7 things to have in place before you buy your first home
Buying a home is likely the biggest financial decision you will ever make, so it’s important that you take it seriously and do your homework.
The home-buying process can be both exhilarating and stressful at the same time. There’s a lot to know and the process can get very overwhelming, especially if you aren’t prepared. But with the right information, you can ensure that you’re ready to apply for a mortgage, shop for a home and close the deal with confidence.
So let’s look at a few things you need to make sure you have in order before even starting the process.
7 things you need to have in place before you start the home-buying process
Buying your first home takes a lot of prep work — from cleaning up your credit score to saving for a down payment and more. In fact, there are several things you need to have in order before you even start shopping for a home. Most importantly, you need to make sure that you’re prepared financially. There are several costs associated with both buying and owning a home, and you don’t want to be blindsided by any of these expenses. So before you even start shopping, you need to make sure that your financial life is prepared for all of things involved in buying and owning a home.
Furthermore, there are a lot of factors that play a role in the decisions involved in the home-buying process, which means you either need to work with a professional or do some serious homework.
Below is a breakdown of some of the things you need to consider and get in place before beginning the search for your new dream home.
1. Enough cash for a down payment
Unless you’re buying a new home with cash, you will need to provide a down payment in order to qualify for a mortgage loan (the exception being if you qualify for a VA loan, which we explain below). This will be a pretty big chunk of cash, so it’s important that you start planning in advance to ensure that you’re financially prepared — and that the transaction doesn’t leave you cash poor or jeopardize your finances in the long run.
Exactly how much you put down will depend on a few factors, including the lender’s qualifications, the community where you’re buying and the type of loan you get. The general rule of thumb to qualify for the best deal on a mortgage typically means providing a 20% down payment. Combined with a good credit score, that will get you the best mortgage interest rate and overall deal on a loan.
But what if you don’t have that much cash? There are still options available for you to get an affordable mortgage loan without putting down anywhere close to 20% of the purchase price, especially if you are a first-time home buyer.
“You do not need to put 20% down to buy a home,” says Natalie Cooper, an Atlanta-based mortgage advisor. “This is a common misconception in today’s market. There are many programs that have low to zero down payment options. And don’t forget to look into down payment assistance programs as well. It is a good idea to speak with a mortgage professional before you are ready to buy so that you know about all the options out there. They can assess your current situation and give you a road map to where you need to be financially. You may be qualified without even knowing it.”
Here’s a breakdown of some of those options:
VA loans, which are backed by the Department of Veterans Affairs (offered to veterans, service members and their spouses) and USDA loans, backed by the Department of Agriculture, offer 0% down payment options for borrowers who qualify.
FHA loans, backed by the Federal Housing Administration, allow down payments as low as 3.5%.
Conventional loans, which are offered by traditional lenders and are not backed by the government, offer down payments as low as 3% to first-time home buyers with good credit.
State and local down payment assistance: Many states offer down payment assistance programs, implemented by government agencies, nonprofits, foundations and even employers. The assistance usually comes in the form of grants, low interest rates and/or tax breaks. Make sure to do your research or ask your Realtor/mortgage advisor to find out if there is a program that you can qualify for.
In general, putting down less money upfront does mean that you could potentially incur some extra expenses, depending on the type of loan. For example, mortgage insurance is required on all FHA loans and sometimes on conventional loans with down payments less than 20%. So while your upfront cost will be lower, your monthly payments will increase. It’s important that you find out all of the details upfront and then factor that in when budgeting for monthly expenses.
2. Enough income to cover monthly mortgage payments
For the majority of people, buying a home involves a mortgage loan, because most people don’t have the cash to cover such a big purchase. A mortgage loan is a long-term loan that allows you to buy a home and pay it off over time, with interest.
The main factors that determine your monthly mortgage payments are the size and term of the loan. Size is the amount of money you borrow and the term is the length of time you have to pay it back. Generally, the longer your term, the lower your monthly payment. That’s why 30-year mortgages are the most popular. Once you know the size of the loan you need to purchase your new home, a mortgage calculator is an easy way to compare mortgage types and various lenders. But keep in mind, not all mortgage calculators will include any additional expenses/fees.
Something a lot of first-time buyers don’t realize is that size and term are not the only two expenses that are rolled into your mortgage payments. There are other costs that are typically added to your monthly payment, which means it will likely be higher than you estimated just using the size and term. In other words, your mortgage payment doesn’t just cover your loan payments. So it’s crucial that you understand and consider these extra expenses when determining how much house you can actually afford (how much cash you have each month to make your payments).
