March 20, 2017

How to Buy Your First Home

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Purchasing your first home involves a ton of steps. The process can seem overwhelming. Our step-by-step guide is designed to make it easier.

You should begin by answering the questions below to see if you are ready to buy a home. If you are, then you'll continue reading to learn the steps necessary for loan approval.

Self-Assessment for Buying Your First Home

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First, determine if you are ready to purchase a home. You need to take many different factors into considering because securing a mortgage is serious business. More than likely, buying a home is one of the largest purchases you will ever make. Ask yourself the following questions to determine your readiness:

  • Do you have enough money saved?
    Knowing how much money you need is important. For starters, you need more than just the down payment. You need money for closing costs, moving costs, and emergency funds too. In a perfect world, you want a 20% down payment. On a $150,000 home, this means $30,000. Add between 2% and 5% to this number for closing costs.

  • Can you afford the monthly payments?

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    Owning a home involves more costs than renting - you have to pay for utilities every month, plus property taxes, home insurance and, of course, your mortgage. If you can't afford 20% down, private mortgage insurance will become part of your monthly obligations as well.

    Tip: Have you thought about the pros and cons of renting vs. buying? You may find you’re better off renting believe it or not — some smart renters are able to have more net worth than homebuyers, and in some regions, renting is actually cheaper in the long run.

    Related: How Much Money Do You Need to Buy a House

  • Is your credit good enough?
    Your credit score tells the lender a story about your financial history. They look at your score and credit history. Together, this helps them determine your financial responsibility. Do you pay your bills on time? Do you overextend your credit? Do you have a lot of debt? We recommend obtaining a copy of your credit report before you apply for a mortgage. Look at your history and the validity of each account. Contact the credit bureau if there are errors and pay down any high balances to improve your score.

    Tip: When you apply for a mortgage, what is the lender going to think of you? The big number they want to see is your credit score — 680 or higher will usually get you a stamp of a approval with the best interest rates reserved for those with a score of 740 or higher. And 620-680 is considered fair but you may not get the best terms available. It’s wise to know what your credit score is before you apply, so you can decide if you need more time to build it up or figure out why it is what it is.

  • Is your employment and income stable?
    Lenders do not want to see rocky employment history or wavering income. Consider the past few years of your life. How many jobs have you held? Were they in the same industry? Did your income remain stable, increase, or decrease? The more stable your income and employment, the more likely you are to obtain a loan approval. Changing jobs is not necessarily a bad thing, though. If you stay in the same industry but advance your career, it can actually help.

  • Are your debts under control?
    Your debt-to-income ratio plays a role in your loan eligibility as well. Too many debts with too little income will result in a denial. Lenders look at the debts indicated on your credit report. These are things like auto loans, student loans, and credit card debts. These payments, plus your proposed mortgage payment, make up your monthly debts. Divide this total by your gross monthly income and you have your debt ratio. Most loan programs require a total debt ratio lower than 36%.

Answering these questions will help determine if you are ready to purchase your first home. More details are available in our article "How to Get Approved for a Mortgage."

Did you know: First-time homebuyers make up almost half the buyer's market.

Think You're Ready? Get Pre-Qualified

Once you check all the boxes above, that means it's time to see what the bank thinks. You don't have to use the same bank when you find a home, but it will give you an idea of what you might be able to afford. You can get a pre-qualification online or over the phone. It's a short and informal process.

You'll need to disclose your income, assets, estimated credit score, and estimated debts. The lender then provides you with their estimate of what you might expect to receive in the way of a loan. Keep in mind that an approval doesn't occur until you provide the lender with the actual proof of everything you stated and estimated, but it does give you a good starting point. This amount can guide you to the right areas and sizes to start looking for your future home.

Did you know: You are never too old to buy a home. In fact, the median age for first-time homebuyers is 33 years old, according to Zillow.

Decide if you Want to Use a Realtor

Now that you have an idea of what you might be able to afford, you're that much closer to actual house hunting. But first, you should decide if you want to use a realtor or not. For the buyer, these services are "free," meaning you don't pay the realtor outright. The seller pays the realtor out of the proceeds of the sale, but of course that means that the cost of the realtor often gets built into the asking price of your home.

A realtor can be a valuable tool, though. The right one can help you find homes within your budget and requirements that you might not have found on your own. Realtors may even have access to listings sooner than the general public, meaning you can get to it sooner than other house hunters. This takes a lot of the legwork off your shoulders.

And with the time you're saving while your realtor is searching for homes for you, you can focus on securing your mortgage. This is a part of the process you must handle yourself.

