How to Buy Your First Home
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
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?
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.Related: How Much Money Do You Need to Buy a House? We help you figure out whether the time is right to purchase a house now or whether you should wait.
- 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."
Time for a Preapproval
After you decide you are ready, it is time for the pre approval. This is the first step to purchasing your first home. It 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. They may discuss loan terms, such as 30-, 20-, or 15-year terms. You may also hear about conventional, FHA, USDA, or VA financing. 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% (FHA financing is for first-time buyers only). 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.
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.
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. This way you not only offer the right amount, but you 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. 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.
Closing the Loan
Closing the loan and taking possession of the home occurs after underwriting. Underwriters look at the documents you provided. They may ask for further documentation or explanations. They will also evaluate the appraisal. They check to ensure there is enough collateral for your specific loan program. 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.
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.