There is a lot that goes into the home buying process and can be stressful as well.
I laid out what you should expect and how to set yourself up for success by being prepared to buy a house.
1. Check Your Credit Report and Credit Score
A Credit report shows:
- Loan history
- Accounts that were opened and closed
- Payment history
- Credit balance
You can use go to www.annualcreditreport.com to obtain your free report once every 12 months. I would recommend doing this at least 6-12 months out before getting preapproved for a mortgage or start looking at houses in case you find an issue you have time to fix it.
This is what lenders will use in order to assess how safe it is to have you as a customer. A strong credit score 700+ will save you a lot of money on the interest rate given for your mortgage loan.
Most credit card companies now let you view your score or you can check one of the three credit reporting agencies: TransUnion, Experian, Equifax
2. Calculate How Much House You Can Afford Using The 28/36 Rule
Your maximum household expenses should not exceed 28% of your gross monthly income which is your monthly mortgage payment.
Total household debt should not exceed more than 36% of your gross monthly income. This is your debt to income ratio.
If your household expenses and total household debt are lower than 28/36 you should be able to afford a home.
Calculating Total household expenses 28%:
This is what your mortgage payment would be. What is included is everything that goes into your monthly mortgage payment: Principal, Interest, Taxes, and Insurance also known as PITI.
If you make $5,000 a month after taxes your monthly mortgage payment should be no more than $1,400 a month (Remember this amount includes Principal, Interest, Taxes, and Insurance).
.28 x 5000 = 1,400
Calculating Your Total Debt To Income Ratio 36%:
This is your monthly debt payment amount divided by gross monthly income. Make sure to add all loan payments you make monthly into this amount.
If you have $1300 in monthly debt and make $5,000 a month, then your debt-to-income ratio is .26 which is 26%. The goal with this number is to have it below 36%.
1300 / 5000 = .26
After calculating your 28/36 numbers and you are at or below these numbers show that you should be able to safely afford a home. In the above examples the numbers came out to 28%/26% which would show you are on the right path to afford a home without running into trouble.
The 28%/36% rule is a broadly accepted starting point for determining home affordability. You want to really make sure to take your entire financial situation into account when considering how much house you can afford.
3. Save For A Down Payment
It has always been recommended to save 20% for a down payment but many lenders now allow you to put down as little as 3% depending on the loan and lender.
Just a reminder by putting down less than 20% you will most likely have to pay for private mortgage insurance (PMI) that is added into your mortgage payment which can be .3%-1.5% of the entire loan amount on an annual basis.
If you do have to pay PMI it can be removed by having at least 20% equity in the home. You may ask the lender to cancel PMI when you have paid down the mortgage balance to 80% of the home’s original appraised value. When the balance drops to 78%, the mortgage servicer is required to eliminate PMI.
I recommend playing around with a mortgage calculator to get an idea of how much your monthly payment will be. This will also give you an idea of how much of a down payment you should save as well.
4. Save for Closing Cost
Closing costs is another payment that you should save for when planning to buy a house. Some new home buyers may not be familiar with what closing costs can be and be surprised when the time comes to close on a home finding out how much it is.
Closing costs tend to include all administrative fees and expenses that are charged when creating your loan. This can end up being 2% – 5% of the house selling price is a good estimate.
Example of closing cost on a $200,000 house can be $8,000 if closing fees are 4%.
.04 x 200,000 = 8,000
Closing costs vary differently in each transaction. Here is what could be include in closing cost:
- Application Fee: Covers the cost for the lender to process your application.
- Appraisal: Paid to the appraisal company to confirm the fair market value of the home.
- Attorney Fee: Pays for an attorney to review the closing documents on behalf of the buyer or the lender.
- Closing Fee or Escrow Fee: Paid to the title company, escrow company or attorney for conducting the closing. The title company or escrow oversees the closing as an independent party in your home purchase.
- Courier Fee: This covers the cost of transporting documents to complete the loan transaction as quickly as possible.
- Credit Report: Your credit report is pulled from the three credit reporting agencies to get your credit history and score. Your credit score is what determines the interest rate you get on your loan.
- Escrow Deposit for Property Taxes & Mortgage Insurance: Often you are asked to put down two months of property tax and mortgage insurance payments at closing.
- FHA Up-Front Mortgage Insurance Premium (UPMIP): If you have an FHA loan, you’ll be required to pay the UPMIP of 1.75% of the base loan amount. You are also able to roll this into the cost of the loan if you prefer.
