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First Time Home Buyer Guide

Owning a HomeFirst Time Home Buyer Guide

Buying your first home involves a lot of research, a lot of deliberation… and a lot of money. That’s why we put together this guide – to help you get educated, be more prepared, and feel more confident throughout the home buying process.

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Questions first time home buyers should ask

So you’re ready to buy a home — or are you? Before you get too deep into the home buying process, there are a few factors you should consider first to ensure buying a home is the right move. Find out if you’re personally and financially ready to buy a home by asking yourself these questions.

In this chapter

  • Am I financially ready to own a home?
  • How much house can I afford?
  • Should I build a home or buy?
  • Do I have to put 20% down on a house?
  • Is mortgage preapproval for me?

Am I really ready to buy a house?

You’ve been dreaming of becoming a homeowner for years. Perhaps you’ve envisioned yourself entertaining in the kitchen or tucking your kids into their bedrooms at night. But take a step back for a moment; just because you feel ready to buy doesn’t mean you’re ready on paper.

Making the decision to rent vs. buy a home is largely a numbers game. Consider how much you currently pay every month for rent. Then compare that to the cost of owning in your desired neighborhood.

Once you factor in the mortgage, interest, property tax, homeowners insurance, yearly maintenance costs, and maybe a homeowners association fee, owning a home might turn out to be more expensive than you thought. It’s also important to consider how long you plan to live there, whether the property will appreciate in value, and how much in interest and taxes you can write off. The decision to rent vs. buy requires some math, and it isn’t exactly simple.

There are also other personal and financial considerations. For example, consider the many pros and cons of renting vs. buying. Renting lets you move whenever you want and avoid the expense and hassle of maintaining the property. Owning a home might be more expensive and time-consuming, but it can provide stability and a long-term investment.

Ultimately, the decision to buy a home is a personal one. If you determine you’re not ready yet, that’s perfectly OK. In fact, you may decide to be a lifelong renter, which can be a good financial decision. However, if you know you want to buy someday, then it helps to crunch the numbers, set a goal, and work out a timeline for getting there.

What size down payment do I need?

In addition to knowing how much money you can afford for a monthly housing payment, you’ll also need to figure out how much cash you need up front as a down payment. How much down payment for a house is typically required? Again, the answer depends on your situation.

If you can afford it, saving up a 20% down payment for a home is ideal. Putting down less usually means you’ll have to pay private mortgage insurance (PMI) until the property reaches 20% equity. Lenders may also charge a slightly higher interest rate to offset the risk of accepting less money down. Plus, the less money you put down, the more money you have to borrow.

However, just because a 20% down payment is recommended doesn’t mean it’s required. In fact, only 43% of home buyers put down the full 20%, while nearly a quarter put down 5% or less, according to a 2018 market analysis by Zillow.

In some cases, it can make sense to put down less than 20%. For example, if home values are rising quickly, they may outpace your ability to save up enough money. So you might put down less than 20% to avoid being priced out of the market. If you’re buying an expensive property, you might not want that much of your cash tied up in an illiquid asset.

Some government-backed loan programs allow homeowners to put down much less than 20%, allowing them to get into affordable housing without paying exorbitant interest rates or PMI – more on that below.

Should I get preapproved for a mortgage?

There’s one step you can consider taking, which isn’t required but might make it easier to figure out how much home you can afford. Plus, it could help seal the deal when you finally make an offer on a home. That step is getting preapproved for a mortgage.

Mortgage preapproval means a lender has already determined what mortgage programs you qualify for, how much you can borrow, and at what interest rate, even though you haven’t picked out a house yet. Once approved, you’ll get a preapproval letter that you can provide sellers you’re interested in buying from, giving them reassurance that you’re more likely to secure financing right away.

Most pre-approvals are good for 60 to 90 days, allowing you enough time to shop around for a home and negotiate an offer. However, preapproval doesn’t guarantee a loan — you’ll still need to go through the full mortgage approval process once you’re ready to buy a property.