Here’s a look at what a total monthly mortgage payment typically includes:
Principal: A portion of each mortgage payment is dedicated to the repayment of the principal balance (the total loan amount). Loans are structured in a way that you pay more in interest at the beginning and then over time, more and more of your payment will go toward the principal.
Interest: This is the lender’s reward for taking a risk and loaning you the money to buy a house. The interest rate has a direct impact on the size of the monthly mortgage payments. The higher the interest rate, the higher the payment. So in general, a lower interest rate means you can borrow more money — because your monthly payments will be more affordable. On the other hand, a higher interest rate will increase the amount you owe each month and therefore reduce how much you can borrow (how much you can spend on a home).
Taxes: Just like when you buy anything else, when you buy a home or piece of property, you will owe some kind of government taxes on it. These property taxes are owed on an annual basis and can be rolled into your monthly mortgage payments. The total amount due is divided by the total number of monthly mortgage payments in a given year. The lender collects the payments and holds them in escrow until the taxes have to be paid.
An escrow account is set up by the lender at the time of closing. A portion of your total monthly mortgage payment is then put into this account each month to cover property taxes and insurance at the end of the year. By rolling the payments into your monthly mortgage payment, this allows you to pay the total amount due over the course of 12 months, rather than owing one big chunk of cash at the end of the year.
Insurance: Like property taxes, insurance payments are made with each mortgage payment and held in escrow until the bill is due. There are two types of insurance coverage that may be included in a mortgage payment. One is property insurance, which protects the home and its contents from fire, theft and other disasters. The other is PMI (private mortgage insurance), which is often mandatory for people who buy a home with a down payment of less than 20% of the loan (depending on the lender). This type of insurance protects the lender in the event the borrower is unable to repay the loan.
So when calculating what you should expect to pay monthly, it’s crucial to consider all of these costs that will be included in your mortgage payments. This is important to be aware of, because not all mortgage calculators will include these costs and you don’t want to get blindsided by the actual amount of money you’ll need each month to cover the mortgage payment and associated costs. You must consider all costs to ensure you’re financially prepared.
3. A Realtor
When you’re thinking about starting the home-buying process, one of the first decisions you need to make is whether you want to work with a professional or try to handle things on your own. How do you decide? Well, if you’re a first-time homebuyer, working with a Realtor can help make the process much easier and smoother all around. Having a Realtor gives you an ally throughout what can be a very emotional and financially taxing process. A good Realtor will not only understand the ins and outs of everything involved, but also help you close the best deal with confidence.
A common misconception is that using a Realtor to help you find and buy a new home will cost you a lot of money. But in fact, using a Realtor will rarely cost the buyer anything extra.
“Depending on the state you live in, most often the seller pays commissions for any Realtors involved in the transaction/purchase of the home,” says Rachel Brochstein, an Atlanta-based agent with Harry Norman, Realtors. “The biggest reason why a buyer should use a Realtor is because it gives you an ally in the process. I fight for my clients and my clients’ needs, and I help take the burden of a very stressful process off their shoulders so they can live their lives. A Realtor is there to help a buyer navigate every aspect of the process, including things like contracts, inspectors and translating certain information that can be overwhelming to a buyer. It is my full-time job to make sure that this transaction happens the way my clients want it to.”
Another misconception is that you must use the Realtor to find your dream home. While a Realtor can certainly help you do this, it’s not a requirement. If you find a great home online or some other way, the Realtor can step in and help facilitate the process moving forward.
“You may find the house you want to buy on your own, but finding a house and buying a house are two very different processes,” says Brochstein.
4. A pre-approval letter
In order to get a pre-approval for a mortgage, a loan officer will look at your finances — your income, debt, assets and credit history — and determine how much money you can borrow, how much you could pay per month and what your interest rate will be. You can then take this letter to sellers to show them that you have the means to buy the home. This gives sellers peace of mind knowing that they aren’t wasting their time with someone who can’t afford to buy their home.
Here are a few reasons why you want to get a pre-approval before you start shopping for a home:
Budgeting: Once you get a pre-approval, you will know how much mortgage you can afford and you can then start looking at houses within your price range. The last thing you want to do is fall in love with a home and then realize that you can’t afford it. Having a pre-approval helps you avoid that and allows you to shop within your budget.
It expedites the buying process: Once you get a pre-approval, the lender has all of your information stored in its system. So when it comes time to make an offer on a home, the process of actually creating the loan is much easier and quicker.
