You start dreaming of how wonderful it would be to own a Container House and start looking around the internet at homes. It’s an admirable goal with lots of great benefits; building equity, improving your credit score, potential income down the road, but first and foremost it’s a place that you can call your own and build precious memories with your family.
“The distance between your dream home and owning a home is called action”
Dreaming about owning a home is the first and most important step, but buying your first home can be one of the most exhilarating and stressful moments of your life.
Armed with the right information, you can shop for a house, apply for a mortgage, and close the deal with confidence.
Where to Start
The most important thing to do before buying a home is to make sure that it’s the right time to buy. Generally owning a home for at least 5 year, pays of financially (Capital Gains tax benefit, this is for another post). You should play around with a Rent vs. Buy Calculator
Step 1: How Much House Can You Afford?
I know it’s a touchy subject, but it’s an important one. If you stretch your budget to buy your primary residence that you can barely make payments on, it becomes a liability.
You should want to buy a home, because you want a home, not as an investment. Only buy a house that you can afford today!
As a rule of thumb try to keep your housing expenses (Mortgage, Interest, Property Taxes and Home owners insurance) at about 30% of your income, if you spend much more than that you risk the chance of finding it difficult to cover your monthly expenses.
Step 2: Get your Financial House in Order.
Imagine, you have been searching for the house of your dreams, you finally found it, you go ahead and make an offer, the next day you go down to your bank to apply for a mortgage only to find out that you are not financially qualified to buy it. Your credit score is too low. This could have been avoided with a little advance preparation.
Check Your Credit Score- It should not come as a surprise but getting a mortgage requires a good credit score. This would be a good time to look at your credit score.
You can do so at credit karma or annual credit report both are free to sign up. Be sure to check for errors, this could include accounts that don’t belong to you, wrong addresses, and incorrect payment status.
Let’s say you applied for a store card, and the sales clerk miss spelled or gets your address partially correct on your application, it can be reported as having an “alias” which can be detrimental to your credit score. Errors can take a few months to correct so get a head start.
A fast way to improve your score is to pay down any credit card balances that you have and avoid using them for a few months before you apply for a mortgage, also avoid applying for a new credit card or loan until you have the keys to your new home.
When applying for a mortgage with a spouse or a partner even their credit score and history will be checked.
Save Cash for a Down Payment and Other Expenses
Having a good credit score is just part of the process. Typically down payments are 20% of the purchase price.
Even if you’re able to secure a Federal Housing Administration loan (FHA loan – for first-time home buyers only), you’ll still need to have at least a 3.5% down payment some loans will require a 5% down payment.
Let’s say you have a Mortgage $500,000
Typical down $100,000 ($500,000 x 20%)
FHA 3.5% down $17,500 ($500,000 x 3.5%)
FHA 5.00% down $25,000 ($500,000 x 5.00%)
The more money you put down the less the loan amount you will have to take out. Typically banks only lend about 80% of the purchase price of the home.
As you are saving money for the down payment avoid the temptation to invest it in stocks or other investments. You are saving that money for a specific reason, keep it that way! Open an online savings account with banks such as Ally Bank where they give you about 1%.
Other expenses can be and are not limited to, fees for appraising your home, checking your credit score, preparing your mortgage documents (more about that below), if you are buying points to reduce your interest rate (for another discussion).
Step 3: Gather your Documents And Get Pre-Qualified.
When applying for a mortgage you can be sure that the banks will go over your financial records with a microscope. Typically you will need the following documents
1. W-2’s (or 1099 income statements) for last 2 years
2. Recent bank Statements
3. Federal Tax returns for last 2 years
4. Recent Paystubs and other proof of income
5. Proof of investment income if any.
Get pre-qualified for a loan. This can usually be done online or by calling your bank. When you get pre-qualified for a loan, the bank takes an initial look into your financials and based on that they tell you whether you are qualified or not for the loan amount you are requesting. This is a free and non-binding process which shows the seller that you are a serious buyer.
This will give you an idea of how much house you can afford. Getting pre-qualified is not the same as getting the loan approval that process requires a more in depth look at your financials by your bank.
Step 4: Applying For a Mortgage.
The process of applying for a mortgage can be a little intimidating, as stated above the bank will look at your finances with a microscope that said it is a process that is required for home ownership.
In order to better understand the mortgages we first need to look at the 4 common mortgage types
Fixed Mortgage- Typically a mortgage for 15 to 30 years (30 years being the most common) and as the name suggests a fixed interest rate. Bank rate is a great place to check out the interest rates for your area.
Adjustable Rate Mortgage- is a mortgage where the interest rate fluctuates with the market and is typically 5 to 10 years long. The interest rate on this type of loan adjusts annually.
Balloon Mortgage- is a mortgage where you make small payments (interest only) for a fixed number of years and then pay the rest of the sum in one lump sum. Stay away from them!
FHA Loan- is a mortgage issued by federally qualified lenders and insured by the Federal Housing Administration (FHA). They are designed for low-to-moderate income borrowers who are unable to make a large down payment.
Be mindful of fees that the banks or mortgage broker may charge, these are not separate from the loan amount. As stated in step 2 there can be fees for the home appraisal, checking your credit score, preparing documentation, Private Mortgage Insurance (PMI) if your down payment is less than 20%.
In some cases, there may be an option to buy “points” at closing to reduce your interest rate. 1 point is equal to 1% of your mortgage amount (or $1000, for every $100,000).
In order to figure out if paying down your points is a good way to save money on your mortgage, you will need to figure out how long you need to stay in the home to save the amount you paid upfront to buy down the rate in your monthly payments. For instance, if you paid 2% or $8,000 to reduce your rate to 4% (from 6% the bank was initially asking) on the $400,000 loan, the monthly payment on the 30-year fixed mortgage will go from $2398.20 a month to $1909.66 a month. It would take about 17 months to see the $8000 come back in savings.
$2398.20 (payment at 6%) -$1909.66 (payment at 4%) = 488.54 * 17 (months)
“The only wrong way to get a mortgage is to walk into your local bank, ask for a loan officer and accept whatever rate they give you without ever shopping around”
You should compare mortgage rates online at Bank Rate, Lending Tree, your bank, your local credit union, and a mortgage broker.
Start the mortgage shopping process sooner rather than later, you may be able to get better rates, and have the peace of mind that you did your due diligence.
Step 5: Choose A Great Realtor.
Not all realtors are created equal. It is very important to have a great realtor on your side. Interview a few and see whom you are most comfortable with. They are there to guide you and serve you during this process.
When you go to an open house, never tell the agent you love the house, or give them any kind of information about how much you are willing to pay for the house. That agent represents the SELLER, not you!
There are 2 types of agents that you can work with.
Buyer’s Agents- is an agent who represents you, and only you in a real estate transaction. They agree to only represent you and your best interest. (They have a fiduciary duty towards you, meaning they have your best interest in mind)
Dual Agents- This type of agent is an agent that may represent the seller as well as you the buyer. This information has to be disclosed upfront when you decide to hire them. Both you (the buyer) and the seller have to agree to this.
They cannot provide you with a fiduciary duty because they represent both the seller and you the buyer. Not to say that this can’t work, but to avoid any conflict of interest, what most real estate agencies will do in this type of situation is they will assign 2 different agents, one to represent you and another to represent the seller. This is industry standard.