The Complete Guide to House Buying
Point of Interest
Before buying a home, do your research, talk to the experts, and read the paperwork. Once you decide to become a homeowner, you want to worry about things like mowing the lawn, not whether you made the best financial decision with your mortgage.
Buying a home is one of the biggest financial commitments you’ll ever make. But don’t let that scare you — homeownership is a step many people eventually take. The key is to do plenty of research self-reflection. Homeownership is a big deal, but it can also be a fulfilling experience.
There’s no set path to homeownership, although there are several important markers. You’ll have to look at your overall financial situation, qualify for a mortgage, learn about the housing market, meet with real estate agents, and perhaps, most importantly, determine whether buying a home now is the right choice for you.
Are you ready to buy a house?
There will never be a perfect time to buy a house. But there are some reasons to not take the plunge right away. If you’re just following the crowd — perhaps all of your friends are buying homes — you might want to think twice. After all, no one’s finances or personal circumstances are exactly the same. This is why there’s no one answer to questions like, “what’s the best savings account?” or “what’s the best money market account?” — what’s right for one person isn’t necessarily right for you. The same is true when buying a house.
Reaching a milestone is another tempting reason to buy. Perhaps you’ve reached a certain age, started a new job, graduated from school or moved to a new city. But none of these necessarily signal that it’s time homeownership.
To know if now is really the right time, ask yourself a few questions. Ideally, the answer to all of these is “yes.” If it isn’t, you may want to think a bit more deeply about your decision.
- Are you ready to maintain a home?
- Can you afford the ongoing costs of homeownership?
- Do you plan to live in the new home for at least a few years?
- Does homeownership fit in with family plans and responsibilities?
- Does buying make financial sense?
Once you know the time is right, start thinking more definitively about money. Specifically, determine how to pay for a new home and how this new asset fits into your overall financial plan.
Organize your finances
You should be on solid footing financially before you think about homeownership. That means different things to different people. Most people feel secure if they have a steady income and don’t anticipate any big changes in the next couple of years. Sketch out your current household budget and create a personal balance sheet. Include your auto loans, personal loans, and get a sense of your debt-to-income ratio.
This analysis lets you know how much you have and how much you owe. The next step is deciding how you can fit in a mortgage payment and housing expenses.
Determine how much you can afford
You can do this at any stage, but some find it helpful to use a mortgage calculator to get an idea of how much their monthly expenses will increase with a new loan. This gives you an idea of how much you can spend and how much down payment you may need.
Save for a down payment
The more you pay in cash, the less you have to borrow. That means a big down payment is usually better. But the exact terms depend on your lender. Usually, a 20% down payment means you don’t have to buy private mortgage insurance. Anything less than 20%, and you may have to pay a bit more per month and pay a lump sum fee for the insurance.
Mortgage insurance protects your lender in case you default on payments. If you have a low down payment, your lender may require that you carry this insurance for the lifetime of the loan. That’s even after you have significant equity in your home — adding to your overall costs.
A 20% down payment reduces the length of your loan and the time it takes to own a home free and clear. But it may also be a huge barrier to get into the market. Those that struggle to come up with 20% down might want to look at various low down payment options. A Federal Housing Authority loan may only require 3.5% down, Fannie Mae and Freddie Mac just 3%, and Veterans’ Affairs loans have no minimum down payment.
But of course, there’s a catch. A low down payment means you might have a longer term mortgage or higher monthly payments. The minimum down payment depends on your lender; the better your credit worthiness, the better deal you’ll get.
Check your credit score
Your credit score makes a big impact on the deal mortgage lenders will offer. So check now for errors or high balances. Remember, some of your biggest creditors may only report once a month at statement time. If you’ve just paid off that high credit card bill, it may take a few days to reflect in your score. Also, credit reports aren’t always accurate. If you spot mistakes, take steps to correct them by contacting the creditor in question or the reporting agency.
Because it can take some time to clean up your credit, start monitoring it as soon as you begin to weigh whether or not to buy a house.
Understanding the mortgage
Most people get funding through a conventional mortgage. These are provided by banks, credit unions, financial companies, or Fannie Mae/Freddie Mac. Mortgage loans that are backed through government entities — apart from Fannie or Freddie — are considered non-conventional. These include the Federal Housing Authority, Veterans’ Affairs, or USDA Rural Housing Service Loans.
Government loans may have more flexible requirements, like lower down payments, but funding approval also comes with certain conditions, like you may have to live in the home.
Mortgages are secured against the asset: your home. So in the event of default, you may lose this asset entirely.
