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You’ve watched enough HGTV — or heard enough family friends tell you what a great investment they made in real estate 20 years ago — to know that buying a home can be a smart move for many reasons. The value will likely accrue in value over time. It’s the natural foundation for building a family. And it can serve as one of those milestones that makes you feel like you’re doing adulthood right.
If you’re like most potential first-time home buyers, you’ve likely downloaded all the realtor apps, and maybe even started attending open houses in your area. That’s a great first start, but there are other factors to consider before making an offer. Here’s a primer on all the little details you need to know before you do.
First, You Have to Save for a House
Hold in your mind, for just a moment, the idea of putting 20 percent down for a first-time mortgage. Does it get the heart palpitating? Don’t sweat. You just a need game plan.
If it’s a three-year goal or part of a longer-term vision, now’s the perfect time to start investing in a brokerage account,” says Joy Liu, head of trainer development at money-planning service Financial Gym. “If you figure it will take you three to seven years, a brokerage account can give you, on average, six to eight percent interest, and you can get some assistance from the market to get you to that lump sum,” says Liu. “Saving that money in a savings account,” she notes, will merely “earn you max two percent.”
Got debt? And student loans? You’re not alone. Three out of four of millennials do. Just start attacking these goals one by one: “The general order of business is paying off high-interest credit-card debt first. Then stoking that emergency fund. Then, start saving for the house.”
For down payments, 20 percent is still the magic number, says Liu, though you can find some lenders who will go lower in certain circumstances. You also want three percent down for closing costs, and $10K contingency fund.
“There’s always an extra $10K at the end of the process of buying a house, like a surprise leaky roof that the seller won’t fix.” In real terms, for a $250K house (that’s pretty average for the US but low for major cities), you want to have $50K for down payment, $7,500 for closing and $10K for contingency, which comes to $67K. Adjust as need be for your target spend.
You also want to work on increasing your credit score. “Seven twenty or higher will assure that you can get the best interest rates,” says Liu. Not a part of the 700 club right yet? Work with your financial advisor to get credit-card debts down to 10 to 20 percent of their limits, clear up any issues on your credit report, and start paying bills like credit cards and car loans regularly.
There are ways around a 20 percent down payment, though. FHA loans (government-backed loans) allow you to put as little as 3.5 percent down. These have some stipulations, like you need a credit score above 580 and your debt-to-income ratio must be below 43 percent (find out all the details here). State and local programs for first-time home-buyers can also help with down payment assistance, and certain lenders will let you borrow with less than 20 percent down, when backed with a PMI, or extra private mortgage insurance [link to Mortgages story], each month, which can cost about .5-1 percent of the total loan amount every year.
However, says Liu, doing the due diligence to save the full 20 percent means you are financially healthy, and you want to be going into to your first home mortgage in a healthy way, because that will lead to less stress down the road.
Get Approved for a Mortgage
You’ve got bank. Now it’s time to find one.
You can use a broker or do your own research [link to Mortgages story] to find the best mortgage deal. Or, if you have a preferred bank, you can ask them what kinds of terms they can offer you. They may allow you to buy down the ultimate interest rate by using points or fees paid directly to the lender at closing. One point is typically one percent of your mortgage. Credit unions might offer more competitive rates than traditional banks; you can research them at the National Credit Union Association (NCUA). Shopping around is key, says Jim Morrison, homebuying expert and author of Home Buying in 30 Minutes. “Ask for recommendations from friends and family who’ve recently been through the process.”
Once you find a broker or lender, they’ll do a pre-approval check to determine how much you can realistically afford. It’s usually a quick process. You’ll do a credit check, income check, and add up any assets and outstanding debt. This will help you figure out a comfortable monthly payment and overall mortgage range. And you can tell brokers you are “pre-approved” although that doesn’t guarantee anything.
“Most lenders will only allow 43 percent of your combined gross income to make up your total debt load. To figure this out for yourself, add up student loans, car loans, combined credit card debt, and the total monthly mortgage payment and divide that number into your gross monthly incomes,” says Liu.
Once you’re pre-qualified, this intel will be used to determine your interest rate, which as of early 2019, is around 5 percent for people with great credit. If you need to wait a year or two to buy a home, and interest rates go up, you can choose to refinance later for a better rate. This could require going through a closing process again, so it’s worth it to work on your credit score as much as possible so you can get the best rate possible when you do decide to apply.
You’ll also work with the broker or lender on a type of loan you’ll need [link to Mortgage article]: There are 30-year-fixed rate mortgages (the most typical loan for first-time buyers), different types of ARMs or adjustable-rate mortgages, FHA loans (or government-backed loans), and VA loans. In some cases, there may be the possibility of balloon loans, which require one large payment at the end of the term—a shock consumers generally try to avoid (you can sometimes pay off the principal sooner than specified to avoid this charge, too).
Find the Right Neighborhood
You want to think about a few things, says Jim Morrison, mortgage expert and author of Homebuying in 30 Minutes. School systems may matter to you if you have kids or want to have them soon. Crime rates may also be a factor. Taxes and insurances (homeowners, and possibly flood or earthquake) must be checked to get a sense of your total monthly payments.
Ultimately, it’s about adding up all the factors (and x-factors, like access to public transit, noise concerns, or new construction fortelling an impending boom) and choosing what feels right for your needs. “Real estate is really intuitive. Living in your own neighborhood, you have all the intel you need: whether it’s up and coming, it’s peaked, or it’s past its prime,” says Liu.