Credibility as a buyer: Having a mortgage pre-approval proves to the seller that you have your finances in order, you’re serious about buying and that you have the means to actually purchase the home. It gives the seller peace of mind knowing that you won’t be denied a mortgage if they decide to sell you their home.
It’s more precise than a pre-qualification: A pre-approval and pre-qualification are very different. A pre-qualification is when you hand over your finances to a lender and without further research, they give you an estimate of how much they might lend you. But since there’s no in-depth research involved and the numbers may not be exactly accurate (since they just use whatever you tell them), the estimate they give you may not be anywhere near what you can afford. A pre-approval involves a thorough inquiry into your finances, rather than the lender simply asking you how much you make etc. Getting a pre-approval is much more accurate and very often, sellers may require it in order to be sure that you will be able to get the amount you need to buy their home if/when the time comes.
“One of the most important things that people don’t realize they need to do is to shop around for different loan options from different lenders,” says Brochstein. “When shopping around with different lenders, you always want to request a ‘fee sheet,’ which is a breakdown of the actual loan and costs associated with closing the deal. You can then take the sheet to other lenders to try to get a better deal.”
So where does getting a pre-approval letter fall in the home-buying process? According to Brochstein, this is one of the very first things you’ll want to do. But even before you do this, you’ll want to make sure that your finances are prepared. Here are a couple of things to clean up before you start this process:
Debt: You should try to pay off as much of your debt as possible before taking on a mortgage loan. This will reduce how much cash you have going out each month, ensuring that you can afford to cover your mortgage and other expenses with ease.
Emergency savings: You need to have at least 3-6 months worth of living expenses set aside in cash in case of an emergency, such as a job loss. This will allow you to cover your mortgage and other expenses each month until you can get things back on track. The last thing you want to do is take on a mortgage, something happen and then you have to default on your loan.
5. The financial stability to maintain the home and property
One big difference between renting and owning is the cost of maintenance. Once you buy a home, gone are the days of calling the in-house repair guy to come fix things for free. If something breaks or needs to be replaced, that money is coming out of your pocket.
When you’re preparing to become a first-time homeowner, it’s important that you consider the various costs associated with owning and maintaining the property. Depending on the situation, repairs can cost you thousands of dollars — and if you aren’t financially prepared, that’s a very easy way to start racking up credit card debt that you can’t pay off. So when you’re considering all of the costs of buying and owning a home, you need to make sure that you have a solid amount of cash in emergency savings and a big enough financial cushion to cover things that keep the home in good condition.
According to US News and Freddie Mac, homebuyers should budget up to 4% of the property's value in annual maintenance costs. That's $12,000 for a $300,000 home. Or $1,000 per month. But keep in mind that you never know when something big will come up, which means you need to have enough cash put aside to be able to pay for the bigger issues when they do happen.
Here are some examples of maintenance costs:
Landscaping
Roof leaks
Plumbing
HVAC system
Gutter cleaning
Window replacements
Hazard insurances
Heating and electricity
Water
Sewer
Exterior paint
Pressure washing
Property management fees
Private mortgage insurance
Replacing appliances
It’s crucial that you consider all of the costs of owning before deciding to buy. This will allow you to buy a house that you can actually afford to maintain and keep long term. The last thing you want to do is buy a big expensive house and then realize that you can’t actually afford to cover all of the expenses. Plus, keeping a home in good condition is crucial for its resale value.
6. A decent credit score
Understanding your credit and credit score is a crucial first step in the home-buying process. Your credit score helps determine the interest rate and other costs you pay on a mortgage loan — meaning it determines how good of a deal you can get. So when you’re preparing to start the home-buying process, you need to get an official copy of your credit report from each of the three main credit bureaus (you can do this once a year for free). You want to make sure that there are no mistakes or other issues you didn’t know about that may impact your ability to get a good deal on a mortgage. And depending on what you find, you may have to delay the process and begin repairing your credit — in order to get the best deal on a loan.
How lenders use your credit
If your credit score is high, it shows lenders that you’re financially responsible and that you haven’t racked up a bunch of debt you can’t pay off. Lenders consider it likely that you will pay your monthly mortgage payments consistently and on time, which means they are willing to offer you a lower interest rate and other costs on your loan. The best deals are typically reserved for those with a credit score of 700 or higher.
If you have poor credit, lenders see you as a bigger risk — they aren’t sure that you will be able to pay your monthly payments based on your financial history. This typically means they will charge you a higher interest rate in exchange for taking the risk of loaning you the money to buy a house.
