Buying your first home can be tedious and overwhelming.
While it’s exciting to visit properties and daydream about your dream home, getting over the financing hurdles is another story. But don’t fret.
This comprehensive guide for first-time home buyers will walk you through the entire process from start to finish.
Before Your Start Searching
Check Your Credit
Not only will your credit play a huge factor in whether or not you’re approved for a mortgage, but it will also determine your interest rate.
A small increase or decrease in interest rates may not seem like a big deal. However, mortgage loans are for a hefty sum and for an extended period of time. So, a slight increase or decrease equates to thousands of dollars more spent or saved over the life of the loan.
To have the best chance of being approved for a loan, you should aim for a credit score of at least 620. It’s possible to get approved for select loan programs with a score as low as 580, but you may have fewer lends to choose from.
Run the Numbers
It’s tempting to start searching for homes when you know your credit score is up to par. But that’s probably not a good move until you determine how much home you can afford. Yes, the loan officer will give you a figure when you obtain a pre-approval, but that amount isn’t always indicative of what you can actually afford.
Why so? Well, they focus on what’s called the debt-to-income (DTI) ratio to get an idea of a loan amount you qualify for. Lenders prefer a debt to income ratio of 43 percent or lower, with your new mortgage payment, according to the Consumer Financial Protection Bureau. To illustrate:
|Current Monthly Debt||Gross Income||Debt-to-Income Ratio||Maximum Mortgage Payment (using 43% recommendation)|
**Quick note: Debt-to-Income Ratio = Aggregate Amount of Monthly Debt / Gross Income
The problem isn’t it fails to consider any expenses that are not related to debt. And if you have hefty insurance, childcare or even grocery bills, that could be a major problem.
So, your best bet is to take a look at your current budget and come up with a realistic figure for your new mortgage payment. But don’t forget to keep the recommended DTI ratio in mind.
Explore Mortgage Options
There are several mortgage options on the market, but the most prevalent are:
- Conventional Mortgages: usually requires a credit score of 620 or higher and a DTI ratio of 36 percent or lower. If the loan amount is over $417,000, it becomes a Jumbo Loan and requires a higher down payment.
- FHA Loans: insured by the Federal Housing Administration and usually requires a credit score of at least 580, low down payment and are less stringent than conventional mortgages.
- VA Mortgages: insured by the Department of Veterans Affairs and doesn’t require a down payment and is easier to qualify for than conventional loan products, but you must be an active-duty member of the armed forces. Some surviving spouses also qualify.
Most mortgages have a 30 or 15-year term. The latter will cost you more per month, but you’ll save a load of cash on interest.
You can also choose from a fixed or adjustable rate mortgage (ARM). Fixed-rate mortgages have the same interest rate for the duration of the loan. But ARMs typically start with a lower interest rate for a set amount of time. In fact, they usually span from five to ten years and then adjust depending on the market.
Some homebuyers choose ARMs over fixed-rate mortgages because it gives them the option to make a smaller monthly payment in the first few years. It could also mean that you can qualify for a more expensive home. But, be careful not to get too overextended as erratic market behavior could cause the rate to skyrocket.
This is one of the more time-consuming parts of the entire mortgage process. The good news you don’t have to settle for the first offer that comes your way out of fear that your credit score will take a hit.
“FICO Scores ignore [mortgage] inquiries made in the 30 days prior to scoring,” according to myFICO. So, you won’t be penalized for multiple inquiries.
So, start by researching lenders that you may be interested in working with. You could also solicit the help of a mortgage broker if you’re strapped for time or want someone to do the legwork for you.
Once you’ve settled on a few lenders, be prepared to provide the following to get pre-approved:
- Financial statements to confirm your assets, including retirement accounts and real estate
- Recent bank statements
- Last two pay stubs
- W-2s from the last two years
If you qualify, the mortgage lender will then provide you with a pre-approval letter, valid for a certain time period, that specifies how much you’re eligible for.
Save Up for a Down Payment and Closing Costs
During the pre-approval process, the lender should have discussed loan options that could be a good fit for you. They also communicated how much you will need to contribute to the down payment and closing costs.
While there are some sellers that may be willing to cover closing costs, be prepared to provide earnest money to secure your offer. And if a hefty down payment is required because you’re taking out a jumbo loan or don’t qualify for the FHA or VA program, now’s the time to make a plan to get you to the finish line before closing.
If the seller is not paying closing costs, expect to pay between 2 and 5 percent of the sales price. And if a hefty down payment isn’t required, it’s not a bad idea to bring money to the table. Doing so allows you to reduce the Loan-to-Value, which positions you as less risky to the lender.
You may also be able to avoid private mortgage insurance (PMI), which is required until you reach 20 percent in equity, and possibly qualify for a reduced interest rate.
How to Find the Perfect Home
Go Home Shopping
All squared away with a pre-approval and plan to save up the cash you need? Now, it’s time to go home shopping. But before you go, you have to decide if you want to enlist the assistance of a real estate agent.
It’s possible to find a slew of listings on the web with minimal effort, but real estate agents have access to a system that could expand your reach. Even better, they could be integral in helping you choose a home that’s a good buy and negotiating the final purchase price.