Types of loans

When it comes to getting your hands on financing for a home, you can choose from several loan types. Not only do you have options such as fixed-rate and adjustable-rate loans, but also special financing programs designed for both first time and experienced home buyers.

In this chapter

  • What types of mortgages are available?
  • Are there mortgage options for people who don’t have great credit?
  • Can I get a mortgage with a low down payment?
  • Are there special programs for first time home buyers?

Conventional mortgages

A conventional mortgage is not backed, or insured, by a government agency. Instead, this type of loan is funded by an independent financial institution. Many conventional loans are considered “conforming loans” because they conform to guidelines set by two government-sponsored entities, Fannie Mae and Freddie Mac. Non-conforming loans usually exceed the loan maximums set by Fannie and Freddie, also known as jumbo loans.

Conventional loans typically require better credit and higher down payments than other government-backed loans, though it is possible for first time home buyers to get a conventional loan with as little as 3% down, according to lending marketplace Rocket Mortgage. Again, if you put less than 20% down on a conventional mortgage, you’re required to pay PMI.

FHA loans

Loans made through the Federal Housing Administration (FHA) can be a good option for first time home buyers who don’t have great credit or a lot saved for a down payment. These loans differ from conventional mortgages because even though they’re issued by individual banks, the loans are insured by the federal government. This means banks are more likely to approve loans with lower down payments and credit scores, since the funds are guaranteed if the borrower can’t make payments.

It’s possible to put down as little as 3.5% on an FHA loan, though you’ll be required to meet a certain credit score minimum depending on exactly how much you put down. Still, that credit requirement is typically lower than what you can qualify with on a conventional mortgage.

FHA loans also require an upfront mortgage insurance premium of 1.75% of the total loan value at closing, regardless of how much you put down. You must also pay monthly mortgage insurance, which can be canceled after 11 years if you originally put down more than 10% on the loan.

VA loans

Eligible veterans, servicemembers, and surviving spouses can qualify for a mortgage through the U.S. Department of Veterans Affairs (VA). Like FHA loans, VA loans are made through private lenders but backed by the federal government.

Often, these loans require no money down and no mortgage insurance. However, borrowers are subject to credit, income, and other eligibility requirements, though these are usually less strict than conventional mortgages.

USDA loans

The U.S. Department of Agriculture (USDA) guarantees loans for home buyers in eligible rural areas who meet certain income requirements. These loans offer low-interest rates and often no money down, even if the borrower doesn’t have great credit. However, PMI is required for small down payments.

Special first time home buyer loan programs

In addition to these national loan types, there are other loans, programs, and grants available to first time home buyers on the local level. For example, the Good Neighbor Next Door program offers significant home discounts to firefighters, teachers, law enforcement officers, and others who choose to buy in certain revitalization areas.

The HomePath Ready Buyer program offers assistance toward closing costs for first time buyers of Fannie Mae-foreclosed homes. The U.S Department of Housing and Urban Development (HUD) offers a directory of first time home buyer loan programs by state. Check out your state to see what programs you might qualify for.


First time home buyer qualifications

When shopping for a home loan, it’s helpful to know how lenders will evaluate you as a borrower. Every lender will have its own set of eligibility requirements, but there are some basic first time home buyer qualifications you can expect to be measured against.

In this chapter

  • What is a first time home buyer?
  • Is there a minimum credit score needed to buy a home?
  • How to calculate your debt-to-income ratio

Who qualifies as a first time home buyer?

First time home buyers often qualify for special financing terms and benefits, but what actually constitutes a first time buyer? The definition might surprise you. According to HUD, you’re considered a first time home buyer if you meet any of the following criteria:

  • You or your spouse haven’t owned a principal residence in at least three years.
  • You’re a single parent who has only owned a home with a former spouse while married.
  • You are a displaced homemaker and only owned a home with a spouse.
  • You have only owned a principal residence that wasn’t permanently affixed to a permanent foundation (a mobile home).
  • You have only owned a property that didn’t meet state, local, or model building codes, and it would cost more to bring that property into compliance than to build a new home.

