If you're considering going through the home buying process, you might wonder where to start and what this decision means for your finances now and in the future. After all, you'll need to get a good idea of all the upfront costs, your options for financing the property and the amount you can actually afford to spend on a new place. You have other considerations, too, such as knowing what to expect when house-hunting and how to get the best financing offer. To get more acquainted with the important financial aspects of buying a home, take a look at these 10 things home buyers must know.
1. Know the House-Hunting Process
When you start looking for homes, you'll need to come up with an idea of the size, location and type of home you want. You'll also determine whether you'd prefer a pre-owned home or new construction. Along with using websites like Zillow to explore options, you can find a real estate agent to look out for new listings and guide you through the rest of the homebuying process. They'll be able to provide information about typical housing prices and offer advice on properties for your financial situation.
Read More: Buying a House for the First Time
2. Understand the Path to Closing
Alongside or even before looking at homes, you'll likely work on arranging your finances to afford the upfront costs as well as get a preapproval letter from a lender. Once you're in the offer stage, you'll continue to work with the lender to submit every document needed for approval. You'll work on other tasks like hiring a home inspector, getting the property appraised and preparing for the closing meeting too.
During the closing meeting, the final upfront costs get paid, paperwork gets completed and you arrange for moving into the property. This will take coordination among you, the lender, the seller and the real estate agent.
Read More: Buying a Home Timeline: What You Need to Know
3. Become Familiar With the Costs
To make sure your current financial situation warrants buying a home, you'll need to know all the costs involved from the actual home price to recurring expenses you'll face after move-in day. Here are some you should particularly consider:
- Home sale price: The sale price will depend on factors such as the housing market, neighborhood, size, condition, features and economy as well as whether you purchase an existing home or have a new home constructed. The U.S. Census Bureau listed a $349,400 median home sales price in Feb. 2021.
- Monthly mortgage payment: Your monthly mortgage payment usually significantly adds to your expenses, and it's got several parts. These can include your loan principal and interest, homeowner's insurance premiums, private mortgage insurance (PMI) and property taxes. The property taxes and homeowner's insurance are part of the escrow and need to be paid even once you've finished the mortgage term.
- Earnest money and down payment deposits: Although amounts vary widely, you'll usually provide a small amount of earnest money with a house offer and then a more significant down payment (usually 3 to 20 percent of the house price) at closing. However, options to avoid a down payment do exist.
- Closing costs: Along with the down payment, you'll normally pay another 3 to 5 percent of the house's price in closing costs. Common items in this category include credit and application fees, home inspection and appraisal charges, escrow deposits, upfront PMI and points, title insurance and search, origination fees and costs associated with transferring and recording the deed.
- Utilities: You'll often pay to set up fees for utilities such as cable, electric, water and sewer for your new home, and then you'll experience regular charges every month after that.
- Repairs and Maintenance: While your new home may come with a warranty, you'll still need some cash to handle minor repairs and maintenance. Later on, more expensive needs such as a new roof can arise.
- Homeowner association (HOA) fees: HOA fees frequently apply to condo and townhouse purchases and can be significant for such properties since they can include certain utilities alongside maintenance and amenities. Some communities may have annual HOA fees that are smaller since they include fewer services.
Read More: What Are the Costs When Buying a House?
4. Estimate What You Can Afford
Knowing what you can afford helps set expectations both for your property search and mortgage approval. Ultimately, lenders will look at figures such as front- and back-end debt-to-income ratios to determine how big of a mortgage payment fits in with your current income and debts, so you'll want to gather your annual gross income, total monthly debt payments and expected down payment as well as consider the loan term (such as 15 or 30 years) that appeals to you. Your interest rate, which is based on factors ranging from your credit score to market conditions, will affect the mortgage payment and thus home affordability.
Freddie Mac has a calculator where you input this data and get maximum home price and mortgage payment amounts. You can then look at your budget and determine how big of a payment you feel comfortable with. If the maximum loan price is too low, this could mean it might not be the right time to finance a home, or you may need to work on a bigger down payment, lower your debt or boost your income.
5. Know How Mortgages Work
A home loan comes with many important terms and concepts to understand. The mortgage loan is for financing the remainder of the home's price after the down payment plus any extras rolled in. It usually has a term of at least 15 years, during which you'll make payments of principal plus interest alongside the escrow components and any mortgage insurance.
Read More: How Does a Mortgage Work?
You can get an adjustable-rate or fixed-rate mortgage depending on whether you want the interest charge to vary. You'll want to shop around to get good mortgage rates since they vary by loan, financial situation, lender, market conditions and even the property type. You can also save on interest if you opt to buy discount points or make a larger down payment so you need a smaller loan amount.
The mortgage is secured by the home, so the lender can take the property from you due to nonpayment through the foreclosure process. This means you should think about your finances carefully before taking out a mortgage and keep your lender notified of any financial issues you face later on.
Be aware of the many factors lenders look at when determining your mortgage eligibility and amount. They'll look at your credit score to see if it meets the minimum for the loan program, and higher credit scores usually lead to better mortgage rates.
6. Understand the Mortgage Application Process
You can find a lender through your current bank, check for options online or even ask your real estate agent for recommendations. You'll then want to ask about getting preapproved so that you can explore the mortgage terms offered to you and compare that with some other lenders in your area. To have a better chance of getting a mortgage with good terms, seek out multiple lenders.
