Overcome the fear of getting your first home--Step by Step!
First-time Homebuyer Guide
BARBARA Whelehan JULY 8, 2019 (Used with Permission from Bankrate)
So you’re in the market to buy a home. Whether it’s your first foray into the exciting home-buying process or you’ve been through it before and have forgotten the details, this guide will provide first-time homebuyer tips to prepare you for what’s ahead.
What is a first-time homebuyer?
Logically, a first-time homebuyer might refer to someone who has never purchased a home before. But in some contexts, the definition is actually much broader than that.
Prospective homebuyers who can’t scrape together a substantial down payment may be eligible for assistance through first-time homebuyer grants and loan programs. To qualify for many of these programs, prospective buyers generally must not have owned a home for at least the previous three years.
In other words, you don’t have to be a complete novice to qualify as a first-time homebuyer. Lenders and government agencies have loan programs in place to help people realize the American dream of homeownership, even if they’ve experienced it before.
How to qualify for a home
Qualifying for a home can be a challenge. Home prices have shot up since the housing crisis and are now at all-time highs. Meanwhile, wages continue to stagnate and consumer debt levels have surpassed $4 trillion – not including mortgage debt – increasing 22 percent over the past five years.
However, these general economic conditions may not apply to your personal financial situation. Before looking at housing options, take stock of your finances by answering these questions.
How much home can you afford?
First look at how much debt you have relative to your income, called the debt-to-income ratio. When determining how much of your gross income you should spend on a home, most financial advisers say it should be capped at 36 percent.
The ideal ratio for housing costs, including the mortgage payment, real estate taxes, homeowners insurance and homeowners association dues, should be 28 percent, while 36 percent should represent all your monthly debt, including housing. Some lenders even allow a DTI ratio up to 50 percent, however, the higher your DTI ratio, the more likely you are to pay a higher interest rate because you’re considered a riskier borrower. You don’t want to become house poor and stretch your monthly budget to its limit, so proceed with caution.
Do you need a down payment?
With a 20 percent down payment, you can avoid paying private mortgage insurance, which actually covers the lender (not you) should you default on the loan. But first-time homebuyers can get away with paying less than 5 percent with certain types of loans. USDA or VA loans require no down payment at all, while FHA loans require a minimum of 3.5 percent down. Conventional loans backed by Fannie Mae and Freddie Mac require as little as 3 percent down.
Is there a minimum credit score?
With a high credit score, you can get favorable loan terms that will save you gobs of money over the life of your mortgage loan. But you can still get a loan with a score as low as 500 (for FHA loans) or 620 (for conventional loans).
Benefits of owning a home
Owning a home can be a great way to build wealth, because you are putting relatively little down upfront. Meanwhile, you’re leveraging your investment and reaping the benefit of building equity as you pay down your loan. Of course, the real estate market doesn’t always go up, as we learned during the housing crisis. So it’s important to consider your budget and lifestyle in your buying decision.
Mortgage rates remain attractively low on a historical basis. If you choose a 15- or 30-year fixed-rate mortgage, your monthly payment will be predictable for the duration of the term, whereas rental prices tend to rise each year. Even if you get an adjustable-rate mortgage, the cap is fixed so you know what to expect in the future.
Buying in a nice neighborhood in a good school district tends to hold up the value of a home, and a homeowner can develop good friendships and strong bonds in the community. Owning a home also affords autonomy – you can make improvements as you see fit without having to answer to a landlord.
Is rent to-own a good idea?
Signing a lease-purchase agreement with the idea of owning a home in the future can work for people who currently have financial constraints or a problematic credit score. Rent-to-own gives you time to build savings and pay down debt to get more favorable mortgage terms in the future. But rent-to-own transactions can be complicated, and you might be better off simply waiting until you can purchase in the future. Getting legal advice is a wise step if you’re considering this route.
The arrangement requires both landlord/seller and tenant/buyer to make upfront decisions about the purchase date, how the home’s purchase price will be determined and who will assume responsibility for paying for maintenance and repairs as well as property taxes.
Usually a portion of the rent payment is allocated toward the down payment, so this can be a good way to build your investment gradually. However, depending on the laws in your state, you could lose your investment entirely if you fail to make a payment due to job loss or other misfortune.