Qualifying for a mortgage
There is a difference between being “preapproved” and “prequalified” for a mortgage. Preapproval means just that — your lender has determined you are approved to incur a mortgage for a specific amount. The preapproval process is detailed, because the lender is promising to lend you the funds once you’re ready to buy a home. Prequalification, on the other hand, is merely a rough calculation of what the lender might be willing to front you. There’s no legal promise the approval will go through.
You should know the preapproval process when you experience it — you’ll be asked for proof of income, employment, assets, and identity. But if you’re not sure whether you’re up for “approval” or “qualification,” ask outright. You should know why your lender wants the information it requests — and what you’ll get in return.
Mortgage interest rates and points
One big choice you have to make is between a fixed-rate and an adjustable-rate mortgage. A fixed-rate mortgage (FRM) is exactly what it seems: a set interest rate over the lifetime of your mortgage, with a reliable monthly payment and amortization schedule. An adjustable-rate mortgage (ARM) will change, according to a set index. Your lender should reveal which index your mortgage is tied to. The introductory rate on an adjustable-rate mortgage might be lower than with a fixed-rate loan, but be mindful that this will change over time.
A low interest rate may seem tempting — and it can be a good deal. But mortgage rates are often tricky. Be wary of low interest rates that seem too good to be true. Often, those rates are offset by “points,” which are paid to lenders or brokers. Those will possibly show up in your closing costs. Before accepting the deal, ask your lender to spell out exactly how much you’ll pay in dollars. Those points may be worth it, especially if you plan to live in your home — and therefore keep the same mortgage with the low interest rate — for years to come. Or, points may cost you significantly.
Learn more about mortgage rates.
Mortgage terms and conditions
Many people will get a 30-year mortgage. That keeps monthly costs reasonable, but makes your home more expensive in the long run. That’s because you’ll pay more interest over the lifetime of your loan. For some, this additional expense is worth it to get in on the market. A shorter term means higher payments, but in the long run your home will cost less. You’ll also own the house outright sooner than with a longer-term mortgage.
Most mortgages come with certain conditions. For example, you may be limited in how many extra payments you can make per year. If you pay off the loan early, you will likely incur a prepayment penalty.
The takeaway? Read your contract thoroughly, and speak with a lawyer, licensed real estate agent or broker if anything is confusing. Even if you didn’t understand something in the contract, you’ll still have to pay.
Mortgage closing costs
Once the sale closes, you aren’t quite done with the expenses. For that reason, it’s a good idea to think about closing costs now, while you’re figuring out how a mortgage fits into your financial plan. Your closing costs include things like:
- Property tax
- Home insurance premiums
- Mortgage broker commission
- Title insurance
- Title search
- Home inspection
- Attorney fees
- Loan origination fee
Your closing costs will vary, but a ball park amount is 3% to 4% of your home’s value.
Choosing a mortgage lender
Before you choose a mortgage lender, it’s a good idea to determine whether you want a conventional or government-backed loan. This may seem confusing, as government-backed loans are also issued through private companies. But there’s a big difference in the approval processes.
Once you know the kind of mortgage you need, obtain quotes from at least three different lenders. Shopping around lets you know what kind of deal you might get. You can also start with your current financial institution. After all, if they offer the best credit cards and CDs, they may also have the mortgage that’s right for you.
But take caution here as well: just because a particular lender is willing to give you a mortgage doesn’t mean you should sign on the dotted line right away.
“The seller may receive more than one offer. They will look at the reputation of your lender. Sometimes a seller will go with a slightly lower offer that is backed by a great lender rather than a higher offer backed by a shaky lender,” says Benjamin Ross, realtor in Corpus Christi, Texas.
Ross’ advice? Do your research, and consider talking to a realtor to find a reputable lender.
Another option is to work with a mortgage broker. They act as intermediaries between homebuyers and lenders, and are paid by the lender when a deal closes. Like individual lenders, brokers have varying reputations. It’s important to find one that you feel best represents you and your values, because they will become a large part of one of the biggest financial transactions of your life.
Avoid budget pitfalls when buying a house
With all the focus on buying a new home, many people overlook the other costs of homeownership. Some of these happen right away — like new furnishings and appliances that aren’t included in your contract for sale. Have a look at what forms part of the sale and what doesn’t — it may come as a shock to have to pay out of pocket for a washer and dryer when you assumed they came with the home.
You may also incur significant moving costs. This isn’t like when you were in college and could rely on a few friends to throw some boxes into a truck. You may have to hire a moving company and perhaps travel a long distance. Get some quotes for this service, including packing materials, labor and transport. Don’t forget, not only does your stuff move, but you have to get to your new residence as well. If you’re changing cities, that may require a flight or road trip, so budget accordingly.