First-Time Home Buyer: Understanding the Basics

first time home buyer

If you’re a first-time home buyer about to start house hunting you’ll need to know the basics of home buying.

Because this will be the first home you purchase you’re prone to make mistakes, especially if you don’t learn everything you can about the home buying process.

In this article we’re going to show you everything you need to know about buying your first home.

What kind of mortgage to get, how to get a low rate, how to ensure you don’t buy a home with ┬áproblems and more.

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Understanding the Basics of Home Buying

  • Get pre-approved before you start your search
  • Improve your credit score before closing
  • Shop and compare multiple lenders
  • Choose the right real estate agent
  • Choosing the right house
  • Know how much home you can afford
  • The importance of a home inspection
  • Have all your mortgage documents ready
  • Be prepared for closing

Getting Pre-Approved

It is important that you have a pre-approval letter in hand before you start your home search. Most sellers will not even accept an offer from a buyer that does not have a mortgage pre-approval letter. In fact, many real estate agents will not even start showing you homes before you get that pre-approval letter.

Pre-qualified is not the same thing as pre-approved. Pre-qualified just means a lender has pulled credit but has not verified any income, assets, or verified employment. Many agents and sellers will not accept a pre-qualification letter.

Getting pre-approved is free and can usually be done in a matter of minutes. You will need to send a mortgage lender a few documents to validate your income, assets, and credit.

First thing a lender will do is pull a copy of your credit report and FICO scores from all three major credit bureaus. Secondly, they will request the following documents.

  • Last 2 years of tax returns
  • Previous month or two worth of pay-stubs
  • 2-3 months of bank statements
  • Proof of funds for down payment in savings, 401k, or other investment account

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Maximize Your Credit Score Before Closing

Your credit rating is the most important factor in the mortgage rate you will receive. The lower your score is the higher your rate will be. Before you put in an offer on a home you need to ensure your credit score is being maximized.

There are a few things you can do now that will increase your credit score in as little as 30-45 days.

Pay down credit card balances – The amount of available credit you are using on your credit cards is called your credit utilization ratio and makes up 30% of your overall credit score. Only your payment history (35%) has a bigger impact on your score. Try to pay down your credit card balances below 15% of their limit.

Don’t apply for new credit – Credit inquiries and new accounts each make up 10% of your score. You should wait on getting a new credit card or a new car until after you have closed on your home.

Contact creditors about collections and late payments – If you have any collection accounts on your report you can contact the collection agency and see if they will remove the delinquent account if you pay it off. This is known as a pay for delete. You can also call creditors to see if they will remove late payments as an act of goodwill. Sometimes it works.

Get Mortgage Quotes from at Least 3-4 Lenders

Mortgage rates and closing costs can vary greatly from lender to lender. It’s important to shop multiple lenders and get multiple quotes. This way you can make sure the rate you’re receiving is competitive. You can also use loan offers from other lenders to help you negotiate better terms with your mortgage company.

Shop and Compare Multiple Loan Offers

Choosing the Right Real Estate Agent

Not all Realtors are created equal. In fact, each realtor will have his or her own strengths and weaknesses. Some are very busy but are great negotiators while others may dedicate more time and be a better option for first-time homebuyers.

You can talk to friends or family to see if they have any recommendations. Or you can hop on Trulia or Zillow and search real estate agents in your area and read customer reviews.

Buying your first home will take time, you will have tons of questions, you need a realtor with patience who can take the time to explain everything to you.

Buying the “Right” Home

The old adage “Locations, Location, Location” is very true. It’s good to know which area you want to be in, but you should remain open to surrounding neighborhoods. Sometimes prices can be quite high in the community you want to live in.

Know which features you want in a home. 3 bedrooms, 3 bathrooms, formal dinning, media room, etc. Chances are you will have to compromise a little when buying your first home.

Right down all the features you want in order of importance. You can use the list later on see which home gives you the most important features you need.

Know How Much House You can Afford

When it comes to finding out how much house you can afford your debt-to-income ratio is the most important factor. You can figure out your DTI ratio by adding up all your monthly debt payments, such as credit card payments, student and personal loans, and your estimated mortgage payment.

Then divide that number by your gross monthly income before taxes. You will need a debt-to-income ratio of 41% or lower for most mortgage loans. However, a 36% DTI ratio is considered ideal.

Front-End and Back-End Ratios

Front-end ratio – This is your DTI ratio before adding your estimated mortgage payment. Most lenders will want to see a front-end ratio no higher than 28%.

Back-end ratio – This is your debt-to-income ratio after including your estimated mortgage payment into your monthly debt obligations. Lenders prefer a back-end ratio below 36%, sometimes a 41% ratio may be accepted.

Some first-time home buyers are unaware of all the additional monthly costs associated with a mortgage loan. In additional to your mortgage payment, property taxes, private mortgage insurance (PMI) and homeowners insurance is added to your monthly payment.

Use our home affordability calculator to find out how much you will qualify for. Our calculator includes PMI (if needed), property tax rate in your state, and homeowners insurance.

Don’t Skip the Home Inspection

It may seem the house is in great shape or is so new you don’t think there are any issues. But don’t ever skip the home inspection, even brand new homes may have issues only a professional can spot.

Inspections cost between $300-$500 on average. It’s well worth it. The alternative is finding out your home needs a new $10,000 roof or some other expensive repair. If anything is found that needs to be fixed you can ask the seller to make the repair before closing.

Have Your Documents Ready

Mortgages are often quite complicated and require tons of paperwork. Not having all the documents or taking your time to respond to document requests from your mortgage lender can lead to delays in closing. To avoid this it’s important to gather all of the documents needed for a mortgage and submit them early on.

Required Mortgage Documents

  • Two years of W2’s
  • Previous 3-4 Pay-stubs
  • Previous months Bank Statements
  • Tax returns from the two prior years
  • Profit and loss statements if self-employed
  • Divorcee decree (if applies)
  • Bankruptcy paperwork (if applies)

FHA Loans – The First Time Home Buyer Loan

It used to be the case that in order to qualify for a mortgage you needed flawless credit and at least 20% down. In an effort to increase homeownership the Government created the Federal Housing Administration starting insuring mortgages reducing the minimum guidelines and making them easier to qualify for.

FHA home loans are the mortgage loan most used by first-time home buyers. Why are they so popular?

For starters, FHA home loans allow for the lowest credit scores of all mortgage programs. Some lenders can accept a 580 credit score in some cases.

The biggest reason first-time home buyers don’t buy a home is because of the large downpayment. Most conventional loans require a 5% – 20% down payment. However, FHA loans require just a 3.5% down payment if you have at least a 580 credit score. This allows more borrowers to buy their first home.

Check FHA Rates

USDA Rural Development Loan

The U.S. Department of Agriculture created the USDA housing program to encourage homeownership in rural areas. There are several benefits of USDA loans including 100% financing. You do not need a down payment. Mortgage insurance rates are also lower than any other type of mortgage, just 0.35%.

In order to qualify you will need to buy a property in a designated USDA area. You can check the USDA eligibly map here.

First Time Home Buyer Down-Payment Assistance Programs and Grants

One of the benefits of buying your first home is that their are many grants and down payment assistance programs for first-time buyers. You can apply for a first time home buyer program by searching on your local city or county website.

There are also HUD sponsored programs in all 50 states. You can search for available programs and grants in your state on the HUD website.