If you've decided on settling down in a community and ending your time as a renter, then you might feel ready to start down the path of becoming a first-time homebuyer. Pursuing this path to becoming homeowners comes with several benefits ranging from having a place you can customize as you please to benefiting financially from the investment. But from starting the initial research on the type of home to buy to figure out how to save for and finance your home purchase and what down payment assistance programs and other programs exist, you might feel unsure about the whole process.
To get some clarity, take a look at seven things you should know about buying a home for the first time.
1. Assess First-Time Homebuyer Readiness
Although first-time homeownership might sound appealing, take some time to make sure you can commit financially to this decision since you'll have new challenges you didn't face while renting. Not only will you likely need thousands of dollars to cover the upfront costs, but you'll probably have higher expenses in addition to your monthly mortgage payment once you move in. That's because bills ranging from maintenance to utilities will be your responsibility, and they usually cost more than when renting. You also need to make sure you're able to live in one place for several years to at least break even.
Take a good look at your finances including your cash reserves, credit score, income and current debts. If buying a home would mean emptying your savings account, you might keep saving longer and hold off on the home purchase. Having a tight budget already can make it harder to afford the mortgage payment and extra costs of homeownership, and having a low credit score can either mean a higher interest rate or roadblocks to getting approved by a loan officer for the necessary financing. Ultimately, assessing your finances shows you where you might need to do some work before starting the first-time homebuying process, or it could indicate you're in a good place to move forward now.
To make sure you can afford a home comfortably, try out a mortgage affordability calculator. This helps you decide on everything from a down payment and loan term to the target home price and mortgage payment amount. If the estimated loan eligibility amount seems too low, you might consider strategies like a larger down payment, side job or reduction in current debts to meet your goal.
Read More: First-Time Homebuyers: Buying a Home Guide
2. Understand Home Purchase Costs
To move forward financially, take some time to understand the key costs involved in buying a home to make sure that you have enough saved or that you have another means to obtain the funds.
Here are three main categories of costs:
- Home purchase price: The biggest expense is the price you ultimately offer the seller for their home, and this amount depends on the individual property, community and market conditions. In a very competitive market, you could end up paying even more than the home's sticker price, while you might save some thousands in a less competitive market where the seller really wants to be rid of the home. You usually finance the house cost minus any money put down. So, the home price becomes important when you start deciding how big of a mortgage you can afford. Often, a real estate agent can supply you with pertinent information about the market.
- Down payment: In some circumstances – such as where you choose a no-down-payment mortgage program or take advantage of down payment assistance – you won't have to use your own funds for a down payment. It might also be possible to arrange a loan with a low down payment if your credit and financial position warrant it. However, you can otherwise expect to have a minimum of 3 percent of the property's price to pay up front. For some loan programs, the minimum can rise to 20 percent. You usually put down a small portion of the amount, called the earnest money, as soon as you submit an offer.
- Closing costs: Running as high as 5 or 6 percent of the property price, closing costs can sometimes exceed the down payment amount and thus require careful consideration. This category includes a broad array of items related to the mortgage application origination, property transfer, legal tasks, appraisals and inspections, prepaid items such as interest and taxes and more. Closing cost assistance programs may help with the expense.
Read More: What Is a Home Down Payment?
3. Explore Strategies for Finding Homes
Before you can find your dream home, you need a clear picture of the characteristics you want the home to have as well as its location. Decide whether you prefer the customization options of having a new home built and can afford the higher cost, or if you'd prefer a used home that can have a lower price tag and allow for personal touches and renovations. You also need to think about the home's size, the type of yard it has, the number and types of rooms, the inclusion of any amenities like a pool or energy-efficient systems and its overall appearance.
Finding a good realtor can make your home hunt much easier than trying to search the neighborhood and online on your own, so seek out recommendations in the community and take time to explain your needs. Your realtor will help with everything from alerting you about matching home listings and scheduling showings to walking you through the offer and negotiation processes. If you're moving to a new place, a realtor can even help advise you on what your future home's neighborhood is like and make sure you find a property in the right location for your family's needs.
Read More: Buying a Home Timeline: What You Need to Know
4. Understand Home Mortgage Loan Options
You can look into a bank or credit union to provide guidance with different mortgage loan programs and requirements and figure out which home loan program would work for you, as well as any income limits.
Here are some options to know about:
- Federal Housing Administration (FHA) loans: Especially popular for first-time homebuyer loans, FHA loans offer opportunities for less creditworthy borrowers to buy homes with a 3.5 or 10 percent down payment. A credit score under 580 requires a higher down payment, and borrowers with any credit score must agree to mortgage insurance premiums (PMI) annually and up front.
- Conventional loans: Designed for people with better credit scores of at least 620, conventional loans can come with a 3 or 5 percent down payment. These loans feature a single private mortgage insurance premium and a higher allowance for the debt-to-income (DTI) ratio.
- Veterans Affairs (VA) loans: Only available to active duty, retired and reserve military members who have enough service time – along with spouses in some cases – VA loans offer the perk of no down payment needed. Lenders set the credit standards for this option, so the credit score requirement is similar to conventional loans. A single funding fee applies to take out this loan.