If you're not into the idea of a realtor, you can shop homes for sale by owner as well. But no matter which direction you decide to go in, the next step is finding a lender so you can secure a pre-approval.

Find a Lender

Finding a lender early in the home buying process really helps move things along. Even if you got a pre-qualification before, you still need a pre-approval to actually get the loan. The pre-qualification doesn't really mean anything. It simply helps you contextualize your ability to buy a home.

First, you need a lender. You might decide to stick with the lender that provided the pre-qualification, but it's smart to shop around a bit, too. A good rule of thumb is to obtain quotes from at least three lenders. You can start with your current bank or credit union, but don't stop there. Check online for other lenders and brokers in your area.

You can then compare interest rates, closing costs, and terms, giving you a better overall idea of what is available to you. Each factor affects the outcome of your loan. Focusing on the interest rate alone isn't always wise.

Once you make a decision, you will need pre-approval. Read on to learn how to secure this.

Time for a Preapproval

A pre-approval lets you know how much you can afford and what kind of payment you can expect to make. Without a pre-approval, some sellers will not take your bid seriously. They want bidders who have the proven ability to secure financing. The pre-approval shows sellers you are not only serious but qualified as well.

The lender will need the following documents to determine your loan eligibility:

  • Income documents: The lender needs your latest two paystubs as well as W-2s and/or tax returns from the last two years. They use this information to determine your income pattern and employment stability over time.

  • Asset statements: The lender needs to verify that you have sufficient funds for the down payment. Lenders make sure the funds are yours by requesting a paper trail over the last 12 months.

  • Credit report: You must provide your personal information, including your social security number. This allows the lender to pull your credit report.

During the pre-approval process, the lender may provide you with several loan options. A few terms you may hear include:

  • 15, 20, or 30-year terms - This describes how long you have to pay the loan back. The shorter the term, the higher the payment. You may benefit from paying less interest, though, if you make your payments on time. The longer you borrow money, the more interest you pay.

  • Conventional, FHA, USDA, or VA - These are the mortgage types available. Conventional loans are the most common, but not the only option available. FHA loans may have more flexible guidelines for borrowers with mediocre credit scores. VA loans are for veterans that served our country. They don't require a down payment and also have flexible terms.

  • Points - Points are fees you may pay at the closing. Every lender charges a different amount. 1 point equals 1% of your loan amount. If you borrow $100,000, 1 point equals $1,000. You may hear the term discount points. You may pay these in exchange for a lower interest rate. You may also hear about origination points. These are fees charged by certain lenders to process your loan. They have nothing to do with the interest rate.

Each of these pertains to specific loan programs. Every lender has different programs available, just as every borrower qualifies for different programs.

While a pre-approval does not bind you to any particular lender, it would be smart to shop around and see where you can get the best rates and conditions.

Learn more about the pre-approval process in our article "Mortgage Approval: What You Need to Know."

Tip: You need to decide between a fixed and adjustable rate mortgage (ARM). With a fixed mortgage, you have the same interest rate from year one to year 30, unless you move or refinance. It won’t change, so the payments are predictable. With a an ARM, you could probably get a lower interest rate than you would with a fixed — but you’d have to deal with the uncertainty of it changing over time.

Time to Shop for a Home

So now that you've done the hard work, you can finally start shopping for a home. Waiting until this point to start the actual shopping will help you stay focused and within your budget.

With your pre-approval, the lender tells you the max amount you can borrow at what terms and with which program. They write each of these details on your pre-approval letter. For example, if you are pre-approved for a $200,000 loan with FHA financing for 30 years, that's what the letter will state. Some sellers allow government-backed financing, such as FHA or VA loans, while others prefer to avoid them. You should just be upfront about your loan right to help prevent issues arising further down the road.

The amount on the pre-approval letter does not dictate your purchase price - that varies depending on how much you can put down. Add the amount you will use for the down payment to the pre-approval loan amount to come up with the maximum you can bid on a house. (That's not to say you want to pay the maximum. The amount you can afford really depends on you and whether that amount makes sense for a particular house.)

When you do factor in how much you can offer on a house, remember to factor in your closing and moving costs as well. You don't want to spend all of your savings on the down payment just to buy a more expensive home.

Tip: Learn how to determine the right home purchase price in our article "How Much House Can I Afford?"

Your pre-approval should state the down payment percentage the lender approved. For example, if you qualified for FHA financing, you need a minimum down payment of 3.5%. If you qualify for conventional financing, you will be expected to put down more (if it's less than 20%, you'll also need to pay private mortgage insurance or PMI). This affects your monthly payment and debt ratio, so proceed carefully.