“Below 680 is when the friction starts and as you get down to 620 it gets increasingly difficult. The fees are going to go up and the ability for you to get a lower down payment mortgage is going to be hard,” says Bill Banfield, executive vice president of capital markets for Quicken Loans.
How lenders view different credit scores
With that said, one common misconception is that you have to have a near-perfect credit score in order to get a mortgage loan. Of course the higher your score the better, but even with decent credit, you can still qualify for some loan programs. And in fact, even if you have poor credit, there are still options available.
Here are some general rules of thumb to go by when it comes to credit scores and the ability to get a conventional, fixed-rate mortgage loan (the best option/deal):
Any score in the 700s or above is considered excellent and will most likely get you a loan with the lowest interest rate.
When your score drops into the 600s, lenders start to see you as a higher risk and you won’t be able to qualify for the best rates. A score of 680 is still considered decent, but when you get below the 660s, many lenders will start denying your request for a mortgage loan. For other lenders, a lower score in the 600s may be the cut-off. It all depends on each specific lender’s required qualifications.
So, if your credit score is in the 700s, you should be ready to get pre-approved for a conventional loan. If your score is in the 600s or lower, you will need to go another route.
How to get a mortgage loan with bad credit
There are other mortgage loan programs available besides just the conventional, fixed rate mortgage loan from a traditional bank or lender. These are easier to qualify for and even designed for borrowers with credit scores as low as 500. The type of deal you can get is still determined by your credit score and other factors, so you want to get it as high as you can before you start the mortgage qualification process.
“The best loan programs will always be available to those with higher credit scores; however, there are many products in the market for buyers who are in the process of repairing or building their credit,” says Brochstein. “Every buyer’s situation is unique and finding the right lender with the right programs is important to make the transaction a financial success.”
So if your credit isn’t in great shape, here are a few steps to take to find an affordable mortgage loan.
Improve your credit score
By following a few strict rules, you can increase your score by a lot, and quickly. Doing so would potentially help you qualify for the best rates available in today’s market. Here’s how to increase your credit score quickly.
One thing to remember when you’re repairing your credit in order to buy a house is that you should not apply for more credit, including credit cards. This will make lenders suspicious of your financial stability. Plus, applying for new credit damages your credit score even further in the short term.
Check eligibility for FHA and VA loans
Find out if you are eligible for an affordable mortgage backed by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA). FHA and VA loans are backed by the federal government and have less-stringent credit requirements.
FHA loans are issued by FHA-approved banks and other mortgage lenders. These loans are guaranteed by the government, which means lenders are more willing to lend to borrowers with lower credit scores. You can qualify for a 10% down FHA loan with a credit score as low as 500. If your credit score is 580 or higher, you may qualify for a loan with as little as 3.5% down. One catch though is that FHA loans require you to have mortgage insurance, which will drive up your overall and monthly costs. But when it comes to perks, FHA loans typically have:
Lower down payments than conventional loans
Lower closing costs
Easier qualification
For military service members, veterans, and their spouses, VA-approved lenders offer affordable mortgages with as little as 0% down. To apply, you need to have a valid Certificate of Eligibility that proves your (or your spouse’s) service history.
With a federal guarantee on a portion of the loan, VA loans have several advantages for bad-credit borrowers:
No down payment
No mortgage insurance requirement
No minimum credit qualifications
Lower closing costs
One-time funding fee that can be financed
According to Bankrate, “another benefit of FHA and VA loans is that the rates are on par, or sometimes even lower than conventional loans.”
Come up with a large down payment
Being able to offer a large down payment can often get you a better deal from a lender, because it shows you’re willing to take on more of the risk and the lender won’t have to loan you so much money to buy a home. So if you can delay your process and save up more cash (by taking on more work, selling things or getting help from family), you will get a better deal on a loan when the time comes.
If you go this route, the money needs to sit in a savings account for a period of time before a lender views it as viable. “The lender has to know where that money came from, so let it season in an account for at least 60 days. Otherwise you might not be able to use it right away,” Banfield told Bankrate.
Shop credit unions and community banks
Check your eligibility to join a credit union here.
With credit unions and community banks, the lending criteria is often less strict than that of traditional, big banks.
Credit unions are not-for-profit financial institutions that exist to serve their members, so they often offer more favorable terms.