As you can see, the definition of a “first time home buyer” is fairly broad. In fact, you could have previously owned a home and still qualify.

Credit score requirements

Your credit score is a major determining factor in getting approved for a mortgage. Fortunately, the credit score needed as a first time home buyer is sometimes lower than for other borrowers. The specific credit score you need to qualify for a first time home buyer loan will depend on the loan type.

For example, you typically only need a credit score of 640 to qualify for most first time home buyer assistance programs, according to Experian. A minimum score of 680 is usually needed for conventional mortgages. On the other hand, you can qualify for an FHA loan with a score as low as 500, provided you put at least 10% down.

Keep in mind, however, that these are simply the minimum scores that lenders will consider. Having a credit score that meets or exceeds the minimum doesn’t guarantee that you’ll be approved for a mortgage, since the decision is based on multiple factors and is ultimately up to individual lenders and their requirements. Plus, the best interest rates and terms are generally reserved for borrowers with excellent scores since they present the lowest borrowing risk.

Debt-to-income ratio

Remember the 28/36 rule mentioned above? Another term for your monthly debt obligation compared to your monthly gross income is known as your debt-to-income ratio, or DTI. Your DTI is another important factor lenders look at when you apply for a mortgage. And though limiting your total monthly debt to 36% of your income is ideal, it isn’t a hard limit when it comes to borrowing.

For example, the federal rule for a “qualified mortgage” is set to 43%, though there are exemptions that allow for higher ratios. Fannie Mae, the largest provider of mortgage loans in the U.S., upped its maximum debt-to-income ratio for a mortgage from 45% to 50% in 2017. That means some mortgage borrowers may qualify for a loan if their mortgage payment and all other debts equal no more than 50% of their monthly gross income.

Of course, the lower your DTI, the more attractive you are as a borrower. So if your DTI nears the maximum allowed, consider working on paying down some of your outstanding debt before applying for a mortgage.


Shopping for your dream home

Now that you know what loan options are available and what you might qualify for, it’s time to go house hunting. This is arguably the most fun part of the home buying process, but it’s just as complex and requires diligent planning and strong judgment.

In this chapter

  • Do I need a Realtor?
  • What to expect from the home inspection
  • How to make an offer on a house

Hiring a Realtor

Though it’s not technically required, hiring a Realtor can help aid the process of both buying and selling a home. Not to be confused with a real estate agent, which is anyone who has a license to sell property, a Realtor is an agent or broker who is a member of the National Association of Realtors and must follow a strict code of ethics. Realtors don’t just help you find the best properties — they can also lead negotiations, stick around for inspections, and even direct you toward the best mortgage loan for your situation.

To find a Realtor, you can start with a basic online search. However, it helps to ask trusted friends and family for their recommendations. You should also feel free to ask plenty of questions, such as how long they’ve practiced and what their schedule is like, until you’ve found a person you feel comfortable working with.

Getting a home inspection

Once you’ve found the perfect property that you plan to buy, you’ll need to have it inspected. It’s common to arrange a home inspection after you make an offer, but getting it done before submitting an official offer can put you in a better negotiating position. The cost of a home inspection varies geographically, though a typical range is $300-$500, according to HUD.

The home inspection will give you a clearer idea of how much the property could cost you in terms of renovations, repairs, and ongoing maintenance. A home inspector will take a look at various areas of the house, especially spots that are prone to hidden damage, such as the roof, walls, foundation, plumbing, and electrical.

You shouldn’t expect the report to come back perfect, but you also want to be wary of expensive, surprise problems. If major repairs are needed, the seller may lower the home’s price or agree to get the repairs done themselves.