Tip: In order to qualify for the low 3.5% down payment on an FHA loan, your credit score must be at least 580. If your credit score falls between 500-579, you may qualify, but with a 10% down payment. All FHA loans charge annual mortgage insurance no matter how much you borrow. This insurance lasts for the term of the loan.

Conventional loans allow down payments as low as 5% for borrowers with good credit. Any down payment less than 20% requires PMI. The difference here is you can get rid of it once you owe less than 80% of the value of your home.

Using your pre-approval as a guide, you and your realtor can shop within your budget to help you find a home.

You can use several methods when you shop for your first home:

  • Browse real estate websites offering MLS listings and For Sale by Owner properties
  • Work with a realtor who can alert you of listings within your budget and desired area
  • Attend open houses to get a feel for the type of houses that are available in your price range

Take your time when you shop for your first home. Compare different homes and their costs and conditions first. You may think the first home you love is the one, but after viewing other options, your feelings may change.

Make a list before you start looking, deciding which features are "must have" and just "nice to haves". You should also think of factors that are deal breakers. Keep this list in front of you will help you remain objective as it is very easy to get caught up in the emotion of buying a house. Because you love some things about a home, you may overlook something you would otherwise consider a deal breaker.

Placing the Offer

Once you decide on a home you love, it's time to place an offer. We suggest using a realtor and/or attorney for this step. A basic purchase contract will include the following:

  • Property information including the address and legal description
  • Agreed upon purchase price
  • Agreed upon down payment and/or earnest money
  • Agreed upon closing date
  • Description of items staying in the home
  • Necessary disclosures pertaining to lead paint
  • Warranty information

You may also want to include appropriate contingencies in your contract. A few of the most common contingencies for first-time homebuyers include:

  • Inspection contingency: This gives you time to pay for and have an inspection of the property. Once you're informed of any issues, you can then determine if you still want to purchase the home. With the help of your realtor or attorney, you should determine if you need a termite inspection along with a general inspection. Including these contingencies in your contract protects you. If you need to back out before the expiration of the contingency, you can do so without losing any money.

  • Financing contingency: This gives you a specific amount of time to secure your loan. Even if you have a pre-approval, you still need an approval without conditions. An underwriter needs to evaluate your documents to make sure everything meets the program's requirements. If your financing falls through before the expiration date, you can back out of the purchase without penalty.

  • Appraisal contingency: You have no control over the value of the property. You also do not have control over the amount the seller asks for the home. An appraisal contingency gives you a way out. If the value does not meet or exceed the agreed upon sales price, you do not have to purchase the home.

Once the seller accepts your offer along with your contingencies, all parties sign the sales contract.

Processing the Loan

With a signed purchase contract and all necessary documents with the lender, the waiting begins. If you have a pre-approval, your wait may be slightly shorter. The lender will go over your income documents again and might even re-verify your employment or income. The real waiting pertains to the appraisal and title search. The underwriter needs both documents to proceed. They both have an impact on your loan.

  • Appraisal: This report shows the underwriter the value and condition of the home. FHA loans require certain standards to be met to ensure the home is safe and sanitary. Without the right appraisal, the underwriter can't clear your loan to close no matter how qualified you are for the loan.

  • Title search: This is an examination of the prior ownerships of the property. The examiner also looks for other liens on the property. All liens must be cleared before you can close on the loan. Unpaid tax liens or unpaid contractors are common reasons for liens on a home.

Once the underwriter approves the appraisal and clear title, you are well on your way to the closing table.

Closing the Loan

Closing the loan and taking possession of the home occurs after underwriting. When the underwriter clears everything, you'll receive a "clear to close" notice. This means the closing agent, lender, and seller can arrange a closing date. At the closing, you sign the necessary documents that make you a first-time homebuyer with your first mortgage.

You can expect to see your loan officer, the seller, your attorney, and real estate agent at the closing table. They all sit alongside the closing agent. The agent runs the show while the others provide support as needed.

You'll need to bring certain items to the closing:

  • Proof of paid homeowner's insurance for the next 12 months
  • Photo ID
  • Cashier's check for the amount of your down payment and any closing costs

You should receive a closing statement at least three days before your closing date. This will tell you how much money you must bring to the closing. It also gives you a chance to go over the loan details to make sure they are what you agreed to at the start of the process.

Bottom Line

Buying your first home is fun and overwhelming at the same time. Take your time and truthfully answer the questions at the start of the article. With our self-assessment and tips, buying your first home can go smoother than you thought.

More from CreditDonkey:


How to Save for a House


How Much Money Do You Need to Buy a House


Pre Approval Mortgage

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