Step-by-step first-time homebuyer guide
Step 1: Assess your personal finances.
Many homebuyers navigate open houses and the home-buying process without first evaluating their personal finances. A smarter approach is to first check your credit reports and score, examine your budget and assess your ability to make a down payment and pay closing costs. There’s also an earnest money deposit, which is a smaller deposit submitted with your initial offer. Some states require a deposit of 10 percent of a home’s purchase price from a buyer, while other states might allow earnest money of just a few hundred dollars.
Organize your paperwork to show lenders proof of your income and financial stability. This means gathering your pay stubs or W-2 forms, federal tax returns, bank statements and lists of all assets and debts. A lender will check your credit score and report and verify your income.
How this affects you: Determining how much home you can afford, as well as how much you can put down on a home, helps you set reasonable goals. Assess your ability to pay closing costs, which can range from 2 percent to 5 percent of the home’s purchase price. See if you might qualify for first-time homebuyer grants and programs that help with down payment or closing costs. Become familiar with the different types of mortgage loans available and their down payment requirements.
Takeaway: Don’t make decisions based solely on emotions. Do your research.
Step 2: Get mortgage quotes from three lenders
Apply for a mortgage with at least three lenders so you can compare interest rates and terms. You want to pay the lowest interest rate because less money spent on a mortgage payment means more money in your budget for inevitable maintenance and repairs that come with homeownership.
Investigate your loan options. Different loan programs have different requirements. If you have trouble finding a bank that will lend to you because you have poor credit or a lot of debt, you might need to take time to work on your finances before moving forward with a home purchase.
How this affects you: FHA loans are available to low- and moderate-income borrowers with a checkered credit history and a score as low as 500. You’ll still have to prove you have the means to make the mortgage payment in a timely manner.
Takeaway: You want to pay the lowest rate on a mortgage and get the best terms possible. Your financial history will impact the offers you get. Don’t forget to check mortgage rates online, too.
Step 3: Get preapproved for a mortgage
After you’ve gotten quotes from a few lenders, you’re ready to get preapproved for a mortgage. You’re in a stronger position to make an offer on a home in your price range with a preapproval letter in hand. The preapproval letter typically spells out how much you’re qualified to borrow, what loan program you’re using and the expected down payment you can make. Final approval for a loan will take place after the information you provided is verified by the underwriter and other conditions are met, such as an appraisal that supports the home’s sales price.
How this affects you: A preapproval letter is a must in a competitive market, and sellers will take your offer more seriously.
Takeaway: Be prepared for a lender to dig into all aspects of your financial life.
Step 4: Find a good real estate agent
A real estate agent can help enormously in the home-buying process. Agents who work in a particular market know the area well and can provide valuable insights about school districts and neighborhoods. When you’re ready to look at homes, interview agents and hire one to help you find the right one. Consider a buyer’s agent who will help you find the right home, negotiate the best offer and recommend other professionals whose interests are aligned with yours.
How this affects you: Listing agents generally represent the seller and their main goal is to get the best price on a home. The seller pays the commission to the listing brokerage, who disburses funds to all parties involved. If a buyer’s agent is involved, the listing brokerage pays the buyer’s brokerage, who in turn pays the buyer’s agent.
Takeaway: It’s best to work with someone who represents your interests.
Step 5: Shop for your home
This is the fun part. Provide your agent with a list of your top requirements so that you don’t waste your time looking at homes that don’t meet your needs. When you view homes, take notes or photos because otherwise you might forget the unique features of each home after looking at several properties.
Tour the neighborhood to see how traffic flows and to get a sense of its character. Check crime statistics and talk to neighbors, too. For a home you’re strongly considering, get a copy of the homeowner’s association documents so you know what the rules and fees are, if applicable.
How this affects you: You want to avoid making mistakes in the home-buying process by doing your due diligence upfront. How would you feel if you discovered the neighborhood was too congested with traffic or the nearby schools are underperforming?
Takeaway: Investigate as much as you can to avoid unpleasant surprises later. Never buy a home sight unseen.
Step 6: Make an offer
Once you find the home of your dreams, it’s time to make an offer. This is arguably the most exciting and nail-biting part of the home-buying process. Your agent can run an analysis of comparable listings (or “comps” in industry speak) that have recently sold in the area to help you make a competitive offer.
