Buying your first house is a massive step but the thought of owning our own place – not throwing money down the rental drain, the tax benefits, the choice of colors and appliances! – is quite exciting. You begin by scouring websites and spending your weekend house hunting. Walking through an open house here, finding a dream home, then working with a real estate agent... all part of the home buying process but nowhere near all the steps of buying a new home.
On your way to homeownership, there things you need to know. Ready?
1. If your credit report is clean
This is a no-brainer. To get a loan, lenders will review your credit. You don’t want to be surprised by what they may find. (I once had a parking ticket from a vacation in San Diego that was unpaid and appeared on my report that had to be cleaned before I could close!)
Each of the three main credit reporting agencies provides you with one free credit report per year. Take advantage of this and take a look at what potential lenders may see. If you spot any errors that could be bringing your score down, get them cleared off your credit report before seeking pre-qualification or pre-approval from a lender.
2. Your credit score
More than what is on your credit report is the FICO score
attached to it. Before you can qualify for a mortgage you need to know how your credit score stacks up. If you have poor credit, your chances of qualifying for a loan go down – and the loans you find will have higher rates that could make buying the house of your choice tricky.
You can turn to a mortgage calculator, such as that featured on MyFico.com. Depending on your FICO score, it will show you what you can expect to pay.
Here is an example of a $300,000 30-year fixed rate by FICO score.
|FICO Score||APR||Monthly Payment||Total Interest Paid|
3. Your debt-to-income ratio
Generally, you want to spend no more than 20% of your annual income on your mortgage and housing. Lenders look at where your income is going too. Your debt-to-income ratio will determine if you are a potential borrower that borrowers your full limit and struggles to pay down debt and if you have a high debt ratio to your income you could be turned down or, once again, given a terrible interest rate.
A positive debt-to-income ratio is 35% or less. This means your debt is 35% or less of your income – and no more than 28% of that toward your mortgage.
4. What PMI is
You may have heard you’ll need at least 20% down payment
on a house and while that is ideal, you could potentially purchase a house for less. With a 3% down payment, for example, you may qualify for a Federal Housing Administration (FHA) loan
. This may sound appealing except with a low down payment a lender will attach a PMI to your loan.
PMI is private mortgage insurance that lenders add when they are taking a chance with a borrower. These hefty payments will fall off your monthly payments once your loan drops below 80% of your home’s value – 20% down. It generally takes 3 to 5 years for this to happen and you could be paying a few extra hundred dollars per month on these payments, as they generally run between 0.5 and 1% of your loan amount.
5. Closing costs
Going through the process of buying a home involves lots of numbers. You may think because you are receiving a mortgage to cover much of the costs that you are all set, even if you have a 20% down payment. But you’ll need additional closing costs. These include realtor fees, loan application fees, transfer feeds, deeds, and more and could result in your needing a few thousand additional dollars on the day you close.
6. Where all of your financial statements are
When going through a mortgage approval process, your finances are under heavy scrutiny. You will need to account for every major deposit into your bank account, your taxes for the last several years, investments, losses, and then some. And you’ll need copies of every document.
Go through your filing cabinets, emails, accounts, etc., and begin to organize ahead of time so you aren’t surprised or in a scramble as the closing date approaches.
7. If you want to work with a mortgage broker or a mortgage lender
A mortgage broker can do the work of comparing various mortgage lenders for you, reviewing your finances, and helping you to secure the right loan through a lender willing to work with you. But you can do this yourself. You could talk to the bank in which you bank about its programs, review online lenders like Quicken Loans and LendingTree, or use platforms that pursue the best mortgage lenders for you based on a series of questions you answer – similar to what a broker would do, just online.
8. If you are prequalified or preapproved
Many first-time homebuyers get confused between prequalified
. If you are prequalified it means a lender has given your finances a once over and can guesstimate what you should qualify for. To be pre-approved requires a few extra steps and is more official in the eyes of sellers – it shows you are serious and have the financial backing from a lender when looking at their home.
9. The different mortgage types
Besides the FHA loans designed to assist first-time homebuyers, learn about the different options you have for buying a home. For conventional loans, you can choose from a fixed-rate or an adjustable-rate mortgage.
With a fixed rate, you will pay the same rates for the entire duration of your mortgage. With an adjustable rate, you often enjoy lower rates for the first few years to help you if you aren’t quite where you want to be and then increase later, when your income is expected to increase, too. These loans sound attractive due to the low monthly rates during those first few years but can hurt in the long run, especially if rates skyrocket.
10. Current interest rates
Speaking of interest rates, stay abreast of the federal interest rates. If they are low, it’s a great time to buy. If they are high, you may want to wait until they drop. Luckily, following the pandemic, the Feds have lowered rates and in 2021 mortgage rates are lower than 3% – this is an excellent time to buy if your credit is good.
Of course, if you want a house without waiting, you could attempt to refinance a high-interest mortgage later. But a new loan comes with new closing costs.
11. What the property taxes are
Everyone purchasing their home wants to live in a good neighborhood in a safe community with good schools. And those areas typically have higher property taxes to pay for those great schools and public safety. Review property taxes in towns where you are looking at homes to help determine your budget. If they are high, you’ll want to find a lower-priced home to keep the mortgage and taxes in line with your budget.
12. How much the home will cost to insure
Every home with a mortgage must have homeowners insurance. (Even if you don’t have a mortgage you should have insurance but that’s another story.) Lenders want to protect their investment and will require you have homeowners selected and ready to go at closing. Monthly rates, which can be paid by you directly or incorporated into your mortgage payments, will depend on the structure more than what is inside. Even if a house is affordable, take the age of the property and the costs of replacing it should something happen and the insurance value of the home may exceed the actual price.
13. The cost of an HOA
Perhaps you found your dream house and it comes with a Homeowners Association (HOA). Someone maintains the grass and a community pool, tennis courts, hiking paths – sounds good, right? But how much will that cost you? Association fees can run from $100 to $700 per month and are mandatory for all residents within an HOA community. You can vote to decrease rates but you can never leave an HOA unless you move out of the neighborhood. Factor fees into your monthly budget and determine if an HOA is a deal-breaker for you.
14. If you are ready for repairs
A real estate agent will always suggest you complete a home inspection before closing. Having a professional home inspector examine a house can uncover problems that could be costly to repair. Some sellers will sell a troublesome property "as-is" and you could be left with a fixer-upper. Others are willing to negotiate on repairs. You can request certain repairs are made by the seller before closing, in which a final walk-through and receipts of repair confirm them, or you may choose to have the costs of repairs deducted from the purchase price and then work on fixing the problems yourself after closing, at your expense.
15. How much house you can afford
You may be prequalified or pre-approved by a lender for a hefty dollar amount that can get you the house of your dreams. However, just because a lender says you can have a loan doesn’t mean you can actually afford the monthly mortgage payments you’ll need to make. A home purchase is more than than the purchase price. You don’t want to be putting more than 20% of your income into your housing or you will be known by what is referred to as “house poor.”
Your mortgage won’t be your only payments: There are the costs listed above (property taxes, insurance, HOA fees, PMI) as well as your debts, such as student loans, credit card debt, and more. You’ll want to factor in everything you possibly can to ensure you stay in that 20% or less of your income zone and maintain a healthy debt-to-income ratio.
The bottom line
Buying your first home is one of the biggest financial decisions you will make in your lifetime. Be sure you understand all of the intricacies that go into the process of receiving the keys to your very own home.