Step 1. Start Saving Now!Whether you’re planning on purchasing a home in the near future or finding the home of your dreams sounds like a distant dream itself, one of the most important steps you can take in becoming a homeowner is to start saving now. Even if you don’t see yourself purchasing a home any time soon, chances are you won’t want to be a tenant for all of your life, and owning a home is one of the greatest ways to build wealth today. A home is a tremendous asset, and can help you turn rent payments made to a landlord into equity that can improve your long-term financial outlook. Most lenders will require a down payment of 20% of your home loan, and while there are ways to lower that amount (we’ll talk about that below), the best means to muster up a down payment when that day comes is to begin saving for it now. Set a little aside every paycheck, and you’ll be surprised how quickly your down payment nest egg will grow.
Step 2. Evaluate Your FinancesWhen the prospect of buying your first home draws nearer, begin to ask yourself how much house you can reasonably afford. A home is certainly an excellent asset to have, but going overboard and taking out too big of a mortgage can leave you struggling to make your monthly payments. Be honest with yourself when determining what kind of home you should look for, and avoid weighing yourself down with excessive debt. Do a financial self-check before you start looking, and include the following questions:
What’s My Credit Score?Financial institutions will only be willing to lend you money if they feel you’re a reliable payor. Your credit score is the primary metric lenders will use to determine your financial trustworthiness, and the higher it is, the better the terms of your loan will be. Some lenders may be willing to work with those with poor credit history, but these loans often come at very poor conditions to the borrower, so take some time to bolster your credit score by making consistent payments and paying off debt before looking into buying a house if you can.
How Much Debt Do I Have?When you apply for a mortgage, your lender will look at how much debt you hold relative to your current income. This is called your debt-to-income ratio, and lenders prefer for it to be no more that 36% tops — and the lower the better. Minimizing your debt will help you get the best possible mortgage rates, so take some time to pay down what you owe in other areas before you begin the hunt for your dream home.
How Stable is My Job?Lenders know that you won’t be able to make any payments on your mortgage if you don’t have enough income. To keep you from biting off more than you can chew, most financial institutions will not qualify you for a mortgage exceeding roughly three times your annual income. This gives you a good idea of how much house you can afford — though you’ll need to factor in other expenses for a final figure.
What Else Should I Factor In?Those other expenses include property taxes, homeowners’ insurance, closing costs, and possibly home repairs — and they can amount to more than you’d expect. Closing costs alone can account for 2–5% of the total cost of your mortgage (though sometimes you can negotiate with the seller to have them cover the cost of closing the deal), and property taxes will vary by region.
What Can I Afford?Now that you have a well-calculated number in mind, you’ll have a better idea of what houses are on the menu. If you’re still paying off a lot of debt and building your credit history but need to buy a home now, a starter home or fixer-upper may be the best choice for you — and it may be best to wait a while, if you can. On the other hand, those with little debt and solid income may opt for a move-in-ready home now. If you find yourself in the former category, don’t be discouraged; you can still build up to the home of your dreams over time, and adding value to a starter home can be a great way to do that — perhaps through renovation. By now you may be exhausted just thinking about the planning that goes into your home search, but take heart: evaluating your buying power honestly will help you make the right home-buying decision, and will save you a lot of stress and expense down the road. Now that you know how much house to hunt for, let’s move on to the next steps.
Step 3. Find a Mortgage and Get Pre-qualifiedOnce you decide you’re ready to become a homeowner, a good first step to take is to get pre-qualified for a mortgage. This is the first part of the loan application process whereby you’ll inform the lender of your credit, debts, income and other assets to pre-determine how much of a loan you’re eligible for — though nothing will be verified. Note that pre-qualification is not the same as pre-approval; the former is an informal assessment of what your mortgage might look like based on the information you provide, whereas the latter requires the completion of a mortgage application, and all records are verified. Because neither are a finalized loan, some novices skip this step and charge straight into their home search, but this is a serious mistake. Most sellers won’t entertain an offer without some notice of pre-approval, as this demonstrates that you’re a serious buyer. It also gives you some leverage in your negotiations as well as a competitive edge over rookies who didn’t prepare, so have your paperwork in order before you start the house hunt.
Shop AroundAs you get your loan in order, don’t forget that buying a home means shopping for two things at once: the home itself, and the mortgage rate that works best for you. More goes into finding the right mortgage than we can talk about here, but here are a few loan types you should be aware of as a first-time homebuyer:
- FHA loans – These typically only require a 3.5% down payment, instead of the usual 20% — though some conventional mortgages geared towards first-time buyers may require a down payment of as little as 3%.
- USDA loans – These are targeted towards buyers in rural communities, and often require no down payment. (This is also where Native American Tribal loans can be found).
- VA loans – These are for veterans and often require no down payment. They may also accommodate a lower credit score.
Step 4. Start the SearchCongratulations! At this point you know how much house to look for and have all your paperwork in place, so you can finally get to the fun part of shopping for your home: looking at houses. This may be the most enjoyable part of the homebuyer’s journey, but it’s no less overwhelming. To help you along the way, make a list of the must-haves for your new home, so you don’t waste time on houses that don’t meet your minimum requirements. Possible deal-breakers may include:
- Number of bedrooms
- Number of bathrooms
- Yard size
- Storage capacity
Hire a Real Estate AgentEven with the most thorough record-keeping, chances are you’ll still need some help. That’s where real estate agents come in handy, as their knowledge of the market can help buyers find the gem they’re looking for, and save some time in their home search. You may think you can go without a real estate agent to keep costs down, but given that their paid by the seller, you have little to lose from hiring one, and much to gain if you do. Here are just a few things they bring to the table:
- Knowledge of the market
- Familiarity with the community (school districts, property taxes, public transportation, etc.)
- Experience with the process
- Negotiating skills
- Knowledge of loans and tax breaks for first-time buyers
- Some sellers won’t discuss an offer if you don’t have one