The lender will need key financials like your income, estimated home price and contact details and will perform a credit report pull to assess whether you qualify for the mortgage program you want. They'll check your information against mortgage requirements and ask for some documentation. If you pass all the checks, then you'll get issued a preapproval letter that shows you're likely – but not guaranteed – to get approved during the underwriting process once you've found a home.
7. Prepare for Mortgage Qualification Requirements
Be aware of the many factors lenders look at when determining your mortgage eligibility and amount. They'll look at your credit score to see if it meets the minimum for the loan program, and higher credit scores usually lead to better mortgage rates. They'll consider your total debt-to-income ratio to make sure it doesn't exceed 43 to 50 percent depending on the mortgage program, and they'll look at how your estimated housing payment compares to your income too.
Other important factors include a stable income with reliable documentation, an acceptable down payment amount, extra cash reserves and adherence to any guidelines for the specific mortgage program. A co-borrower can help with meeting income and credit requirements, so this can be an option if you have trouble getting financing alone.
Read More: What Credit Score Do I Need for a Mortgage?
8. Explore Mortgage Loan Program Options
When financing your home purchase, you'll need to choose the right mortgage program for your financial situation. Your options depend on the loan amount, your credit profile, the down payment you can afford, the home's location and more. Some of the most common home loan options include the following:
- Conventional: If you have a good credit score and at least 3 percent of the home's price for a down payment, a conventional loan can provide you with competitive interest rates and flexible options for the loan term. The government doesn't back these loans, so they tend to have more stringent qualifications, and you pay PMI unless your down payment meets or exceeds 20 percent.
- Jumbo: Considered riskier by lenders, jumbo loans can help you finance a property with a price exceeding the usual conforming loan limits in the area. This loan type can come with slightly higher mortgage rates than smaller conventional loans and more strict qualifications for your credit score, income and cash reserves. Lenders usually want a hefty down payment too.
- Federal Housing Administration (FHA): Unlike conventional loans, the government backs FHA loans, so borrowers can get benefits like easier credit requirements. FHA loans allow for either a 3.5 percent or 10 percent minimum down payment depending on your credit score, and you can qualify with a credit score as low as 500. The downside of the option is mortgage insurance paid both upfront and monthly.
- U.S. Department of Agriculture (USDA): The government offers USDA loans to homebuyers financing properties classified as located in a rural area. This option usually means no down payment plus you can get access to funds to renovate distressed properties. However, you'll find limits on your maximum income and the home's price, and guarantee fees apply.
- U.S. Department of Veterans Affairs (VA): As another government-backed option without a down payment needed, a VA loan requires falling in one of the categories of service members, spouses or veterans and meeting length of service requirements. No income limits apply, you don't need to pay PMI and you get low mortgage rates. However, there's an upfront funding fee to pay.
Read More: Buying a Home Programs: What You Need to Know
9. Look Into Homebuyer Assistance Programs
Especially if you're a first-time homebuyer, you'll likely find that your state's housing authority has various loan and grant programs to help with your purchase. Some programs help people who meet income guidelines, while others target specific groups of professionals. Often, you'll get some form of a grant or a forgivable or deferred loan that you can use for the down payment and closing costs, and this can offer relief when you'd have no issue affording the mortgage payment but would struggle with paying so much upfront.
You can find your state's programs through participating lenders and learn about specific benefits and requirements. For example, Texas offers as much as 5 percent of the mortgage amount through its assistance programs to people who meet income guidelines. The state also doesn't restrict the benefit to first-time homebuyers either.
Read More: Buying a Home With No Money Down
10. Consider Possible Tax Benefits
After you complete the purchase process, you may take advantage of various tax benefits available to homebuyers. Many of these include itemized deductions that you take instead of the standard deduction and have limits to be aware of.
For example, the IRS allows itemizers to deduct mortgage interest (subject to a $750,000 mortgage limit for most taxpayers), property taxes (up to $10,000), mortgage insurance premiums, discount points and qualified home equity loan interest if you meet all the conditions. If you're self-employed, you could also take advantage of the home office expense deduction where you have two calculation options available.
If you later decide to make certain home improvements, additional tax credits can apply. This typically includes work done to add alternative energy equipment, upgrade to energy-efficient systems and add efficient roofing and insulation.
- IRS: Energy Incentives for Individuals: Residential Property Updated Questions and Answers
- IRS: 2020 Instructions for Schedule A (2020)
- Texas State Affordable Housing Corporation: Loans & Down Payment Assistance
- U.S. Department of Housing and Urban Development: Local Homebuying Programs
- Consumer Financial Protection Bureau: Understand Loan Options
- NerdWallet: 8 Types of Mortgage Loans for Buyers and Refinancers
- Consumer Financial Protection Bureau: What Are All the Costs of Buying a Home?
- Census Bureau: Monthly New Residential Sales, February 2021
- The Motley Fool: 10 Expenses of Home Ownership You Need to Know
- Consumer Financial Protection Bureau: On a Mortgage, What’s the Difference Between My Principal and Interest Payment and My Total Monthly Payment?
- Ohio Department of Commerce: Home Buyer’s Guide
- Consumer Financial Protection Bureau: Decide How Much You Want To Spend on a Home
- Freddie Mac: Home Affordability Calculator
- U.S. Department of Housing and Urban Development: Looking for the Best Mortgage
- Consumer Financial Protection Bureau: What Do I Have To Do To Apply for a Mortgage Loan?
- Consumer Financial Protection Bureau: What Is a Debt-To-Income Ratio? Why Is the 43% Debt-To-Income Ratio Important?
- Consumer Financial Protection Bureau: Get a Prequalification or Preapproval Letter
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.