Making an offer

Now that you have your eyes on a property and an idea of how much you’re willing to pay for it, it’s time to work with your Realtor to submit an offer. Keep in mind that to make an offer on a home, you need to show proof that you have the funds available to go through with the purchase.

Typically, you’ll submit a proof of funds letter along with your offer, which can be obtained from the bank where your money is being held. If you were preapproved for a mortgage, it’s a good idea to include a preapproval letter from the lender, too.

Once you’re prepared to make your offer, this stage will potentially include a few steps:

  1. You submit an offer.
  2. The seller either accepts or rejects the offer.
  3. If the seller rejects it, they may submit a counter-offer.
  4. You then review the counter-offer and decide whether to accept or reject it. You may counter again, with both parties either choosing to walk away, or hopefully, coming to an agreement.

It’s important to submit an attractive offer that isn’t too low or too high compared to the asking price, and avoid letting emotions guide your decision making. That can be a tall order, as you likely have a lot of hope and anticipation riding on whether or not your offer is accepted. But your agent (if you choose to work with one) can help guide you through the process.

Once your offer is accepted, you sign the purchase agreement. This is a contract that outlines a number of details, including the purchase amount, a mortgage contingency agreement that lets you off the hook if you can’t secure financing within a certain period of time, and closing date. It can also list items included in the sale (such as furniture, appliances, etc.), a guarantee from the seller that the home’s title is clear, and much more.

Also included in the purchase agreement is how escrow will be handled. The escrow process is an important step that involves setting aside some money to be held by an impartial third party while the home sale is finalized.

These funds serve as a deposit equal to a small percentage of the sale price, and a promise to the seller that you will make good on your offer. If you back out of the sale in a way that violates the purchase agreement, the seller keeps that money.


The home buying process

As you work on nailing down the home of your dreams and making an offer, you also need to pursue financing. The home buying process can be a bit tedious and complex, so familiarizing yourself with the steps ahead of time can help you navigate it all.

In this chapter

  • Applying for a mortgage
  • Things to consider when choosing a lender
  • How to close on a loan

Preparing to apply for a mortgage

Getting a mortgage requires quite a bit of paperwork. You’ll find the process to go much smoother if you have all your documents prepared and organized ahead of time, especially if you have to spend some time digging for older information like tax statements or pay stubs.

When you go through the mortgage application process, expect to be asked for the following documents:

  • Income verification documents such as W-2s for the past two years of employment, pay stubs from the last 30 days, and income tax returns from the last two to three years.
    • If you’re self-employed, you’ll need to provide additional documentation to prove that you can afford a mortgage payment, including 1099 forms and profit-and-loss statements.
    • If you also rely on income from child support or alimony, you’ll need to provide copies of the court order and bank statements showing the payments.
  • Proof of assets, including two to three months of bank statements, retirement and investment account statements, and any other accounts.
    • If you are relying on gifted funds for the down payment, you’ll also need to provide a gift form and potentially bank statements showing where the money came from.
  • List of debts, including credit card balances, student loans, auto loans, and any existing mortgages. You may or may not be required to submit documentation showing you own these debts.
  • Additional records may be needed, depending on your situation. This could include proof of rent payments, divorce decree, proof that a previous bankruptcy has been discharged, and more.

Choosing a lender

Next, you’ll need to compare multiple lenders and choose the best one to apply through. Usually, lenders will allow you to submit a few personal details and get a quote without going through the full application process.

Get quotes from several mortgage lenders so you can compare offers first. There are several factors you should consider, including:

  • Mortgage rate: The interest rate you pay on your mortgage will significantly impact the lifetime cost of the loan. Compare rates across multiple lenders and try to get the lowest one possible.
  • Loan terms: Are you looking for a fixed-rate loan? An adjustable rate? Graduated payments? Maybe you prefer a 15-year term instead of a 30-year term. Research which lenders offer the types of loans you’re interested in.
  • Low fees: In addition to the mortgage rate, fees are another way your mortgage can cost much more over time. It’s important to find mortgage lenders that charge fees that make sense — and charge few fees at all.


