Thinking of buying your first home? First-time buying is exciting. It’s filled with the dreamy pleasure of beholding perfect kitchens, bedrooms and baths, and the cliff-hanger phone calls about your loan approval. (“We’re nearly there! I just need one more document…”) You’ll peruse home inspection results, negotiate the home price so you can re-do that floor, and, ultimately, you’ll get to “yes” with the seller. By the time you finally sit down at the closing table, you’ll feel intense relief, and one of the biggest thrills of your life. Here are some tips to help make that day a resounding success.
How to Get in the Perfect Position to Buy Your First Home
“How do I know I’m ready to buy my first home?” you might wonder. Ask yourself two questions:
- Have I saved enough?
- Can I prove my ability to faithfully repay a long-term loan?
If you answer “yes” to those two questions:
You’re a Saver
If you save more than you spend, you should get the loan you need. Set a portion of your earnings aside every month. With good savings in the bank for a down payment, you can get a loan with acceptable terms when the right time comes.
That said, be a spender, too—within moderation. Reject the habit of routinely carrying credit card debt. Instead, form a personal financial history that shows you spending just enough on a few major cards. To help keep your credit scores up:
- Set up automatic payments to be sure you pay back each monthly balance.
- Try never to use more than 30% of any card’s limits.
- In the months leading up to your home purchase, don’t apply for new credit cards. Avoid switching insurance companies. If possible, steer clear of any actions that could place new inquiries on your credit history.
A credit score in the 700s will earn you the best available mortgage rates, and that matters a lot. Small differences in rates turn into massive amounts of interest over a 30-year loan.
You’re a Worker
Qualifying for a good loan is also about earning capacity. If you have worked full-time for the same employer for more than two years, your income is steady or gradually rising, and you have the W2s and pay stubs to show it, you’re ahead of the game when you set out to buy.
What if you work for yourself? You’ll likely need to jump through some extra hoops to prove your ability to repay the loan. Expect the lender to require documentation showing your continuing earning capacity in a field in which you’ve worked for more than two years. An additional part-time job, if you stay in it for two years or more, can help to convince the loan underwriter that you’ll have a steady income and the money to cover your mortgage payment every month for years to come.
How Much Do You Need for a Down Payment?
Your mortgage company’s officer will tell you how much you should put down on a home of a specific market value. Get a sizable house down payment ready. Why?
- The bigger your down payment, the lower the lender’s risk—so, the lower your interest rate will be.
- Avoid the burden of PMI—private mortgage insurance. If your down payment is low, lenders add PMI to your monthly mortgage debt. This extra payment keeps you from fully taking advantage of low mortgage interest rates.
- Put 20% down to get the best insurance, because you’ll be less likely to go underwater if property values drop.
Loans can involve monthly payments of up to 35% of a homeowner’s income, but it’s wise to keep your housing budget under a fourth of your earnings. That’s why your mortgage company’s representative will probably advise you not to pour almost all your money into your down payment and your monthly payments. And a good real estate agent will pay attention to your current needs and your future goals, and support your mission to stay within your budget. These experts know you’ll need money in the bank. You’ll need to cover closing costs. You’ll need to pay for your move and you’ll want to furnish and make repairs in your new place as needed. Keeping an ample cash reserve you can live off for six months and use for emergencies is important.
On that note…
Prepare to Handle Costs Beyond the Home’s Price Tag
Many first-time home buyers second-guess themselves after they buy, and that includes more than half of millennials. Usually, what’s troubling them is the unplanned costs later on. What costs should you plan to handle?
- Property taxes. These pay for schools and other public services, and you can send them to your local tax assessor when billed, but they will likely already be paid through your mortgage payments. To know how much tax you’ll owe, multiply your home’s assessed value (not the market value) by the local tax rate. Say the local tax rate is 2%. If you buy a home assessed for tax purposes at $250,000, then $2% of 250,000 is $5,000 a year.
- Upkeep costs. Choosing a fixer-upper or an oversized home can lead to an unexpected level of spending after buying. You’ll have to pay for home improvement equipment, cleaning services, designers, and renovators.
It’s a lot easier to contain costs when you pick a modest house or condo that meets your needs rather than a show-stopper—or a money pit.
Knowledge Is Power
We’ll leave you with a couple of common issues first-time buyers don’t always anticipate. Know, and head problems off at the pass!
- If you use a parent’s money, create the documentation. Remember, the lender has to know that you can repay to loan. First, find out if using a gift is acceptable. If so, does the lender need a down payment gift letter? A gift letter identifies the person making the gift and its amount and origin, along with a statement that the money is a gift, not debt.
- Raiding your retirement fund? Get ready for the fees and taxes. If you tap retirement funds early, you must pay fees, and the IRS regards the money you withdraw as income. Expect to pay the extra income taxes or reimburse the government on any income-based federal benefits.
Finally, consider the value of the modest home. For most people, a home’s size and architecture aren’t the real keys to happy homeownership. The social life buyers find in their new surroundings matters more. Buying a home means becoming part of a community. So, look for good people and a good home.
For a longer treatment of this topic, refer to the Consumer Finance Protection Bureau: https://www.consumerfinance.gov/about-us/blog/how-decide-how-much-spend-your-down-payment/