of money speaks highly of the buyers' financial strength and responsibility. Clearly this isn't always the case, however, in most instances it is."
This line of thinking is particularly true when it comes to the earnest money deposit, which is the deposit a potential buyer puts down before closing on a house to show they are serious about purchasing.
"If the buyer does not meet their contractual requirements in terms of securing a mortgage commitment inside an agreed upon timeframe, the seller can keep the buyer's earnest money deposit. The larger the earnest money deposit, the more the buyer is at risk and the less the seller is at risk. The lower the risk for the seller, the more attractive the offer," adds McPartland.
So, all of that explains why deposits have taken on significant importance. But what about credit scores, you ask? There are many reasons why credit score matters, but here's one particularly important observation.
Good credit translates into more loan products for home buyers to choose from, says Mark Meyerdirk, principal broker at Wahsington D.C.-based Urban Brokers. And when home sellers have countless offers to choose from, their agents will often prioritize by a potential buyer's financial strength by taking into account the buyer's financing type.
"Putting cash offers aside, buyers using conventional financing are preferred to FHA or VA loans," says Meyerdirk. "So, a buyer who has the ability to 'go conventional' has a better chance of success when competing with other buyers."
Ways to separate yourself from the competition
Given this reality, there's a variety of ways to improve your odds of being successful as a homebuyer including the obvious: improve your credit score and increase your down payment.
"There are a multitude of borrowers with good credit right now. Due to this, it's become that much more important to stand out as a borrower and maintain great credit and a great balance sheet," says Adem Selita, CEO and co-founder of The Debt Relief Company.
Some of the best ways to improve and maintain your credit score include lowering the balances on your various credit cards and loans, not making any late payments, and keeping your overall debt to income (DTI) ratio as low as possible.
"Make sure you get your DTI as low as possible. The easiest way to do this is by paying off smaller balance loans and obligations that may be negatively impacting your monthly expenses and therefore your DTI," explains Selita. "The accounts that will most likely be the culprit in this scenario are credit card accounts, personal loans, student loans, and auto loans. If you have any of these types of accounts and they're relatively close to being paid off, take some extra cash to pay these down completely. This will lower your DTI and as an added benefit boost your credit score."
Make a cash offer
If your funds are limitless (which is clearly not the case for everyone) you might also consider an all-cash offer, which apparently has become far more commonplace. An all-cash offer is exactly what it sounds like—an all-cash bid, meaning the homebuyer will purchase the property without having to secure a mortgage loan or some other form of financing.
"Not surprisingly, these offers are more attractive to the seller as the risk of a prospective buyer's financing falling through is eliminated, again, resulting in a faster closing time," says Washburn, of Naples Condo Boutique. "All cash offers seem to be at an all-time high right now, particularly in second home markets like Naples, Florida. Many of our buyers have realized significant gains in their financial portfolios and are shifting these gains to real estate."
Amid current market conditions, cash buyers have a significant advantage over a traditional buyer looking to finance a home purchase, says Washburn.
Include proof of funds when making an offer
A far less expensive way to make your bid on a home more competitive is to provide proof of funds when bidding on a house, says Meyerdirk, of Urban Brokers. This essentially means providing documentation of your financial assets, which can be used to establish your financial strength with a seller, assuring them the deal is not likely to fall through.
"Buyers can flex their financial strength by providing proof of funds," explains Meyerdirk. "Buyers who do this should be sure to include retirement accounts (assuming they have the option to borrow against them) along with any checking and savings account funds they have access to."
One last way to make your offer even more appealing to a seller is to waive most contingencies. It's another tip that Washburn offers his prospective home buyers.
"The only way to compete is to have as few contingencies as possible in the offer," he explains. "A contingency is a condition that must be met before the buyer will proceed. For example, a buyer's offer can be contingent on the buyer selling his house, or the appraisal of the seller's home value, or subject to a positive inspection of the property."
Generally Washburn tells his clients never to waive the inspection contingency, and for good reasons. Doing so as can lead to unpleasant surprises for the buyer in the form of substantive repairs that may need to be made down the road if the home has structural issues. But as a buyer, you may consider waiving other less critical contingencies.
"Today's market means homebuyers have to go to extraordinary lengths to purchase a home — while waiving at least one normal contingency can help you stand out, exercise caution before proceeding with some of these vital protections," says Washburn.