- Flood Determination for Life of Loan Coverage: This is paid to a third party to determine if the property is in a flood zone. You will need to buy flood insurance if your property is found to be located in a flood zone. The insurance, of course, is paid separately.
- Home Inspection: This is to verify the condition of a property and to check for home repairs that may be needed before closing.
- Home Owners Association Transfer Fees: The Seller will pay for this transfer which will show that the dues are paid current, what the dues are, a copy of the association financial statements, minutes and notices. Also included will be Association by-laws, rules and regulations and CC & Rs.
- Homeowners’ Insurance: Your first year’s insurance is often paid at closing.
- Lender’s Policy Title Insurance: This is insurance to assure the lender that you own the home and the lender’s mortgage is a valid lien, and it protects the lender if there is a problem with the title. It is similar to the title search, but always a separate line item.
- Lead-Based Paint Inspection: Covers the cost of evaluating lead-based paint risk.
- Loan Discount Points: “Points” are prepaid interest. One point is one percent of your loan amount. This is a lump sum payment that lowers your monthly payment for the life of your loan.
- Owner’s Policy Title Insurance: This is an insurance policy that protects you in the event someone challenges your ownership of the home.
- Origination Fee: This covers the lender’s administrative costs. It’s usually about 1 percent of the total loan but you can sometimes find mortgages with no origination fee.
- Pest Inspection: This fee covers the cost to inspect for termites or dry rot, which is required in some states and required for government loans.
- Prepaid Interest: Most lenders will ask you to prepay any interest that will accrue between closing and the date of your first mortgage payment.
- Private Mortgage Insurance (PMI): If you’re making a down payment that’s less than 20% of the home’s purchase price then you may be required to pay PMI. You may need to pay the first month’s PMI payment at closing.
- Property Tax: Lenders will want any taxes due within 60 days of purchase by the loan servicer to be paid at closing.
- Recording Fees: A fee charged by your local recording office, usually city or county, for the recording of public land records.
- Survey Fee: This fee goes to a survey company to verify all property lines and things like shared fences on the property. This is not required in all states.
- Title Company Title Search or Exam Fee: This fee is paid to the title company for doing a search of the property’s records. The title company researches the deed to your new home, ensuring that no one else has a claim to the property.
- Transfer Taxes: This is the tax paid when the title passes from seller to buyer.
- Underwriting Fee: This goes to your lender, covering the cost of researching whether or not to approve you for the loan.
- VA Funding Fee: If you have a VA loan, you may be required to pay a VA funding fee at closing or you can roll this fee into the cost of the loan if you prefer. This is a percentage of the loan amount that the VA assesses to fund the VA home loan program, however some borrowers are exempt from this fee. The percentage depends on your type of service and the amount of your down payment.
Make sure to talk with different lenders and ask about how much to expect in closing cost to be as well. I recommend being over prepared for closing costs so there are no surprises in the end.
5. Learn About Different Mortgage Options
There are many different mortgage options out there here are few to get started with in your research to find out what might be best for you:
Conventional Loans: Depending on the lender you can have a down payment as low as 3% and are usually a good choice for borrowers with good to excellent credit.
FHA Loans: Can have a down payment as low as 3.5%.
VA Loans: Are a benefit to veterans and have an option of no down payment as long as the sales price doesn’t exceed the appraised value or mortgage insurance. Make sure to check your eligibility before applying.
I recommend talking with different lenders and researching different loan options to help find what works for you.
Another reason why you should talk with different lenders is important because your interest rate can be different depending on who you choose and that can save you a lot of money in the long run.
Also, when researching different loan options don’t forget about the different loan terms options as well. These can be Fixed rate loans and Adjustable rate mortgages with different term lengths.
Fixed Rate Loans:
Locks in your interest rate for the entire loan term and does not change. Depending on your term length this can be from 10 to 30 years. Interest rates are typically lower the shorter loan terms are but remember your monthly payments will be higher because the term is shorter.
If you are planning to stay in your home for at least seven to ten years, then a fixed rate mortgage offers stability with your monthly payments may be the one to go with.
Adjustable rate mortgages:
These can vary in loan terms as well. The difference when compared to fixed rate loans is that your interest rate that can go up or down during the term of the loan.
You will usually start with a low initial rate for a certain period of time, which could be one to three years or longer depending on the lender. After that initial start time ends the ARM will adjust to its fully indexed rate. That is calculated by adding the margin to the index.
You must be comfortable with an ARM loan since the interest rate can adjust periodically. If you don’t plan to stay in your home beyond a few years, an ARM could save you money on interest payments.