7. Enough cash to cover closing costs and other fees associated with a mortgage loan and purchase of a home
There are several costs that you need to be prepared for when it comes time to get a loan and then close on a house — in addition to the down payment. Here are a few things you’ll need enough cash on hand to cover:
Loan-related fees: These are fees associated with the creation and execution of a mortgage loan.
Application fee: This covers the cost of the actual application process — requesting a new loan, credit checks and administrative fees. The amount of the fee varies depending on the lender and the amount of work required to process and complete your loan application.
Assumption fee: If the seller has an assumable mortgage and you take over the remaining balance of the loan, you may have to pay a variable fee based on the balance.
Attorney’s fees: Some states require an attorney to be present at the closing of a real estate deal and the fee varies based on the number of hours the attorney works for you. Again, this is only the case in some states.
Prepaid interest: A lender will typically require you to pay any interest that accrues on the mortgage loan between the date of the purchase/settlement and the first monthly payment due date. The amount depends on the size and terms of your loan, and you should be prepared to pay it at the time of closing.
Loan origination fee: This is also known as an underwriting fee, administrative fee or processing fee. This is a fee the lender charges for evaluating and preparing your mortgage loan, including things like document preparation, notary fees and the lender’s attorney fees. You should expect to pay about 0.5% of the total amount you’re borrowing for the loan. So for a $300,000 mortgage loan, the loan origination fee would be about $1,500.
Closing costs: These include a variety of fees associated with the services and expenses needed to finalize a mortgage loan. Most of the closing costs fall on the buyer, but the seller typically has to pay a few, too, such as the real estate agent’s commission. Closing costs typically include an appraisal fee (an appraisal proves to the lender that the home is worth what you’re asking to borrow) and an inspection fee (this is required to show that the home is structurally sound and in good enough shape to live in). “Always, always, always get a home inspection,” says Brochstein. “It is the most responsible thing you can do as a homebuyer. Basically you spend a few hundred dollars now to save thousands down the road. Ask your Realtor to recommend a company/person to provide this service. An inspector helps a buyer identify potential problems in the home, as well as helps teach the buyer about their home (where the water shutoffs are, etc). A good inspector provides a detailed report to the buyer and helps explain aspects of home ownership/maintenance. “
Average closing costs for the home buyer can come out to anywhere between about 2% and 5% of the total loan amount. So on a $300,000 home purchase, you would pay somewhere between $6,000 and $15,000 in closing costs, which may include some of the loan-related fees mentioned above. Some lenders may allow you to roll these expenses into the loan, but it’s more cost effective to pay them in cash as a one-time expense. That way you don’t pay interest on it as part of the loan.
Some states, counties and cities offer low-interest loan programs or grants to help first-time home buyers with closing costs, so make sure to check with your local government or ask your Realtor to see if you’re eligible.
Your lender is required to outline all of the closing costs to you at the time you apply for the loan, as well as in the days leading up to closing the deal.
Earnest money: This is a deposit that you offer “in good faith” to the seller to show your interest in purchasing the home. Then if your offer is accepted, that deposit goes toward the purchase price of the house. Earnest money is refundable based on the terms of the negotiated contract.
Additional costs at time of closing: When negotiating a contract, these costs can be paid by either the buyer or the seller. For example, the buyer may offer a certain price if the seller agrees to cover xx amount of the closing costs. Basically, these costs can be used to negotiate the exact terms of the contract.
Taxes to the state and/or city: “You have to pay taxes on your purchase just like anything else,” says Brochstein. “Every city and state are different and the laws vary. For example in Georgia, we have multiple state taxes and fees.”
“Prepaids”: If you get a mortgage loan, this involves an escrow account (prepaying into an account for future expenses) and paying the first part of your mortgage interest upfront.
Escrow Account “cushion”: Typically 2 months of homeowner’s Insurance and taxes.
Interest to the end of the month for your mortgage (mentioned above as “pre-paids”): For example, if you’re closing on the home on the 30th of December you would pay one day of interest; if the closing is on the 1st, you would pay 30 days of interest.
Title search: This is a small fee (a few hundred dollars, depending on where you live) that you pay to the lender to search through a record and history of any money attached to the property — things like liens and each time the property was bought/sold. What they’re looking for is any money owed by the property and who has bought and sold the property, in order to resolve any issues.
HOA fees (if applicable): If the property has an HOA, it can charge fees for things like reserve funds, new keys, new account setup, move-in costs and more. All HOA fees/expenses must be disclosed to the buyer upfront — so you should be aware of these costs well before you get to the closing date.