How to Finance Your First Home Purchase
Mike is a Co-Founder and Chief Operating Officer of Own Up. He has expertise in all areas of residential lending, having led operations for a top 40 lender in the United States.
The mindset of a first-time homebuyer can vary, but it often includes a mix of excitement, nervousness, and a sense of being overwhelmed. For many, buying a home represents a dream come true. However, the process can also be stressful and challenging, with many steps and decisions to make along the way.
If you’re a first-time home buyer, you may feel pressure to find the perfect home that meets all your wants and needs, while also staying within your budget. You may be nervous about navigating the home-buying process, from finding the right mortgage to closing on the home.
You may also worry about making a mistake or missing out on a great opportunity.
It's important for first-time home buyers to approach the process with a clear mind, do their research, and seek guidance from trusted professionals, such as a real estate agent or mortgage advisor.
Whether you're unsure of how to get started, or you're not sure what kind of loan is right for you, there are a few key things you need to know when it comes to financing your first home purchase.
Check Your Credit
One of the first things you'll need to do when preparing to buy your first home is to check your credit score. Your credit score will play a critical role in determining what kind of loan you can qualify for and what interest rate you'll be offered.
What Is a Credit Score?
A credit score is a three-digit number that represents your creditworthiness. It's an assessment of how likely you are to repay debt based on your credit history. Credit scores are used by lenders to evaluate the risk of lending money to someone. The higher the credit score, the more likely a person is to be approved for credit and to receive favorable terms, such as lower interest rates.
What if I Have a Low Credit Score?
If your credit score needs improvement, take steps to boost it before you start house hunting. Start by ordering a free copy of your credit report at www.annualcreditreport.com to review your credit history. If you notice any errors on your report, contact the credit bureaus to dispute them. If you are able to convince the credit bureaus to remove the errors, it could result in a boost for your score.
There are other ways to improve your credit score over time, but they primarily involve paying your bills on time and keeping your debt-to-credit ratio low. For example, if you have high credit card bills, it may help your score to pay down your debts before trying to take out a new mortgage.
Check Your Debt-to-Income Ratio
You'll want to calculate your debt-to-income ratio (DTI), which is the percentage of your monthly income that goes toward paying off debt. Ideally, your DTI should be 43% or lower, but many lenders prefer a lower DTI of around 36%.
Determine Your Budget
Before you start looking at homes, you'll need to have a clear idea of how much of a monthly payment you can afford. Determine your budget by taking a close look at your income; expenses; and other financial obligations, such as car payments and credit card bills.
Once you have a good understanding of your monthly income and expenses, you can start to think about how much you can comfortably afford to spend on your new home. Most financial experts recommend your monthly mortgage payment – including associated costs such as the interest, property taxes, and homeowners insurance – should be no more than 28% of your monthly income.
Other Cost Considerations
There are several other factors that will play a role in the type of home you can afford. Depending on your budget, each of these costs may impact how much cash flow you have left to cover your monthly mortgage and interest.
By taking a close look at your finances and considering all the costs associated with homeownership, you can determine a realistic budget for your first home purchase.
Keep in mind that you will also need to make a down payment on your new home, which can range from 3% to 20% of the purchase price, depending on the type of mortgage loan you choose. The amount of your down payment can greatly impact your monthly mortgage statement; the larger your down payment, the lower your monthly payment will be.
Property taxes vary depending on your location. If you have a strict budget and want to buy a home in a neighborhood with high property taxes, you will have less money to put toward your mortgage each month.
Also keep in mind that property taxes are not considered a fixed cost. In a nutshell: They are likely to change over time, and can change on a yearly basis. When you decide on a neighborhood for your home, be sure you are equipped to deal with the property taxes over time.
Certain types of homes, such as townhouses, condos, or units that are part of a co-op, may be a part of a homeowner association (HOA). These types of communities have pros and cons, but part of belonging to an HOA typically involves monthly fees. These fees will typically cover communal maintenance expenses, such as: landscaping, snow removal, and repairs to common areas that are shared by residences.
Explore Your Loan Options
It is important to educate yourself on the various loan options available and determine which one is suitable for you. Take the time to explore the different loan programs. Each loan type has its own benefits and drawbacks, so it's essential to understand the terms and requirements of each loan to make an informed decision.
Working with an experienced mortgage advisor can help ease the confusion of home financing and provide you with valuable insights into loan programs. A mortgage advisor can provide guidance on the different loan options available and help you determine the best fit for your unique financial situation.
Getting pre-approved for a mortgage is an essential step in the home-buying process. It provides you with a clear understanding of your financial capacity and what you can afford to buy. A pre-approval letter from your preferred lender will help you determine your price range, allowing you to narrow your search and focus on homes that fit your budget.
Furthermore, obtaining pre-approval will provide you with a competitive edge in a hot housing market. This is because a pre-approval letter shows that you are a serious buyer and have already taken steps to secure financing for your new home, making your offer more attractive to sellers.
The pre-approval process typically involves submitting financial documents to a lender for review. This information helps the lender determine your creditworthiness and assess your ability to repay the mortgage.
Once your application is approved, you will receive a pre-approval letter outlining the amount you can borrow and the terms of the loan. Keep in mind that a pre-approval letter is not a guarantee of funding, but it is an excellent indication of your borrowing capacity and a crucial step in the home-buying process.
Work With a Professional
A mortgage advisor can help you understand the complexities of home financing and provide expert guidance to ensure that you make informed decisions. They can assist you in exploring different loan options and finding the right financing solutions to fit your specific needs.
Financing your first home purchase can be a complicated process, but with the right guidance and support, it doesn't have to be overwhelming. By taking the time to research your options, obtaining pre-approval for a loan, and working with a professional, you can feel confident in your ability to secure the financing you need to make your dream of homeownership a reality.