Make sure to research and figure out which loan type is right for you. You can always contact a lender to discuss which loan can be the best choice that works for you.
6. Get Prequalified or Preapproved for a Loan
Before you go, start looking at houses you should know how much of loan you are eligible for. You don’t want to start looking at homes that are $500k and find out you are only approved for homes up to $300k or have the opposite happen where you are looking at homes up to $300k and find out you can buy a home up to $500k.
There are differences in what being “Prequalified” and “Preapproved” are.
Getting “Pre-Qualified” you give the lender your financial information, which is your income, debt, and assets. The lender reviews this and gives you an estimate of how much you can expect to borrow. This process does not review your credit report or take a deep look into your finances. It is based on your verbal information you give them. Just remember the amount you are qualified for is just the amount you might be expected to be approved for but not a guarantee.
During this phase of getting pre-qualified you can go over various mortgage options that they offer as well and what your goals are in purchasing a home.
Getting preapproved is the next step in the lending process and it involves completing an official mortgage application to get preapproved.
To get preapproved you must give the lend all necessary documents to check your finances and current credit rating. The lender can preapprove you for a mortgage up to a specified amount. You will get information on the mortgage interest rate during this time which is based off your credit score and may be able to lock it in as well. Some lenders may charge an application fee for this.
Once you’re a preapproved you will get a conditional commitment in writing for an exact loan amount. Now you can start looking for a home at or below the amount you are approved for. Just remember depending on the lender preapprovals are typically only good for 60-90 days.
Being preapproved does put you at an advantage when making an offer to a seller as well. It shows you are committed buyer and have just a few more steps left to purchasing a home.
Once you get an offer accepted on a home you will provide your lender with the purchase agreement and any other documents needed to start the whole underwriting process.
The lender will hire an appraisal during this time to make sure the home is worth the amount they are going to lend. The lender may require more information if the appraiser finds anything the should be looked at.
Just remember during this time when you are preapproved do not go out a make big purchases, miss any credit card payments, buy a new car or finance a new living room set. Wait until after you close on a home to do all this. The lender will check your income and credit when getting closer to the closing date of your home to make sure nothing has changed when you first got preapproved.
7. Search For Homes
When starting out even before you buy, look online for homes in areas you want to live in. Starting this process will give you an idea how much homes are selling for and how much you will need to save for the down payment.
Once you go through the first steps and are committed to start your search reach out to an agent you want to work with.
Your agent will take down the criteria of what you are looking for and has access to the multiple listing service (MLS) to find homes that meet your criteria.
The great thing about the MLS is it is updated each day and gives accurate information to the agent about properties that you want to look at.
After you go and look at homes in your price range make sure you do the research on the neighborhoods and towns to make sure they fit you and your family’s wants and needs.
Make sure to map out your commute times to see if it is manageable for you.
Visit neighborhoods at different times and days to check what the traffic conditions are like, noise levels and what the activity is like in the neighborhood.
Choose a town and neighborhood that you and your family are happy about don’t just choose it on just property alone it’s the biggest purchase of your life and you should be happy with that purchase.
Attend Open Houses
Alright so once you’ve have done your research or just starting to look and want to see what is in on the market go attend a few open houses.
Go looking at homes that are for sale even they may not be what you are looking for is a way to learn more about the area you want to live. Then when you do find a house you want you will know how your home compares other homes in the neighborhood.
8. Make a Competitive Offer
If you are already preapproved for a loan which I recommend, you are ready to make an offer. If you are a first-time home buyer, it may be hard to know how much you should offer on the home. That’s where you can rely on your real estate agent.
Ask your agent to help you make sure your offer is competitive but also within your budget and the home’s value. I recommend not to make an impulsive offer that’s higher than you can afford just to beat the competition.
9. Prepare for Closing
Once a seller accepts your offer, the closing process will begin. Keep things running smoothly by knowing what to expect when closing on a house.
The average closing process can take 35 to 45 days.
During this time is when underwriting really begins, home inspection is done, lender sends out for an appraisal, and the final walkthrough is done.
Also, during this time keep your spending low, don’t take out any new loans or charge big purchases to your credit cards. Your lender will do another check of your accounts during this time a few days before the closing date.
Make sure you read every document and ask your real estate agent to explain anything you don’t understand especially before you sign the official contract for the home transaction.
10. Move In!
Congratulations time to celebrate you just purchased a home and it is time to move in and make it your own!