Things to consider before buying your first home
Before buying a home for the first time, you need to make sure you're financially and personally prepared for the home buying process. To make this decision, ask yourself these 10 questions.
1. Do you plan to remain in your home for at least five years?
There are many costs associated with buying and selling a home. Because of that, most experts agree it isn't a good idea to buy unless you plan to remain in the home for at least five years. Over that period of time, the home will hopefully appreciate enough in value that you can recoup the expenses associated with its purchase and sale.
2. Will you qualify for a loan based on your financial credentials?
As mentioned above, lenders consider your credit score, debt relative to income, and employment history when determining if you are eligible for a loan. If you don't qualify for a mortgage, or if you qualify only for an expensive loan, you may want to wait until you're in a better financial position before becoming a first time home buyer.
3. How much money do you have for a down payment?
You can qualify for some types of home mortgages with as little as 3% down or with no down payment at all. But this is usually not a good idea. There are added costs associated with taking out a mortgage loan that doesn't require a down payment, even with government-guaranteed mortgages such as FHA or VA loans. And, not having a down payment puts you at risk of owing more than your home is worth.
4. How stable is your job?
Lenders want to see a stable employment history, but it's also a good idea for you personally to make sure your income is reliable. You don't want to buy a home and become unable to make payments because you lost your job.
5. How is the real estate market in your area?
It can be difficult to predict what will happen with the real estate market. Still, you can look at factors such as how long homes are on the market and whether they're selling at asking price, or above it or below it, to assess whether it's a buyer's or seller's market. If it's the right time to buy for you and you plan to stay put for a long time, it may not matter much. But ideally, you want to try to avoid buying when home prices are at their peak.
6. Can you afford a home in your area?
Most experts recommend you keep your housing costs below 30% of your income. If homes are very expensive in your area, it may not be feasible to buy without borrowing too much and becoming house poor. If you tie up too much of your money in your home, it could be difficult for you to save for retirement or accomplish other financial goals.
7. What mortgage terms can you qualify for?
For most Americans, their mortgage is the largest debt they take on. Qualifying for favorable mortgage rates is important to avoid paying more than necessary. When you borrow so much and pay it off over such a long time, even a small difference in interest rates can make a big impact. A $300,000 loan at 3.25% would come at a total cost of $470,023 with monthly payments of $1,306 over 30 years while the same loan at 3.75% would cost $500,165 with monthly payments of $1,389.
8. Do you have enough money for closing costs?
Closing costs are an inescapable expense when buying a home and they can total around 2% to 5% of the purchase price. Make sureyou're prepared for all expenses of owning a home, including:
- Loan origination fees
- Home inspection fees
- Appraisal fees
- A credit check
- Home insurance
- Homeowners association fees
- Prorated property taxes
- Title insurance (this protects you in case there is an unexpected ownership claim on your property)
- Recording fees
- Transfer taxes
- An escrow deposit (this could include depositing several months of mortgage and insurance payments in an escrow account)
- Mortgage insurance up-front premiums (for some type of loans such as FHA Loans)
- Closing fees
- Loan discount points if you want to buy down the interest rate
While some lenders allow you to borrow to cover some of these closing costs, if you do, you'd be paying interest on them over many years. It's often best to pay up front if you can afford to do 50.
9. Do you have an emergency fund?
Many experts recommend setting aside 1% of your home's value every year to cover repair costs. Others suggest budgeting $1 per square foot for maintenance and repair.
Whatever metric you choose, you need to be prepared to pay when things break. You also want to be sure you don't miss a mortgage payment due to a drop in income or an increase in your expenses.
An emergency fund helps you be ready for the responsibility of homeownership. Ideally, this fund will cover three to six months of living expenses (including your new mortgage payment). That will help to ensure you're able to cover costs that arise after you've purchased your home.
10. Do you have money for moving expenses?
Moving can be very expensive, especially if you're making a long-distance move. Make sure you've got money to cover the cost of getting your possessions into your new home.
