The majority of first time home buyers start off very excited. However, they soon feel overwhelmed by the maze of procedures involved in the home buying process.
You have to crunch your cash numbers to know what you can afford, work with real estate agents and sellers, find a lender with the best terms, and more.
The good news, though, is that you have access to several incentives, including federal and state grants, subsidized loans, and tax credits.
We understand how stressful it can be to navigate the process. That's why we want to share first time home buyer tips to steer you in the right direction to avoid expensive mistakes.
Let's get started.
1. Start saving for the down payment and closing costs
Most loan programs require providing a down payment, which can be as low as 3% of your home price. The more money you put down, the lower mortgage interest rates you're likely to get. You won't need a down payment if you are an active military service member, veteran, or surviving spouse.
When it comes to closing costs, you may incur anywhere between 2% to 5% of the loan amount.
Considering home costs run into hundreds of thousands of dollars, down payment and closing costs can prove significant even with the lowest rates.
Let's assume a home costs $250,000. The down payment cost would be at least $7,500. For closing costs, the fees would range from $5,000 to $12,500.
Therefore, it's best to start setting money aside early, as this allows you to break down the amount into smaller targets that you can easily meet every month.
Opening a Certificate of Deposit (CD) is an excellent way to chase your financial target, particularly if you have a couple of years (1-3) before buying a home. A CD offers above-average interest rates that can shield your savings against inflation. A high-yield, FDIC-insured savings account could be ideal for short-term home saving targets, typically 6-12 months.
Besides down payment and closing costs, savings can help you cover other expenses, such as private mortgage insurance (PMI), home repairs, and furnishings.
2. Run some numbers
Mortgage payments require a long-term financial commitment. As such, you need to carefully evaluate your finances to know how much you can afford to commit without getting yourself into a financial strain. Ensure you account for all your personal, healthcare, transportation, housing, and miscellaneous expenses.
Keep in mind lenders run affordability checks to ensure your debt-to-income ratio (DTI) doesn't exceed a specific percentage. Ideally, the cost of your monthly mortgage payments should be less than 28% of your income.
You can use a home affordability calculator to determine your estimated ideal mortgage amount.
3. Build up your credit score
Banks, credit unions, and other financial institutions rely on your credit score to make lending decisions. For most loan types, lenders require home buyers to have a minimum credit score of 620. But you can secure a loan with a credit rating of 500s. A higher score can mean qualifying for lower interest rates on mortgages.
So how do you go about improving your credit score?
· Check the accuracy of your credit reports — Request copies from Experian, TransUnion, or Equifax to see if negative remarks are affecting your credit. These credit reporting agencies give reports for free. If you find an error, dispute it.
· Make all your payments on time — Payment history accounts for 35% of your FICO score.
· Keep your credit utilization low — Credit utilization rate (CUR) accounts for 30% of your FICO score. Generally, you'll want to use less than 30% of your credit limit.
· Don't close your old credit cards — Otherwise, you'll lose your credit limit, and your overall CUR will increase. This can ding your score.
· Be careful when applying for new credit — It is best to wait at least six months between credit card applications.
4. Know your main mortgage options
· Federal Housing Administration (FHA) loans — With a FICO score of at least 580, you can qualify for FHA loans, which require a 3.5% down payment. If your rating is below 579, the down payment rate can go up to 10%.
· Department of Veterans Affairs (VA) loans — VA-backed home loans are designed for active-duty service members, veterans, and eligible surviving spouses. No down payment is needed in the qualification step. VA loans don't have a minimum credit score, but it lies in the 600s.
· U.S. Department of Agriculture (USDA) loans — These loans are for rural first time home buyers. Like VA loans, the USDA loans have no down payment requirements. Also, the lenders set their own FICO scores, but you're likely to get the best deals with a rating over 640.
· Jumbo loans – Since jumbo loans exceed the Federal Housing Finance Agency (FHFA) set limits, lenders require a FICO score of around 700 or higher. Down payments for conforming mortgage loans are about 10% to 15% of the home cost.
· Conventional loans — You access this type of home loan through a private lender, not a government agency. However, there are two government-sponsored enterprises offering these loans; Fannie Mae and Freddie Mac. You'll find conventional lenders offering products with a 3% down payment, but they'll require mortgage insurance if you put down less than 20%. You also need a 620 FICO score or higher to qualify.
