What You Need to Know Before Buying Your First Home
Even after the recent real estate crash, buying a home remains an important financial milestone for many. And, thanks to record low interest rates and still reasonable home prices, many first-time home buyers are hoping to find a good deal.
Before you decide to buy a house, though, it's important to study up a little bit. A home purchase is a large and complex transaction, and you need to know what that entails before you take the plunge. (See also: Buying Your First Home: What to Do and When to Do It)
Your Credit Score
When you buy a home, your credit score matters a great deal. Your score not only determines whether or not you qualify for a mortgage, but it also influences the interest rate you pay.
Before you start shopping around, check your credit situation. You can get your credit report free, once a year from each of the three major bureaus, via AnnualCreditReport.com. It's also possible to check your general progress using truly free consumer credit resources.
Check your credit report for errors now, before you talk to a lender. My husband and I were unpleasantly surprised during our home search to find that duplicate student loan accounts were driving up our debt to income ratio. If there are mistakes or fraudulent accounts, you want to get the problems fixed before you apply.
Pull your credit scores from each of the major credit bureaus. While any score that you receive as a consumer won't exactly match what the lender sees, you can get an idea of where you stand. You can get some of your scores through myFICO.com, or from the credit bureaus. You will likely have to pay for your score.
But it's worth it to know what you need to work on before you apply for a home.
How Much You Can Afford
Decide how much you can afford before you go house hunting. And don't just think about your mortgage payment. In addition to principal and interest, your homeownership costs will include:
- Property taxes
- Homeowners insurance
You might also need to buy furnishings as you prepare to move in. Think about all these costs, and what you can comfortably afford. The rule of thumb is that you should keep your home payment to 30% of your net (after tax) monthly income. I'm more comfortable if my total housing expenses are no more than 25% of my monthly net income. My variable income as a freelancer means that I need to know I can still keep up with the house if I experience a setback.
Take a look at your net income, consider your other expenses, and decide how much you can afford each month in housing costs. Base your house hunting on this number, and don't use "creative" financing to help you "afford" a bigger home.
Don't forget to factor in your down payment. The best case scenario is 20% down, but you can get a mortgage with as little as 3% to 5% down in most cases. You down payment will reduce the amount you borrow and can also help ensure the best possible interest rate for your loan.
When you have a firm idea of where you stand, and what you can afford, you can make better decisions and better direct your home search efforts.
How to Research a Home
You shop around when you want to save $100 on a computer. Shouldn't you do the research when you plan to buy a house?
Before buying your home, do the research. Learn about potential locations, and find out as much as you can about historical home prices in the area. Prioritize characteristics of the home and the neighborhood. Do you want to be near a good school? Do you prefer to be near public transit? What activities are nearby?
Think about what you want most in your home and in the location, and then research homes that fit your requirements. Find out what the market value is of a home as well, so that you know that you are really getting a good deal.
The Mortgage Process
Know the mortgage process before you buy a home. Understand that you will need various forms of identification, as well as documentation proving your income and your assets. If you are self-employed (like me), you might even be required to go through an income audit. Call the lender to find out what documentation they will need ahead of time so that you are prepared.
The mortgage process is a long one that usually takes weeks to complete. After you have a good idea of what you can afford, and where you stand as to credit, you can get mortgage quotes from a variety of lenders.
Pre-Qualification Is Not Pre-Approval
Using information you provide, a lender can pre-qualify you for a home mortgage. This is a somewhat informal look at the amount you can potentially borrow, and the rate you might be eligible for. While this can be useful when comparing offers and for your own information, it won't help your house-hunting efforts. If you want to know what you'll really end up with, you need pre-approval, an official process that involves checking your credit. A pre-approval letter can show buyers that you're serious, and that you will be able to pay for the home.
You Must Maintain Strong Credit Throughout the Process
Realize, too, that you might not be subject to just one credit check. Many lenders run a second credit check, just before you close, to make sure that nothing major has popped up since the process started. If you are buying a home, you need to put the spending on hold, and avoid adding more debt to your situation. Dramatic changes to your credit profile can end the whole deal, just days before you were set to close.
Find out what fees you will pay for closing costs, as well. You will have a number of fees including title, insurance, loan origination, credit check, and others. Get a list of fees you are paying, and make sure you understand what they entail. You don't want any surprises.
Where to Find Help
Many first-time home buyers would benefit from a little guidance. In many cases, it can help to use the services of a buyer's agent. Usually, the cost involved with a buyer's agent is paid by the seller (the commission to the seller's agent is split), so it doesn't cost you anything. A good real estate agent can help you with the ins and outs, and make sure all of the paperwork goes through.
You can also ask someone you trust to look over the terms of your mortgage before you sign. Make sure that extra costs and problems — like prepayment penalties — haven't made their way into the agreement. A real estate attorney can look at the paperwork and make sure everything is in order.