March 20, 2017

How to Buy Your First Home

Read more about Mortgage

Purchasing your first home involves a ton of steps. The process can seem overwhelming. We're making it easier with our step-by-step guide.

Start out by answering the questions below to see if you are ready to buy a home. Then learn the steps necessary for loan approval.

Self-Assessment for Buying Your First Home

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First, you must determine if you are ready to purchase a home. Many factors go into this process. Securing a mortgage is serious business. More than likely it is one of the largest expenditures you will 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 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 to this number between 2% and 5% of the $120,000 loan for closing costs. This can amount to a large chunk of money.

  • Can you pay the monthly payments?

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    Owning a house involves more costs than renting - you'll 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.

  • 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 determines your financial responsibility. Do you pay your bills on time? Do you overextend your credit? Do you have too many debts? 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.

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

  • Are your debts under control?
    Your debt-to-income ratio determines your loan eligibility as well. Too many debts compared to too little income results in a denial. Lenders look at the debts reported on your credit report. Think of 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 programs require a total debt ratio lower than 36%.

These questions help you determine if you are ready to purchase your first home. We provide more details on these topics 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, it's time to see what a bank thinks. You don't have to use this bank when you find a home. It just gives 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 disclose your income, assets, estimated credit score, and estimated debts. The lender then provides you with an estimate of what you might receive. This is not a guaranteed approval. This doesn't occur until you provide the lender with proof of everything you stated. It does, however, give you a good starting point. This amount can guide you to the right areas and size 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 it starts to get real. You have an idea of what you might be able to afford. You are closer to house hunting than when you started. But first, decide if you want to use a realtor. 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. That being said, the cost of the realtor often gets built into the asking price. You aren't stroking the check, though, so why not?

Not sure if you want to use a realtor? Consider this. A realtor can be a valuable tool. The right one may help you find homes within your budget and needs. Realtors may even have earlier access to new listings than the general public. This takes a lot of the legwork off your shoulders. Knowing a home is newly listed could give you the leg up on other house hunters.

In the meantime, you can focus on securing your mortgage. This is part of the process you must handle. While using a realtor isn't mandatory, it is may be helpful.

You can shop homes for sale by owner as well. No matter what you decide, the right 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 helps move things along. Remember the pre-qualification you got? It means nothing when you find a home. You need a pre-approval, which we discuss below.

But, first you need a lender. You might stick with the lender that provided the pre-qualification. We encourage you to shop around, though. Obtain quotes from at least 3 lenders. You can start with your current bank or credit union. Don't stop there, though. Check online for other lenders or brokers in your area.

This gives you a better idea what is available to you. You can then compare interest rates, closing costs, and terms. Each factor affects the outcome of your loan. Focusing on the interest rate alone isn't always wise. We discuss the things you should consider below.

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

Time for a Preapproval

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

The lender needs the following documents to determine your loan eligibility:

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

  • Asset statements: The lender needs to verify 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 preapproval 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 loan types available. Conventional 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 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 preapproval does not bind you to any particular lender, it would be smart to shop around at this point and see where you can get the best rates and conditions.

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

Time to Shop for a Home

You have done the hard work - now you can shop for a home. Waiting until this point helps you stay focused and within your budget.

With your preapproval, the lender tells you the most you can borrow, at what terms and with which program. They write each of these details on your preapproval letter. For example, if you are preapproved for a $200,000 loan with FHA financing for 30 years, the letter says so. Some sellers allow government-backed financing, such as FHA or VA loans, while others prefer to avoid them. When you are up front with everyone right away, it helps to prevent any issues down the road.

The amount on the preapproval letter does not dictate your purchase price - that depends on how much you can put down. Add the amount you will use for the down payment to the preapproval loan 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 your closing and moving costs. 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 preapproval should state the down payment percentage the lender approved you to use. 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). 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 is you can get rid of it once you owe less than 80% of the value of your home.

Using your preapproval 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 new 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. It can be very easy to jump at the first home you fall in love with, but try to be patient. Compare different homes, their costs, and their condition first. You may think you love the first home you see, but then after viewing other homes, your feelings may change.

We suggest making a list before you shop for homes. List the features you "must have" and those you "prefer." You should also think of factors that would be a deal breaker. Having this list in front of you can help you keep an objective mind. It is very easy to get caught up in the emotion of buying a house. You may love some things about a home and overlook something you would otherwise consider a deal breaker. Keep the list and let others know about it. This way you can stay objective about your purchase.

Placing the Offer

Once you decide on a home, it is 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 the 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. You can then review the report to determine if you want to purchase the home with its specific issues. 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 protect you. If you 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 preapproval, 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 docs to the lender, the waiting begins. If you have a pre-approval, your wait may be slightly shorter. The lender will go over your income docs again and maybe 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 of the home. It also shows the condition. FHA loans, for example, require certain standards 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 receive a "clear to close." 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 will need to bring certain items to the closing including:

  • 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 are paying

You should receive a closing statement at least 3 days before your closing date. This will tell you how much money you must bring. 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 could be easier 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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