5. Compare rates and terms of mortgage lenders for first time buyers
No two mortgage lenders are equal. Getting the best deal can mean saving thousands of dollars over the course of your mortgage period.
There are several costs associated with mortgages, such as interest rates, application fees, underwriting costs, and closing costs. Take your time to request loan estimates from multiple lenders — conventional banks, credit unions, mortgage brokers, non-bank mortgage lenders, etc.
Negotiate as many of the fees as possible, and work with the lender to see if you qualify for down payment assistance programs to lower your mortgage costs further.
The length of mortgage repayment is usually 10 to 30 years, but the popular options are the 15-year and 30-year mortgages. A 15-year fixed home loan requires higher monthly payments. However, you enjoy lower interest rates. The interest rate of a 30-year fixed mortgage never changes throughout the loan repayment period.
Mortgage lenders for first time buyers also offer adjustable-rate mortgages (ARMs). The interest rate of an ARM is subject to change after the set fixed-rate period expires. These loans are riskier if the rates shoot up significantly.
6. Obtain a mortgage pre-approval
It's advisable to consider getting pre-approved for a mortgage before you hit the market. A lender evaluates your debt-to-income ratio and provides approval that demonstrates your creditworthiness.
A pre approval mortgage letter can give you an idea of the budget you'll need to bring to closing. It can also give you a competitive advantage and increase your negotiation power when you make an offer to the seller.
Please note that the pre-approval process involves lenders pulling your credit. If you intend to request pre approval mortgage letters from multiple lenders, consider waiting at least 30 days between inquires.
7. Explore your home options
Residential housing types include condominiums, single-family homes, multi-family homes, townhouses, and duplexes. The best option depends on your preferences, homeownership goals, and budget.
You'll come across fixer-upper homes with attractive deals when you enter the market. It is imperative to consider the repair, redecoration, or redesigning costs. If you're not careful, you might end up spending more than you would have paid for a move-in-ready home.
Once you have decided on the type of home you want, make a list of must-have features. This could be the local amenities, size of the lot, kitchen design, bathroom layout, fitted home appliances, etc.
8. Hire a reliable real estate agent with an excellent reputation
Working with a real estate agent is highly recommended. Real estate agents can:
· Advice you on home types to help you make more informed decisions
· Search open listings to find properties that match your needs and are within your price range
· Coordinate appraisals and inspections
· Walk you through the negotiation and closing steps
Keep in mind, though, the agent you hire matters. Do your homework to get a few leads from previous home buyers you might know, or search online. Interview a couple of agents, requesting a list of clients they have helped find homes in your interested area. Settle for an experienced agent you're comfortable working with.
9. Schedule a home inspection
Suppose a real estate agent has helped you to find your dream house. Or perhaps you did it yourself by scouring home for sale signs around the neighborhoods or online listings. Whatever the case, don't assume your potential home is in flawless condition. Make sure you involve a professional home inspection expert to check for issues the seller might not have disclosed.
If the inspector catches significant defects, the seller will likely accept negotiating the selling price or do the repairs. Even if an inspection doesn't flag anything, you can still negotiate for the seller to pay a portion of closing costs. However, your negotiating power would be swayed by the local market conditions. You're likely to leverage more in a seller-dominated market than a buyer's market.
10. Be careful not to overshoot your budget
In a market dominated by buyers, you can easily go over your budget if you feel like you're likely to lose out on a good deal. Even if you have already set up an emergency fund, it's best to stick to properties within your affordable range. There's a home for you. Keep looking.
11. Closing on a house
If you strike a deal, the next step is to close. Be prepared for tons of paperwork before finalizing your real estate transaction. And there is a long list of costs involved, including:
· Home appraisal
· Title search
· Title insurance
· Homeowners insurance
· Private mortgage insurance
· Loan origination fees
· Attorney fees
· Credit report fees
· Mortgage broker fees
· Property taxes
There you have it! We hope this first time home buyers guide has simplified the process for you. If you have any questions or need clarification on something that's making your home buying a little stressful, feel free to reach out.
