First-time homebuyer's guide
Woven into the fabric of our national DNA is a hunger for both new opportunities and exciting challenges. However, some pursuits come with built-in complexities that can seem particularly daunting. Case in point: Is there anything that instills anxiety in the minds of adults quite like the imposing task of diving headfirst into the epic quest of buying a house for the first time?
You’ve probably had people telling you your whole life that buying a home is the single most important purchase you’ll ever make—and guess what? They’re absolutely right. It’s not only of immense importance in terms of procuring the necessary financing and all that entails, but as a first-time homeowner, there’s a vast array of details both large and small to consider when weighing a decision of this magnitude.
Once you figure out issues of affordability and the type of home you want to purchase, you’ll want to select a trustworthy real estate agent and a quality loan officer who’s determined to offer you the best available rates for your first mortgage.
In this article, we will walk you through everything you need to know to be fully prepared and informed as a first-time homebuyer. By reviewing these simple steps and taking a few proactive measures, you can feel more knowledgeable and at ease with the financial part of the process and make time for what’s important: falling in love with your new home.
Steps to buying a first home
Before you’re a happy homeowner, you’re a prudent house hunter; gathering information, visiting new neighborhoods, checking and rechecking your finances and exploring every opportunity to get a good deal on your house and your first mortgage.
How to comparison shop for a house for the first time is a lengthy topic, one deserving of its own handbook. Suffice it to say, whether you’re a single individual or part of a growing family, you’ll want to weigh both needs and wants along with the full scope of your purchasing power.
Asking yourself specific questions that yield actionable answers is an essential starting point. Questions such as: “Where do I want to live and why do I want to live there? And “How much can I really afford” and “Am I looking for a new home or one I can buy at a discount and fix up myself?”
While people buy homes for a variety of reasons including investments and second homes, most homeowners are drawn to the notion of living in their home as their principal residence. This is especially true for first-time homeowners.
However, before you can realistically start finalizing your decision on what kind of house to buy, you’re going to have to take an honest look at your entire financial situation to ensure you can afford the house of your dreams.
First-time homebuyer considerations
The fun part of house hunting is logging on to real estate apps and salivating over spacious kitchens, built-out basements and incredible views. The other part of the process that gets less attention upfront is the nitty gritty financial component to buying a house.
As a first-time homebuyer, having enough funds to cover the down payment, closing costs and fees, as well as monthly mortgage payments is essential. But moving forward with a purchase also means taking into account things like property taxes, homeowner’s insurance and possibly HOA fees, depending on the situation.
While there are ample government programs and grants available to assist you, these work best in combination with a sound financial plan that sets you up for success. And part of that plan as a first-time homebuyer is to conduct due diligence on yourself to ensure banks and mortgage companies will look upon you favorably. There are several things you’ll need to consider.
Overall financial well-being
If you’re like most people, you won’t be able to purchase your new home in one lump sum with the money in your savings account. Instead, you’re going to need a loan, and procuring a mortgage for a first-time homeowner will necessitate that you demonstrate at least a moderate degree of overall financial health.
Some first-time homebuyers find that taking a homebuyer education course can be extremely helpful in providing important information on budgeting, affordability and overall expectations for the mortgage process. Most are available online for free or for a small fee.
Before buying, examine these factors:
- Credit score
- Monthly income
- Debt-to-income ratio
- Savings and assets
Take a moment to seriously reckon with what you afford. Conducting an audit of your personal finances is the best way to know where you stand.
If you decide you’re ready to plunge into the world of homeownership, then it’s recommended you seek preapproval. In today’s competitive housing market, this is an essential streamlining step to take as a first-time homebuyer.
Before you set out on your journey to buy a home, you will need to take a moment to look up your credit score. This is where the rubber meets the road. While there is no specific credit score minimum for first-time homebuyers, you’ll have a much better chance of securing a mortgage on the terms you want if your score falls into the following credit score ranges:*
- Good (670-739)
- Very Good (740-799)
- Exceptional (800-850)
Because this three-digit score is a constantly updated, aggregate expression of creditworthiness, it has become essential to lenders of all types as an instrument to measure the likelihood of responsible, on-time repayment. The average credit score for first-time homeowners is 716.
While credit scores alone do not determine whether you are approved for a mortgage or not, they certainly factor in to a large degree, and can influence such things as the mortgage rate offered and overall costs and fees. As a first-time homebuyer, you don’t want to have bad credit.
Fortunately, there are programs and loans set in place by the federal government that enable you to receive a home loan even with a low credit score that falls into the Fair range (scores starting at 580). With some added stipulations, such as a higher down payment, individuals with Poor credit scores may also receive federally backed loans if they meet the lenders other requirements.
Before you make an offer on a house, make sure you’ve been exercising the kind of financial maturity that’s typically associated with a healthy credit score. It takes time to build good credit, but it’s your No. 1 ally when applying for a mortgage.
One of the most important factors lenders weigh when considering mortgage approval is your monthly income. If credit scores reveal the likelihood of making future payments on time, then income (and savings) are the engines that enable you to make those payments.
There are a range of loans available to today’s borrowers and almost all of them will require you to demonstrate proof of monthly income. It’s very important that you can show lenders that this income is stable and consistent; that’s part of the reason recent college grads with good salaries, for example, might have difficulty gaining approval. In their case, the income is there but it’s not yet demonstrable over a significant period of time.
You can’t mention income in the context of mortgages without quickly pivoting to debt-to-income ratio (DTI), a measurement of monthly income vs. recurring monthly expenses (including the proposed mortgage premium) expressed as a ratio or a percent. For conventional loans (those backed by Fannie Mae and Freddie Mac), it’s recommended that DTI does not exceed 45%. This can be extended to 50% in some instances for individuals with high credit scores, savings and liquid assets.