Closing on the loan

Once the mortgage lender has reviewed your application and supporting documents and decides to approve you for a loan, it’s time to close the loan.

What is the process for closing on a loan? Generally, the loan terms are finalized and the funds are disbursed. Once this happens, you become legally responsible for paying back the loan. This usually occurs at the same time as the home closing.


Other costs to consider

As you can probably tell by now, there are several hidden costs of buying a home that you might not have considered. Many of these expenses go beyond the actual home loan. Here’s a closer look at additional costs of buying a home so you can plan ahead and work them into your budget.

In this chapter

  • What to expect from closing costs
  • What is PMI?
  • How to choose a homeowners insurance policy
  • The cost you may not be thinking about…

Mortgage closing costs

When you close on a home, it’s common for the mortgage lender to charge closing costs. This extra expense is meant to cover the administrative costs of putting together your loan, such as the appraisal, pulling various documents, and performing the underwriting.

So how much are closing costs on a house? Usually, they’re about 2% to 5% of the total loan amount.

Say you borrow $100,000 to buy a house. You can expect your closing costs to total $2,000 to $5,000. These fees can be paid in full at closing, but often they’re rolled into the principal balance of your loan. If you tacked on a 5% closing fee to your $100,000 mortgage, you’d actually walk away with a loan for $105,000. And yes, you pay interest on the full amount.

Private mortgage insurance

As mentioned above, you usually need to pay private mortgage insurance in addition to your regular mortgage payment when you put less than 20% down on the loan. But what is PMI, exactly?

When you put less money down on a loan, you end up having to borrow more. And the larger the loan, the more risk the lender takes on. Essentially, PMI protects the lender if you’re unable to make your payments.

Once your property gains enough equity, you can cancel the PMI. It is possible to find some lenders that offer low down payments with no PMI, but they’ll usually charge a higher interest rate instead to offset the risk.

Learn More About PMI Insurance

Homeowners insurance

Unlike private mortgage insurance, there’s no escaping homeowners insurance. When you buy a home, most lenders require you to also take out a homeowners insurance policy with adequate coverage through an insurance company. This protects you against financial loss if the home is damaged by certain events.

When it comes to how to choose homeowners insurance, the process is similar to choosing a mortgage lender. You’ll want to know all the associated costs, compare various offers, and ensure you’re working with a reputable company.


Home maintenance

One of the reasons owning a home can be more expensive than renting is because you’re responsible for covering all the property’s renovations, repairs, and maintenance. Need to fix the roof? Want to upgrade the kitchen? That’s on you — there’s no landlord to handle it.

Knowing how much to budget for home maintenance will depend on the size of your home, how old it is, what shape it was in when you bought it, and more. However, the Washington Post reports that you should expect to spend 1% to 2% of your home’s value per year on maintenance.

Homeowner association fees

Finally, you might buy a property in an area with a homeowner association (HOA). If so, participation in the HOA is mandatory, and therefore, you’ll be subject to HOA fees.

An HOA is a nonprofit organization of homeowners within a certain area, such as a condominium or gated community, that exists to help maintain the neighborhood according to a set of agreed-upon rules.

For example, an HOA might regulate what color you can paint your house or where guests can park, as well as manage trash pickup and landscaping services. Monthly dues are collected from all the members to cover the costs associated with the HOA. These fees can vary widely, but are typically around $200-$300 per month for a single-family home.


The bottom line

Buying a home requires careful analysis of your finances, the housing market, and the lending options available. And homeownership isn’t for everyone.

However, if you do decide to buy a home, know that it doesn’t have to be a mysterious or stressful process. With knowledge and numbers on your side, you’ll be an informed buyer and inside your dream home in no time.

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