While an exciting step in your life, buying a house for the first time can seem like a confusing process to navigate when it comes to understanding all the financial aspects and steps involved. Not only do you need to determine what type of house you can afford, but you also have to decide on your down payment, find the right type of mortgage and explore first-time homebuyer programs that can help you save money. To better prepare, take a look at the various costs involved with homeownership, your options for getting home financing and the typical home buying steps you'll take.
Thinking About Home Buying
If you're thinking about becoming a first-time homeowner, you have a lot to think about in making your decision. For example, buying a house gives you the financial benefit of having your money go toward building equity in something you own rather than paying to rent a place you won't have a stake in. You can also benefit from the flexibility that owning offers since you can use and customize the place to suit your needs and not have to worry about breaking a landlord's rules.
But at the same time, you have to make sure you're financially ready for both the upfront purchase costs and ongoing costs of being a homeowner. For example, you'll be liable for property taxes and maintenance that you probably didn't have to deal with as a renter. You'll also need to have a large cash reserve to pay for the various costs like the down payment and closing costs on the path to getting the keys to your new home.
Exploring Common Types of Costs
To better understand all the costs associated with homeownership, take a look at some of the most common expenses you usually need to fit into your budget:
- Mortgage payment: You'll likely take out a mortgage loan for the house's sale price minus money from the down payment you offer. Your loan will often take 15 to 30 years to pay off, and you'll pay interest on the principal during the term. The interest rate (which will either be fixed or adjustable) can vary by your credit score, mortgage type and amount, location, lender and more. Your mortgage payment will also include your property taxes, homeowner's insurance premiums and any private mortgage insurance (PMI) that applies to your loan. The PMI usually isn't necessary with a 20 percent down payment or with certain government loans, and some mortgage lenders only require it temporarily until you've built up enough equity.
- Down payment: Although some loans don't require it, you'll often put down at least 3 percent of your home's purchase price in the form of a down payment. This will reduce the mortgage loan amount you need and thus is important for reducing your interest charges over time. If you can afford a 20 percent down payment, then you can especially reap the benefits of lower mortgage payments, less overall interest and no PMI. You may be able to get the funds gifted from a family member or offered through a government program if needed.
- Earnest money deposit: You'll usually provide a small sum of money as an earnest money deposit whenever you make an offer on someone's house since it helps demonstrate you're serious about the offer. If the seller accepts, this money will go toward your closing costs or down payment, while it gets returned to you if you don't ultimately get the house.
- Homeowners' association fees: Some homes reside in communities where an association handles certain maintenance like grass mowing and snow removal, or where you have access to community amenities like a pool. Sometimes, the association might also pay for certain utilities as well. In those cases, you may pay HOA fees that range from a modest yearly amount to thousands of dollars.
- Closing costs: Often adding up to as much as 5 percent of your house's price, closing costs include the various taxes, fees and service costs incurred from the home offer to closing processes. For example, you'll need a home inspection and home appraisal, title search and insurance and credit report pull. Other common closing costs include prepaid taxes and interest, deed recording fees, loan origination and lender fees and various local taxes and fees. Sometimes, you can wrap these in your loan, have the seller help pay them or get some types waived.
- Other ongoing expenses: You'll also want to consider ongoing utility fees, maintenance costs and rising taxes as a homeowner. Emergencies can also happen and give you surprise bills.
Read More: How Low Can Mortgage Rates Go?
Assessing Personal Home Affordability
To determine what your home purchase budget looks like and ensure buying seems suitable for your financial situation, you'll need to consider some key factors such as your income, existing monthly debt payments and the cash reserves you have for the closing costs and down payment. It also helps to take a look at your credit score so that you can have an idea of where you stand, as this will affect your interest rate and mortgage payment amount.
Once you know this information, you can try one of the many home affordability calculators offered through lenders such as the one available through Quicken Loans. After providing the income, debt, cash reserve, location and credit information, you'll get a rough estimate of the maximum home price you can afford. This can help you determine whether you need to take extra steps like boosting income, finding a co-borrower or paying off debt before you make this major purchase.
Researching Mortgage Options and Requirements
If buying a house seems financially right, then you should start exploring mortgage program options so you can choose the best option and find a lender that offers you good terms. Take a look at some of the most common mortgage programs with their pros, cons and requirements:
- Federal Housing Administration (FHA) loan: If you struggle with a lower credit score, an FHA loan could provide you the opportunity to become a first-time homeowner with a score as low as 500. Down payment requirements range from 3.5 to 10 percent depending on your credit profile, while your monthly debt-to-income ratio will need to not go over 43 percent in most cases. This option requires upfront mortgage interest plus additional premiums throughout the life of the loan, and property restrictions apply.
- Conventional loan: As long as you have at least a 620 credit score, you may qualify for a conventional loan that allows for a higher 50 percent debt-to-income ratio and only requires mortgage insurance until you've built up 20 percent equity. You get a lot more flexibility with properties and can pay lower interest rates with this option, although qualification can be tougher.
- VA loan: If no down payment and no mortgage insurance appeal to you, then you may want to see if you qualify for a VA loan as a veteran, current service member or qualified spouse. You can benefit from low interest rates and more flexibility with credit requirements with this option. You do, however, pay a special funding fee, and the house must meet VA standards.
- Jumbo loan: Mortgage programs usually have property cost limits by location, so you may need a special mortgage called a jumbo loan for pricey properties. Qualifying usually means having a minimum 700 credit score, putting down 20 percent and having a low debt-to-income ratio. The interest rate typically exceeds other loans slightly.