Things to consider before buying your first home
Fannie Mae HomeReady Mortgage
This program caters to first-time buyers or repeat buyers with low incomes and limited money available for down payments. It requires a minimum credit score of 620 and your earnings can't exceed 80% of the median income in your local area. First-time buyers must take a homeownership education course. If you complete the course and qualify, you can get a mortgage with as little as 3% down.
Fannie Mae 97% loan-to-value mortgage
First time home buyers can qualify for a 30-year fixed-rate mortgage or an adjustable-rate mortgage with as low as a 3% down payment. A homeownership education course is required if all co-borrowers are first-time borrowers and all borrowers must have a minimum credit score of 620 or higher. Income requirements don't apply to this program.
The HomePath Ready Buyer™ Program
This program is for first-time buyers who complete an educational course and buy a foreclosed property from HomePath owned by Fannie Mae. It pays for closing costs valued at up to 3% of the purchase price of the home. Buyers must plan to make the home their primary residence and begin living in it within 60 days of the time of closing.
Freddie Mac HomeOneSM Loan
This loan is open to first time home buyers who have a minimum credit score of 620. It allows you to get a loan with a down payment as low as 3% but you must complete a homeownership education course if all borrowers are first-time homeowners. There are no income Limits for this program.
Freddie Mac Home Possible®
This program also allows you to qualify for a loan with a down payment of just 3% of the home's price. It's not limited only to first- time borrowers but there is a maximum income limit of 80% of median area income.
Debt-to-income ratio
Lenders want to make sure you have enough money to pay your mortgage loan. To determine this, they look at both your income and your level of debt. There are actually two different debt-to-income ratios they consider:
- Your front-end ratio: This is calculated by comparing your income to your mortgage costs (including principal, interest, taxes, and insurance). If your mortgage costs total $900 per month and your pre-tax income totals $5,000, your front-end ratio would be 18% ($900 divided by $5,000). Most conventional lenders like to see a front-end ratio of no more than 28% although some lenders are flexible and VA, FHA, and USDA loans allow for a higher ratio.
- Your back-end ratio: This ratio is calculated by comparing total debt costs to income. Some debt payments that are factored in include your mortgage payment, car loans, student loans, and credit card debt. Utility payments, car insurance, and certain other monthly bills not reported to major credit reporting agencies aren't considered. Typically, lenders prefer this ratio to be below 43% although some have stricter ratios. You may be able to qualify for VA, FHA, and USDA loans with more debt relative to income.
Advantages of a rate lock
Rate locks are popular with buyers for a reason. Here are a few advantages of locking your rate into place early:
- You are sure of your interest rate and are in a better position to determine how much house you can afford.
- You can focus on what you need to do to get to closing, rather than worry about what is going on with interest rates.
- You can usually extend the low rate for longer if needed.
Disadvantages of a rate lock
Rate locks can be helpful but are not perfect. Here are two of the reasons buyers think twice before locking in an interest rate:
- Rates can change by the hour, and you have no way of knowing if the rates will go down before you close.
- If interest rates do go down, you are stuck with the rate you locked in. The exception is if the original rate lock has a "float-down" provision written in to cover such a situation. If a lender does provide a float-down provision, you can expect to pay more for the rate Lock.
How much does a rate lock cost?
Many mortgage lenders do not charge for a rate lock or rate extension. Among those that do, you are typically looking at 0.25% to 0.50% of the total loan amount for a rate lock (of 60 days or less), and between 0.06% and 0.375% for an extension. That means if you borrow $300,000, it will cost between $750 and $1,500 for the initial lock, and $180 to $1,125 for an extension, payable at closing.
If you find a lender that offers everything you are looking for, do not let the fact that they charge for a rate lock discourage you. Here's why: A rate lock can save you thousands of dollars over the life of a loan and quickly pay for itself. Plus, lenders that offer an automatic rate lock will often build that cost into the loan in a different way.
Let's say want to borrow $300,000 for 30 years and lock in a mortgage at 4% interest. Your principal and interest payment would be $1,432 per month. Now, imagine that you did not lock in the interest rate early enough, and by the time you get to closing, the rate is 4.5%. That small difference means your principal and interest payments would be $1,520 per month instead, which is $88 more each month. By the time you pay the mortgage off in 30 years, you will have paid an extra $31,680.
