For many people, buying your first home can feel more like a dream than a reality, discouraged by home prices across the nation and a short supply of affordable properties. But through proper planning and financial discipline, buying your first home can be much easier and less stressful.
While early planning is essential in any homebuying process, first-time homebuyers can set themselves up for homebuying and homeowning success through the following tips.
1. Know your credit and work to improve it.
Knowing your credit score is a great place to start as you consider buying your first home. Many factors can positively impact your credit score such as low usage compared to total limits, percentage of payments you’ve made on time, and a longer average credit age of your accounts. Your credit score helps determine the interest rate and other costs you pay on a mortgage loan. If your credit scores are high, it tells lenders that you’ve paid your credit card bills on time, haven’t “maxed out” your credit cards, and so on. Lenders see you as likely to pay your loan payments consistently and on time. They see you as a low-risk investment and offer you a lower interest rate and other costs on your loan.
If your score is lower, lenders see you as a risky investment. And, if they approve you for a loan at all, will charge you a higher interest rate in exchange for taking on your perceived risk.
Most lenders have a baseline credit score they use to approve or deny mortgage applicants. Any score in the 700s or above is considered excellent and will most likely get you a loan with the lowest interest rate.
When your score drops into the 600s you start to be seen as a potential risk for loaning money to. A score of 680, for example, is still considered good, but when you get below 660, some lenders start saying no. For others, 640 or 620 is the line at which consideration for a better mortgage loan program may be off the table. It all depends on that particular lender and their required qualifications.
Those scores and cut-off points are for conventional fixed-rate mortgages. Other types of mortgages, such as FHA or VA, are easier to get and even designed for borrowers with credit scores as low as 500.
2. Determine a realistic budget.
Setting a realistic budget is crucial to buying your first home. Spend a few months examining your monthly spending to see what you can actually afford for a mortgage and remember to factor in things like insurance, routine maintenance, and saving for emergency repairs. While you may be approved for a certain amount, make sure you can afford it after other bills such as your cell phone, groceries, and car payments. A good rule of thumb is to spend no more than 30% of your gross monthly income on housing.
As of June 2019, the median price for a new home was more than $310,000, amounting to one of the largest purchases many will make. First-time buyers tend to shop on what the mortgage lender says they can afford, not taking into account other expenses. That sets them up for financial hardship and even a potential foreclosure if they can’t afford the monthly payment.
The 25% Rule Can Get You Started
One of the easiest ways to calculate how much home you can afford is the 25% rule, which says that your mortgage shouldn’t be more than 25% of your income each month. If you have other debts, add them to the mortgage payment to determine how much you can afford. The Federal Housing Authority says that consumers can afford 29% of their gross income for their house. That jumps to 41% if they are living debt-free.
Mortgage lenders look at a prospective borrower’s debt-to-income ratio when determining if they will lend the money. If it’s above 43%, a would-be borrower, in theory, would be denied. But according to the Federal Housing Authority, many lenders are willing to look past a 43% debt-to-income ratio. Let’s say your monthly mortgage payment is $1,000 a month and your other expenses are $1,000 – your monthly debt payment would be $2,000. With gross income of $6,000, your debt to income ratio would be 33%. If that ratio is too high, you may need to look at cheaper properties.
3. Ready your bank account and prepare your financial documents.
Lenders will want to look at your bank statements for the last two months. During this period, it is best to avoid opening any new lines of credit, taking out any new loans, or adding substantially to your debt. Make any large deposits to your accounts before this window, as well, to avoid having to explain your financial situation in great detail.
First, your mortgage lender is going to want to see certain financial records and documents. This is especially true of borrowers with bad credit. To fulfill this requirement, you want to get as organized as possible before applying for a mortgage loan
Tax returns, pay stubs, bank statements, W2s and a list of all your debts are just a few documents you should gather and have ready to go.