Take a look at “comps”—or similar home values in the neighborhood—to figure out what the average prices are for the types of home you seek. “Generally, that’s when you can lean on your realtor. They can pull it from their national database. It’s based on similar houses in this neighborhood that sold for their latest selling price. If you’re getting it for less, maybe it’s a good deal, or maybe there’s something glaringly wrong.”
Understand the Local Tax Rates
Another big part of home ownership? Taxes. But it’s not all bad. “The added benefit of home ownership is that you can deduct your mortgage interest on your taxes. There can be some savings for you depending on your tax bracket.”
But, there are property taxes to consider. It’s important to know how much they’ll be, since they can range anywhere from 1K to 40K or higher depending on location and type of building (the U.S. average was $3,296 in 2016). “Usually, property taxes pay into the school system. Better school systems have higher property taxes. Weigh your value system and what’s right for your family.”
Open houses can be a good place to gather this intel. “It’s like making any other purchase,” says Liu. “You have to make sure you’re well-informed and asking the right questions.” Apps such as Trulia, Zillow, StreetEasy, RedFin and Realtor.com also include all or most of this info in their listings. Just be sure to verify independently.
Once you put in an offer and it’s accepted, your lender will begin the loan origination process, and a home inspection will be scheduled. (Expect to pay up to $1,000.) If any issues are discovered, you’ll need to negotiate with the seller on how they’ll be resolved. How long does it take to buy a house? If all goes well, offer to closing on a home should take 30 to 90 days.
Can’t afford to buy anything in the neighborhood you live in? Consider continuing to rent in your current neighborhood and buying an income property in a more affordable neighborhood. While there are risks associated with being a landlord, you’ll at least be bringing in a few hundred extra a month and getting into the property game.
Figure out Your Insurance Rate
You’ll need it. But, don’t stress out too much.
In most circumstances, it’s baked into your monthly mortgage payment. Principle, interest, taxes and insurance, or PITI, are all added into that fee you pay to the bank for your loan. At closing, you’ll be paying extra money that goes into the escrow account (like a neutral holding cell for monies from various parties) and the lender will use it to take care of property taxes and insurance.
For homeowner’s insurance, it’s usually upwards of $1,000 a year, but it can vary greatly depending on the house. In some instances you can choose to pay for it on your own, annually. (Just don’t forget, so you’re not blindsided at the end of the year.)
Other types of insurance you might need: If you live in a determined flood zone (not always near the water by the way), you may have to buy annual flood insurance through FEMA (and that could be $5K more a year). There’s a big gray area when it comes to natural disasters, though. “That’s another question to ask in the process,” says Liu.
Avoid Liens, Foreclosures and Defaulting
All of these unhappy words mean you’ve missed payments. They all suggest you owe someone money. A lien is when the bank uses the house as collateral until you pay a debt owed. A foreclosure could happen when you’re so behind in payments that the bank has to take your house back from you. And default is a failure to pay a loan.
To avoid any of these outcomes, it’s important to really think through all the costs, including possible emergencies, and work toward building that big lump sum upfront. You know the saying “Patience is a virtue”? Now’s the time to live that precept.
Biggest Mistakes Couples Make: Not having enough cash upfront, says Liu. “It just snowballs into bigger issues when you buy a house you can’t afford. Whether you didn’t have enough saved for a down payment or you didn’t have any extra saved for emergencies, if anything goes wrong, it will have to end up going on a credit card, which you don’t want. You really shouldn’t buy a house until you are absolutely certain you can afford big, emergency expenses.”
Home Buying Checklist
1) Figure out where you want to buy a house and when
2) Determine what the median home price is in your desired areas and using the 43 percent rule, how much you can afford to buy and what monthly payments will be.
3) Do the math on the required 20 percent down payment, taxes, insurance, contingency, emergency fund and other potential expenses.
4) Figure out what you need to do to save up that lump sum.
6) Once you do, and you’re starting to look, get pre-approval from a lender.
7) Work with a realtor to find the right property, and put in an offer.
8) Go back and forth with the seller until they agree, at which time you can arrange “to close.”
9) Walk your beautiful bride (or groom) over the threshold.
Home Value and Tax Calculators
- Find the median home prices in your area with Zillow’s calculator.
- For a quick assessment of home values in your desired city, use Realtor.com’s tool.
- To get a property tax assessment of the area, use Smart Asset.
- Use debt-to-income ratio calculators and figure out what you can expect to pay for a mortgage at Zillow.
Home Loan Glossary
- Comps: short for “comparable sales” of homes located in the same area and of very similar size, condition and features. To give you an idea of what the going rate is for houses/apartments like yours.
- Liens: A right to keep possession of property belonging to another person until a debt owed by that person is paid.
- Foreclosure: A legal process in which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender by forcing the sale of the asset used as the collateral for the loan.
- Closing costs: Fees associated with your home purchase that are paid at the closing of a real estate transaction.
- Default: a legal term meaning failure to pay a loan or debt according to the terms in the promissory note, often after extended delinquency.
- Escrow: Escrow includes depositing necessary monies, documents and instructions into a neutral account. These items stay in the account while the buyer and seller fulfill their obligations. The process ensures that funds aren’t distributed until both buyer and seller meet the terms and conditions of the purchase agreement.