Steps to Take When Buying Your First Home
The following eight steps will help you get your financial and mental houses in order so you can search for a new home with confidence.
1. Assess Your Debt
Lenders want to know that you’ll be able to handle the debt you already have, in addition to your new mortgage payment. An important metric is your debt-to-income (DTI) ratio. It’s a good rule of thumb if your total monthly debt (including your mortgage payment) does not exceed 36% of your gross monthly income. The Consumer Financial Protection Bureau (CFPB) reports that a maximum DTI ratio of 43% is required to receive a qualified mortgage, which is seen as safer for lenders.
Getting your existing debt under control is imperative before you can begin your mortgage application and your house-hunting process. This includes:
- Credit cards: Pay down your credit card balances so you’re using no more than 30% of your available credit. Maxed-out credit cards can signal to lenders that you’re not using your available credit responsibly, which also lowers your credit score.
- Installment loans: You might consider paying off or significantly paying down any installment loans (e.g., auto loans) to ease your monthly obligations.
- Student loans: If you carry student loan debt, consider how these monthly payments will impact your ability to pay a mortgage. Paying off any credit card debt might give you more leeway in your budget to service both your student loans and a mortgage.
The more debt you pay off before applying for a mortgage, the less stress you’ll likely have when it comes to making your monthly payments.
2. Check Your Credit
The better your credit score, the lower the interest rate you’ll get on your mortgage. Checking your credit well in advance of beginning your home search will give you time to correct any errors and improve your score ahead of time.
You can boost your score in a number of ways.
- Pay down credit card debt. When you lower your credit utilization rate, your credit score typically rises.
- Increase credit card limits. If you feel comfortable doing so, you can contact your credit card company and request a credit limit increase. The higher credit limit will lower your credit utilization rate. Before you ask for a credit increase, be sure to ask if the company will initiate a hard inquiry. You don’t want to accidentally lower your score with a hard inquiry when you’re trying to increase your score.
- Dispute errors. If you find a mistake on your credit report, you can typically get valid errors resolved in less than 30 days through the relevant credit bureau’s dispute process.
While credit scores as low as 500 can qualify you for certain mortgages, most lenders will expect a score of at least 620 to 680 to consider your application.
With a lower credit score, lenders may require a larger down payment and charge you a higher interest rate on your loan. Conversely, borrowers with high credit scores (800 or more) have lower down payment requirements and enjoy lower interest rates.
3. Review Your Budget
It’s important to remember that your budget will change when you buy a home and you’ll have new costs beyond just the mortgage payment.
Property taxes, homeowners insurance, and maintenance are just a few of the additions you’ll want to plan for. You may find that your utility bills increase. You’ll also want to make sure you have enough money in savings to cover emergency repairs.
For many types of mortgages, lenders will want to see two months of reserves (for the mortgage, taxes, and insurance) in the bank. For example, if your mortgage, taxes, and insurance payments total $1,000, you’ll need to have $2,000 in readily accessible savings to show. If you’re buying a condominium or townhome, you might also have homeowners association (HOA) fees that will be included when the lender assesses your budget.
The reserves required will vary by lender and by loan size. Even if you ultimately secure a mortgage that doesn’t require reserves, it’s not a bad idea to have a couple of months’ worth of expenses in the bank as a cushion.
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4. Determine Your Down Payment
How much you’ll put down on your home depends on the type of mortgage you receive. However, the typical mortgage down payment ranges from 3.5% to 20%.
Essentially, the higher your down payment, the lower the risk you are to a lender. Lenders assume that buyers investing more cash up front are less likely to walk away from the money they have in their homes. When you put down less than 20%, lenders often mitigate that risk by charging private mortgage insurance (PMI), which is an insurance policy that protects the lender if you default on your loan.
As you consider how much you want to put down, it may help to meet with a mortgage officer to explore possible loan options. An experienced professional can help you determine which loans will require PMI and how much down payment you might need to avoid paying this insurance.
When you save a bit more for a down payment, you may qualify for a mortgage that doesn’t have PMI requirements. Avoiding PMI can potentially save you hundreds of dollars a month.
5. Get Preapproved
When you’ve cleaned up your credit and paid down your debt, you’ll want to get pre-approved for a mortgage. Preapproval is a valuable process for several reasons.
First, you’ll find out exactly how much you’ll be able to borrow and therefore, how much home you can afford. Knowing your purchase power will help guide your home search and keep you from unnecessary disappointments that come with shopping outside your limits.
Next, preapproval positions you as a serious buyer. Many real estate professionals won’t take on buyer clients if they haven’t already been preapproved. A seller’s agent will know a lender has vetted you and that there’s less of a chance your funding will get derailed in the closing process.
Preapproval lets your agent take you shopping with confidence because they know they can make offers on your behalf with confidence.
6. Figure Out the Type of Home You Want
When you know your buying power, you can review all the home options available in your area by first understanding the types of homes that are out there.
- Single-family homes: These are what most people mean when they refer to a house. These homes aren’t attached to other homes.
- Duplexes: These houses are typically two homes with separate entrances in one building and share a single common wall (if side-by-side) or floor/ceiling (if a two-story building).
- Condominiums: These are privately-owned units in a larger building or development of multiple units where owners own the interior of the unit, not the exterior building. Owners typically share common areas and amenities (e.g., pools, gardens, hallways, parking). There are usually HOA fees paid monthly to cover the maintenance of shared areas and amenities.
- Townhomes: These are multistory dwellings constructed side-by-side where the owners own both the interior and exterior of the units. There are usually one or two shared walls with other units and association fees to cover any shared amenities.
As you review the types of homes available in your area, consider the space you need, the cost of each type of home, and any additional fees that the different home types might incur.