And the seller’s agent pays their commission, so need to worry about forking over extra cash. Just be sure to find a real estate professional that is seasoned and reputable.
Now for the fun part: home shopping. Be careful not to judge a home solely by its appearance. Some other important factors to keep in mind:
- Taxes: are the property taxes affordable or beyond what you can comfortably afford? (You can roll property taxes and homeowners insurance into an escrow account, but they can easily make or break your budget if the figures are steep).
- Location: is the home in an area that has historically held its value? Is the location optimal for your commute to and from work?
- Crime: is it a high crime area or is it relatively safe?
- Condition: how old is the property? Does it need tons of repairs or is it close to being move in ready?
- Floorplan: is the floorplan feasible or ideal for your situation? Would it be appealing to other buyers if you had to sell?
- School district: how are the schools? Have they receive good rating or do they struggle to stay afloat?
All of these factors can have an effect on the value of the property over time.
Submit an Offer
You’ve found the perfect home and you’re ready to sign on the dotted. Before you can finalize the paperwork and move in, there’s one more important step. And that’s making the offer. Even if the sales price seems fair, you may need to make an offer that’s higher or lower to snag the home.
Why so? Well, there could be a slight or drastic bidding war going on and the only way for you to win is to beat out the competition. Or maybe you’re realtor did some research and determine the asking price was a bit high based on similar properties in the area or the current condition of the home.
Either way, you want to submit an offer that stands out and gets accepted. Your realtor will be able to do so on your behalf. But if you don’t have a realtor, check out these letters from Trulia to get you started.
The Mortgage Process
Even after your offer is accepted, there’s still more work to do. You’re not done just yet! It’s time to move on to the mortgage process.
Remember that pre-approval letter? Well, the lender is going to make sure all the information you initially provided is accurate through a process called underwriting.
You may be asked to provide a few additional documents, including updated copies of your bank statements or pay stubs if it’s been a bit since you were pre-approved.
The faster you submit the requested information, the quicker you’ll get a response. So, don’t drag your feet if you want a closing date that’s sooner than later.
Home Inspections and Appraisals
Before you close on the home, you will need to have a home inspection and appraisal complete.
The home inspection, which shouldn’t cost you more than $500, will give you an overall assessment of the property and identify any potential issues.
The appraisal also plays an integral role as it will give you a solid idea of what the home’s fair market value. It will be mandated by the lender, but it’s not a bad idea to get an independent appraisal done to serve as a second opinion.
Both the inspection and appraisal could be lifesavers as you may discover that the offering price should be lower or it may be best to walk away from the home altogether.
Purchase Homeowners Insurance
Your lender will require that you take out homeowners insurance. So, you want to start shopping around for quotes and select a policy prior to closing.
Close on Your Loan
At last! You’ve reached the finish line and it’s time to close on your loan. During the closing, expect to:
- Sign a load of paperwork.
- Provide any amounts owed for the down payment.
- Pay closing costs, which could include property tax obligations, premiums for homeowner’s insurance and association dues, title insurance and any other costs associated with finalizing the loan.
- Pay discount points, or prepaid interest that can reduce the interest rate.
But before you show up at closing, it’s a good idea to speak with the lender so you’ll know what to expect. You can also request a copy of the final closing document, or Closing Disclosure, to see a detailed breakdown of expenses.
A Few More Tips
Here are a few more suggestions for first time home buyers to help you get approved for your first loan:
- Refrain from applying for new credit before you close. This could throw off your debt-to-income ratio, lower your credit score, and ultimately prevent you from closing on the loan.
- State and local programs may be available to assist with down payment. If you’re low on funds, be sure to explore options that may be available to you.
- Several builders offer buyer incentives, like allowances for upgrades and closing costs. So if you haven’t considered new construction, it may not be such a bad idea to take a look if the price points are within your budget.
Should You Rent, Instead?
Perhaps you’ve done a little legwork, ran the numbers and are on the fence about home buying. Oftentimes, you will find that it’s cheaper to make mortgage payments than to pay rent.
You can also take advantage of tax deductions and build up equity as you’re making payments. The equity can be borrowed against for a loan or put some extra money in your pocket should you decide to sell before the repayment period ends.
However, renting a home gives you the flexibility to move to a new location if the home isn’t quite what you expected, you don’t like the neighborhood, or if you want something more affordable.
In addition, renting allows you to pass the costs of maintaining the home on to the owner. But as a homeowner, you’ll be responsible for costs associated with maintenance and repairs.
Another reason why some choose to rent over buying is the upfront costs. Most landlords require a security deposit, but it could be substantially lower than the money you may have to bring to the table for the down payment and closing costs.
Ultimately, you have to decide which is the better fit: investing in an asset that could build wealth or continuing to pay rent until you feel the time is right. There is no right or wrong answer; it just depends on your personal preference and financial situation.
By taking the time to learn about the homebuying process, you’ll be well prepared and save yourself time and headaches. Best of all, you’ll increase your chances of landing your dream home with the most competitive mortgage product on the market.