- Jumbo loans: Usually requiring 20 percent down, jumbo loans may be necessary if your chosen property exceeds the location-based limits for regular loan options. Lenders look for the highest credit scores and income for these loans.
- U.S. Department of Agriculture (USDA) loans: If you don't make much more than the median income in the house's location, you could get this no-down-payment loan for a property in a designated rural location. DTI ratio requirements tend to be stricter, while lenders like to see at least a 640 credit score with this option. USDA loans also have annual and upfront fees like FHA loans do.
If regular home financing doesn't work out due to a moderate income or credit issues, you have another option through seller financing. This takes various forms where the home's seller loans you money, usually for a short period of time. For example, if you can't get a mortgage right now, a seller might agree to let you make five years of payments and then request a balloon payment for the rest of the money. If you're in a better financial situation when the balloon payment comes due, you could get a mortgage through a lender to cover that amount.
5. Check About First-Time Homebuyer Programs
Whether you feel concerned about the down payment or closing costs, your state's first-time homebuyer programs may help lessen the financial burden. These programs work in conjunction with loan programs through participating lenders to offer some form of grant or loan for upfront expenses. For example, you might receive a grant up front or some form of forgivable loan on the condition you reside in the new house for a number of years. Other options might come in a second loan with desirable terms and possible deferment.
While it varies by locale, the amount often is up to 5 percent of the amount of the loan. Qualifying can mean meeting income, home price, credit score and homebuyer education course requirements. You might also pay a fee to participate. Check with the U.S. Department of Housing and Urban Development for a link to your state's options.
Read More: Buying a Home Programs: What You Need to Know
6. Know Home Financing Qualifications
The specific minimum standards depend on the different mortgage programs, but you need to prepare your finances for some key requirements or arrange for a co-borrower who can help you where you fall short. Many of these requirements are spelled out in the FAQs for that type of loan.
Here are some of the basics a mortgage lender looks for:
- DTI ratio: Consisting of your total monthly debt payments divided by your total monthly earnings, the back-end DTI ratio helps show lenders the mortgage payment won't strain your finances in a way that adds too much risk to them. Too little income or too much debt can cause you not to meet this requirement for your loan program, and lenders like to see a maximum of 43 percent in most cases. Keep in mind your front-end ratio – which assesses your mortgage payment in relation to your income – can also play a role in mortgage approval.
- Income: Not only must your income amount help you meet the DTI standards, but you need to show the lender they can trust that you'll continue receiving that money. This can mean having earned a similar amount for a couple of years and showing tax documents, paychecks and other evidence to back up income reported.
- Credit score: The minimum credit score for your mortgage approval can range from 500 for FHA loans to 700 for jumbo loans. So, taking steps to keep up a good payment history, reduce existing debt and avoid delinquencies will help. Your credit also helps determine how much you pay for your home, since lower scores translate to higher interest rates that raise your mortgage payment.
- Savings: You need enough savings for closing costs and the down payment (if required and after any assistance received). However, lenders want to see that you still have enough money left over for emergencies so that you can still make your mortgage payment.
Read More: Credit Score for Mortgage Rates: How It Works
7. Learn About Mortgage Applications
For more certainty during the home-shopping process, seek out a mortgage lender as soon as possible to get a clear answer on eligibility and better know your price range. Your first step will involve a preapproval application where you choose the loan type you want, share financial information and documentation with the lender and get a preapproval letter with the potential loan amount, mortgage payment, interest rate and other terms. Once you know the amount you need to borrow for a property, you should receive a loan estimate with more details such as possible closing costs.
The work with the lender continues after you've chosen a home, so they can further inspect your finances, have you sign and submit documents and plan to close on the deal. For example, the lender will want a home appraisal, full mortgage application and items like proof of income. The process ends with your closing meeting where important parties involved in the transaction finish the needed paperwork and fund transfers, and you take on the responsibility of the mortgage.
- Consumer Financial Protection Bureau: Find the Right Home
- Consumer Financial Protection Bureau: What Is "Seller Financing?"
- Nolo: Seller Financing: How It Works in Home Sales
- Consumer Financial Protection Bureau: Understand Loan Options
- Ohio Department of Commerce Division of Real Estate & Professional Licensing: Home Buyer’s Guide
- Freddie Mac: Mortgage Affordability Calculator
- Nevada Housing Division: Home Is Possible Program
- U.S. Department of Housing and Urban Development: Local Information
- Bankrate: What Are the Costs Associated With Buying a Home?
- Consumer Financial Protection Bureau: What Are All the Costs of Buying a Home?
- LendingTree: Minimum Mortgage Requirements for 2021
- Consumer Financial Protection Bureau: Learn What Has and Hasn’t Changed About the Mortgage Process
- Federal Trade Commission: Shopping for a Mortgage
- Rocket Mortgage: How to Qualify for a Mortgage
- Consumer Financial Protection Bureau: What Is a Debt-to-Income Ratio? Why Is the 43% Debt-to-Income Ratio Important?
- Consumer Financial Protection Bureau: How Do I Get and Keep a Good Credit Score?
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.