Your offer should include an offer price, deadline for the seller to respond (usually within 24 to 48 hours) and any contingencies you want to request. Contingencies for financing, appraisal or home inspection, for example, give you the ability to walk away from the deal without penalty under certain conditions.
How this affects you: A good agent will provide an analysis of comparable closed sales in the neighborhood to help you arrive at a reasonable offer price. Once a contract is presented to the seller, your offer can be accepted, rejected or countered with a different price.
Takeaway: Tap your agent’s experience to negotiate with the seller. It may even help to write a flattering letter to the seller describing why you love the home.
Step 7: Negotiate closing costs
Within three days of applying for a mortgage, you’ll get a loan estimate form that will detail the loan terms and estimated closing costs, among other pertinent information. Some closing costs are negotiable. Your lender may charge origination and underwriting fees that could be waived or discounted if you ask. Or the seller may be willing to pick up some of the costs.
How this affects you: Closing costs can also be rolled into your mortgage, but you’ll typically pay a higher interest rate to go this route. Understand where there’s wiggle room to negotiate on certain services. If you follow the advice in Step 1, you might find a grant in your city, county or state that helps you cover closing costs.
Takeaway: Ask your lender to clarify any fees you don’t understand in your loan estimate so you’re not asking these questions at the closing table.
Step 8: Hire a home inspector
An inspection takes about two or three hours and can range from $300 to $1,000, depending on the home’s size and the extent of the inspection. Home inspectors generally check the home’s structure, roof, heating, plumbing and electrical systems, but they typically don’t check for the presence of lead paint or mold.
Your agent can recommend a good inspector, or you can check the websites of a professional inspector association for a list of qualified inspectors. Three prominent associations are the American Society of Home Inspectors, International Association of Certified Home Inspectors and the National Academy of Building Inspection Engineers. Consult HomeAdvisor and Angie’s List. Also, check for complaints with the Better Business Bureau and online Yelp reviews.
How this affects you: Put a contingency clause in place that allows you to cancel the deal without penalty if the home inspection uncovers major problems and the seller is unwilling to address them. You and/or your agent should be present during the inspection so you can ask questions. You may also want to hire someone to check for mold or other potential problems.
Takeaway: You can ask the seller to purchase a one-year home warranty at closing, which can range in price from $300 to $650 and up, depending on the size and features of the property. This can be very reassuring for first-time homebuyers with tight budgets.
Step 9: Get homeowners insurance and finalize move-in details
Homeowners insurance is required by the lender and helps to protect your investment. Premiums vary, so get quotes from several companies or work with an insurance broker who can shop rates for you. Assess your needs and ensure that you buy adequate coverage to completely rebuild your home if it’s destroyed or seriously damaged. If your home is located in a federally-designated flood zone, you’ll need to buy flood insurance, too.
As you prepare for move-in day, contact your local utility, cable and internet providers to arrange new service for your move-in date. Another task: hire a reputable mover and start packing.
How this affects you: Buying a home involves a lot of expected upfront costs – and possibly unpredictable ones after move-in day. Have an emergency fund on hand for surprise repairs and maintenance.
Takeaway: Planning is essential for a smooth transition to your new home.
Step 10: Seal the deal at closing
You’ll have to get updated pay stubs and other financial paperwork just before closing to prove your employment status hasn’t changed and that you’ll be able to make your mortgage payments. Within 24 hours of closing, buyers do a final walk-through of the property to make sure repairs, if any, were made and that the home is vacant.
At the closing table, you’ll sign a lot of paperwork to finalize the loan and transfer ownership of the home from the seller’s name to yours. And you’ll be required to bring a cashier’s check made out to the escrow company, or wire closing funds to the company. Don’t forget to bring your identification, too.
How this affects you: Your real estate agent and lender will walk you through the closing process and explain everything you’re signing, but take your time as you review documents. After all, you’re committing to the largest financial transaction of your life. Three business days before closing, you’ll receive a form called a closing disclosure that outlines your loan details and fees. Compare it to the initial loan estimate to ensure you’re not being charged unexpected fees and that your personal information is accurate.
Takeaway: You now have a new title: homeowner. Congratulations!