- U.S. Department of Agriculture (USDA) loan: If you're interested in buying a house in a rural part of the U.S., you might qualify for a USDA loan without putting money down or paying PMI. Credit score requirements vary by the mortgage lender but are more flexible as long as you can demonstrate a reasonable debt-to-income ratio and a steady income. The main downsides are an initial funding fee plus restrictions on qualifying properties.
Read More: What Is PMI?
Considering First-Time Homebuyer Programs
As a first-time homebuyer, you can take advantage of state programs that can help with paying for the down payment and closing costs as well as offer incentives for mortgage loans. You'll usually find these through your state's housing agency, and they often come in the form of a second loan that becomes like a grant once conditions get met.
Requirements for qualifying will vary but usually involve not having been a homeowner within the last few years and possibly meeting some income and credit score requirements. Also, the programs usually require completing a homebuyer education course to learn more about the process, and the buyer will need to agree to reside in the property for a number of years.
For example, Ohio has down payment assistance programs for low- and middle-income families, recent college graduates and military members as well as a program for people who aren't even first-time homeowners. Homebuyers can get as much as 5 percent toward their home's price through a forgivable second loan. California also has a down payment assistance program that pays 3 to 3.5 percent of the home's price (with an $11,000 ceiling for many borrowers) in the form of a forgivable second loan.
Getting a Mortgage Preapproval
Before shopping for a home with a real estate agent, it helps to locate a lender and get a mortgage preapproval so that you start getting your finances in order and feel more prepared with the next steps. Doing this will provide you with a pre-approval letter you can show your real estate agent and provide when you make home offers later.
You can reach out to banks in your community or research lenders online to ask about mortgage prequalification and fill out an initial application with information about your income, debt, cash reserves, desired mortgage type and intended home purchase cost. You'll provide details about the down payment amount you want to make, and the mortgage lender usually does a credit check to get an initial decision.
Keep in mind that your lender will look at various factors when deciding whether to preapprove you for a mortgage. For example, they'll see if you meet the credit score and debt-to-income requirements for the particular loan, and they'll look at your income stability and cash reserves. You can expect to provide documents verifying your income, cash reserves and identity during this process, and lenders can require more items depending on your situation. You can try multiple lenders to see the different offers since things like interest rates and even loan amounts can vary.
Read More: 5 Requirements to Buy a House
Navigating the Home-Buying Process
With your preapproval, you can start working with a real estate agent to find a home that fits your budget and needs. When you find one that interests you, expect to fill out a home offer form with supplemental paperwork and provide a check for your earnest money.
Your real estate agent will help you negotiate the price for the home based on the prices of nearby properties, the home's condition and your preferences. You can ask for extras like the seller paying part of your closing costs as well. If the seller doesn't accept your offer, they might counteroffer, and you can choose to respond with another amount or just walk away and find another property.
Once you've had your offer accepted on a home, you'll go through all the steps with the real estate agent and your lender to handle the underwriting and closing processes. This means scheduling the home inspection and appraisal, completing the mortgage application with your lender, submitting requested documentation and following through with any remaining requests to get to the closing step. You'll need to have your down payment and closing costs ready for use unless you've arranged for the seller to pay for those or wrapped them into your loan.
Getting Through the Closing Process
Once you've officially qualified for your mortgage and it's time to finalize the home sale, you'll attend a closing meeting where you'll fill out the final paperwork and have your down payment and closing costs paid. This meeting can include many parties such as your real estate agent, attorney, lender, escrow company and title insurance company. Everybody will need to sign the required paperwork in person or electronically.
Being a First-Time Homeowner
After the closing process is complete and you've paid all the expenses, you'll have the responsibility of paying the mortgage, and you'll get the keys for the move-in date. To avoid becoming delinquent on your mortgage and risking foreclosure, you'll need to keep up with payments or contact the lender for arrangements during hardship. You'll also want to have your budget set so that you're prepared for the ongoing expenses of owning a home. Having an emergency fund will come in handy for unforeseen repairs.
- Consumer Financial Protection Bureau: What Are All the Costs of Buying a Home?
- Consumer Financial Protection Bureau: Making the Decision To Rent or Buy
- Consumer Financial Protection Bureau: How Does Paying Down a Mortgage Work?
- Consumer Financial Protection Bureau: Determine Your Down Payment
- Consumer Financial Protection Bureau: What Fees or Charges Are Paid When Closing on a Mortgage and Who Pays Them?
- Consumer Financial Protection Bureau: Understand Loan Options
- Quicken Loans: Home Affordability Calculator
- NerdWallet: 8 Types of Mortgage Loans for Buyers and Refinancers
- Rocket Mortgage: Types Of Mortgages For First-Time Home Buyers
- Rocket Mortgage: Jumbo Loans: What Are They And How Do They Work?
- Ohio Housing Finance Agency: OHFA Homebuyer Program
- California Housing Finance Agency: Loan Programs
- Consumer Financial Protection Bureau: Get a Prequalification or Preapproval Letter
- Michigan: Qualifying for a Mortgage
- Mass.gov: The Homebuying Process in Massachusetts
- Consumer Financial Protection Bureau: What Is a Mortgage "Closing?" What Happens at the Closing?
Ashley Donohoe has written about business and technology topics since 2010. Having a Master of Business Administration degree, bookkeeping certification and experience running a small business and doing tax returns, she is knowledgeable about the tax issues individuals and businesses face. Other places featuring her business writing include Zacks, JobHero, LoveToKnow, Bizfluent, Chron and Study.com.