Savings and assets
Savings are the backbone of any large purchase, and lenders will need to know how much money you have on hand when determining if you’re a qualified, low-risk applicant for a first-time mortgage. Lenders always prefer to work with borrowers who can demonstrate both creditworthiness and ample savings. They are aware that life is full of unexpected events that can quickly gobble up available funds (and put mortgage payments in jeopardy). Having enough savings on hand shows your mortgage provider that you’re prepared to make monthly payments even if an emergency arises.
Given the number crunching, it can be very useful to have a mortgage calculator at your disposal to help you figure out exactly what you can afford. However, even the best industry calculator can’t get inside your head. You’ll have to ultimately determine what you’re comfortable with spending on your house as a first-time homeowner.
First-time homebuyer loans and incentives
Because both the federal and state governments have long believed in homeownership as a key driver of personal and generational wealth, there are certain programs, policies and products in place to provide incentives to first-time homeowners. The following are some of the government programs for first-time homebuyers you can take advantage of.
- Fannie Mae and Freddie Mac: Conventional loans with low down payments options. Credit scores must be at least 620.
- FHA loan: A popular federally backed loan program for buyers with lower credit scores, featuring low down payments.
- USDA loan: no down payment requirement on designated rural and suburban properties.
- VA loan: Home loans for service members (and their spouse) with no down payment requirement.
- State first-time home buyer programs: Many state housing authorities offer an array of discounts to first-time homebuyers in their respective states, including down payment assistance, help with closing costs and tax credits.** Check with your specific state to learn more.
- Dollar Homes: These are foreclosed homes for sale by the government at reduced prices. Check the HUD website for more information.
- Good Neighbor Next Door: Home price discounts for law-enforcement officers, firefighters, first responders and educators. In an effort to foster neighborhood revitalization, discounts can be as much as 50% off the list price of a home. Check the listings in your state to see what is available.
Can you be a first-time homebuyer again?
If you think you need to be buying your first home to be a first-time homebuyer, you're not alone. But whether this is your true first home or you've bought and sold a house or two before, you can still qualify for many government programs for first-time homebuyers.
First-Time Homebuyer Definition
According to most federal agencies (including HUD), “first-time homebuyer” is defined as any individual who has no ownership in a principal residence over the last three (3) years. Have questions about whether you're technically a first-time homebuyer or not? Talk with your loan officer.
Additional incentives for first-time homebuyers: IRA account
Do you have an IRA account?** If so, the government makes a unique exception to the rules that otherwise state that you must be 59 ½ years old to withdraw funds. Regardless of whether you have a Roth or traditional IRA, if you are a first-time homebuyer then you can make a withdrawal up to $10,000 ($20,000 for a couple) for the purposes of buying a home and avoid any penalties so long as you repay the amount within 120 days.
The above is not an exhaustive list of programs; it is a starting point. There are many other nonprofit and employer-based programs and grants worth researching that provide discounts to eligible participants. As a first-time homebuyer, you should leverage a wide range of trusted resources and make sure to ask questions in order to expand your knowledge and obtain the best deal possible.
First-time homebuyer: Post-financing considerations
Once you’ve determined your budget, conducted an audit on your own finances and explored the many government-sponsored and government-aligned options that incentivize first-time homebuyers, you’re ready to take the next pivotal steps in the homebuying process: gaining preapproval, furnishing your lender with all the necessary detailed paperwork and making an offer to the seller.
This is when your chosen lender goes into overdrive: checking credit scores, scrutinizing employment and bank account information and determining your debt-to-income ratio (DTI). If everything matches up, your loan proceeds toward the closing table.
It’s worth noting that even if you’re preapproved for a mortgage, it’s not a done deal until the underwriting department signs off on the loan. Underwriting guidelines are complex and often change given evolving lender-risk analyses. For example, have you made any large recent purchases that are only now becoming evident in your credit score? Details like this can affect determinations from underwriting.
Making an offer
Working in concert with your real estate agent, it’s now time to make an offer that will be greeted favorably by the seller while remaining within your pre-established budget. This is not just a monetary offer, but may also include certain terms and conditions.
Typically, your agent will make the offer to the seller’s agent, with all the necessary terms and conditions included. For example, you might want to include contingency language that addresses the state of your offer should a home inspection reveal alarming structural problems or expensive repairs. Hiring a trusted, accredited home inspector is an important part of the home-buying process and one that first-time homebuyers need to write into their offers. A good real estate agent will advise you on matters such as this and any other conditions that need to be included in the offer.
An appraisal is typically ordered during this period as well; the price (usually a few hundred dollars) comes out of your pocket as part of the closing fees. Appraisals are important because banks and mortgage companies want to make sure the the property value is sufficient collateral for the loan amount requested and that they can recoup the cost of the home in the event that you default.
If everything goes as planned, the seller accepts your offer and the mortgage goes into final approval and then closing. In some cases, lenders offer technology that enables a purely digital contactless closing. This is especially helpful in the era of COVID-19.
Buying a house is serious business. It’s doubly serious when you’re a first-time homebuyer and not yet accustomed to the complexities of the housing market and how to proceed from the dream of a new home to the reality of purchasing one.
While the process of selecting your home and ensuring it aligns with all requisite needs and wants is understandably the most important objective, taking a moment to examine your financial situation and explore first-time homebuyer financing in full detail is a close second. By leveraging all available resources including the assistance of a quality mortgage lender, you’ll be prepared to streamline the process and secure a favorable deal on your new home.
*Sample FICO Score ranges. **Guaranteed Rate does not provide tax advice. Contact your tax advisor with any tax related questions.
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