4. Evaluate which loan product works best for you.
Consider what loan option will work best for your and your financial situation. There are loan products that fit all different types of senarios and might be the difference between not being able to purchase a home at all and the ability to buy your dream house. (I feel like it might make sense to mention various programs somewhere, like FHA, VA, Conventional, etc.)
There are two main types of mortgages: a conventional loan guaranteed by a private lender or banking institution, or a government-backed loan.
Most government-backed mortgages come in one of three forms:
- FHA loans, insured by the Federal Housing Administration, were established to make homebuying more affordable, especially for first-time buyers, by allowing down payments as low as 3.5% of the purchase price.
- VA loans are insured by the Department of Veterans Affairs and offer buyers low- or no down payment options and competitive mortgage rates. They’re available to current military service members and veterans only.
- USDA loans are backed by the U.S. Department of Agriculture and are geared toward rural property buyers who meet income requirements.
Conventional loans, on the other hand, are offered and backed by private entities such as banks, credit unions, private lenders or savings institutions. Borrowers need good credit to qualify. This is because the loans aren’t guaranteed by an outside source — so the possibility of borrower default poses a greater risk for lenders.
Conventional loans have terms of 10, 15, 20 or 30 years. They also require much larger down payments than government-backed loans. Borrowers are expected to put down at least 5%, but that amount can vary based on the lender and the borrower’s credit history.
5. Hire a real estate agent.
Armed with a pre-approval letter and solid financing, you are ready to hire a real estate agent. A real estate agent will be knowledgeable of neighborhoods, market conditions, and the value of homes. They will also negotiate pricing and terms like a pro, saving you a lot of time and hassle.
You might be far out of your element when it comes to reviewing and understanding the multiple documents involved in a real estate deal, and you should have a thorough understanding of what you’re getting into regardless of whether you’re buying or selling. Purchase agreements alone can top 10 pages in 2019, not to mention federal, state, and local document requirements.
Luckily, your agent will be far more familiar with all this paperwork than you are. Consider this if you’re still thinking about saving money: Some mistakes or omissions in these documents can cost you as much as that commission you were trying to avoid paying—or even far more.
Home Purchase Basics
Congratulations on your decision to buy a new home! There are many important things to consider throughout the process, especially if you’re a first-time homebuyer. Here’s some information that will keep you on track.
A home purchase may be your largest financial transaction to date, so it’s important to make the right decisions and to keep an eye on the details. With the assistance of your Real Estate Agent and Loan Officer, it should be an efficient, pleasant, and ultimately rewarding experience.
Count On Your Real Estate Agent To:
1. Preview available homes to weed out those that are overpriced, or undesirable in some other way.
2. Present the homes that suit your needs as you’ve defined them.
3. Help you determine the difference between a “good buy” and a property which, because of its nature (neighborhood, market appeal, etc.), might have to be discounted if you decide to sell in the future.
4. Negotiate the best deal for you. With a Pre-Qualification letter from us in hand, your Real Estate Agent will be able to demonstrate that you are a qualified and capable borrower. This will strongly influence the Seller, and may make the difference between the Seller accepting your offer or someone else’s — even if your offer is lower!
Count On Your Mortgage Loan Officer To:
1. Assist you in selecting the best loan to meet your personal situation and goals. (This single decision can save you thousands of dollars throughout the years!)
2. Keep you informed of your loan status throughout the entire process.
3. Keep your Real Estate Agent informed of our loan progress (Note: your personal information is always kept confidential between you and us; only deal points and progress are shared).
4. Get the appropriate loan for you at the best rates and fees. This will save you significant money “up front” and throughout the years to come.
Count On Yourself To:
1. Keep your Real Estate Agent informed of any questions or concerns as they develop.
2. Keep the process moving by providing documentation and decisions as soon as reasonably possible. By doing so, many of the details are taken care of early in the process so you can comfortably concentrate on any last-minute details or events that require your attention.
3. Enjoy purchasing your home, but do remain objective throughout — to make the business decisions that are best for you.
4. Make sure you are pre-approved as early as possible. This will put the power of financing behind you so you can concentrate on selecting your home.