Buying a home is a huge milestone that comes with some major benefits. Most owners would say they appreciate having a space to call their own and modify according to their tastes. There are also financial benefits, including tax deductions and the fact that most properties will increase in value over time.
So how do you get to that point? Here are some tips for first time home buyers or anyone considering purchasing a home.
While it may sound obvious, you’re going to need some money upfront for a down payment. What’s not obvious is how much you need. Traditional mortgages often require 20% of the purchase price, but there are many options available with smaller down payments. Banks will often allow a smaller down payment for a higher interest rate and mortgage insurance.
If you’re looking for government programs with smaller down payments, one good option is the Federal Housing Administration (FHA) loan. FHA loans are designed for first time homebuyers who may not have a lot of capital or excellent credit scores. They usually require a down payment of only 3.5%
While putting down a smaller down payment seems like a good plan, it does come with a downside. In most cases, it means you are required to purchase private mortgage insurance (PMI). This helps protect the lender in case you default on the loan. The PMI can add 0.5%-1% of your loan’s balance to your payment every year. However, once you have 20% equity (ownership) of the property, then PMI is usually no longer required.
Start thinking of creative ways to save, invest, and put money away for your future down payment. Remember to factor in closing costs and loan origination fees. These vary per lender, but can range from 2%-5% of the purchase price.
Keep It Affordable
Often, mortgage brokers and lenders will run an analysis on your financial data and come back with a number of how much you can afford. While it may be exciting to think about buying an even bigger house, most experts agree that you should treat this number as a ceiling, not as a base.
There are several reasons why it’s a good idea not to stretch yourself too thin when it comes to down payments or monthly mortgage payments. One is that it’s important to have a reserve fund. Say you move in and two weeks later, the water heater breaks. That same week, you discover some electrical issues. Being a homeowner means bearing these costs, and you have little control over when they will pop up. You don’t want to be in a situation where you can’t make a critical repair because you spent all your money on a down payment. For this reason, it’s a good idea to keep a reserve fund in case anything goes wrong.
Another argument for buying a less expensive house is that making costly mortgage payments each month can be stressful and overwhelming if you’ve purchased a home beyond your means. Most people don’t want to make sacrifices in their lifestyle just to afford their mortgage. Remember, even one late mortgage payment is a serious matter. Find a property within your means, build equity, and upgrade only when the time is right.
Shopping around for a lender is a great strategy to save money since not all lenders carry the same rates. Home buyers can save thousands of dollars each year by comparing prices and interest rates. For example, on a $300,000 loan, half a percentage point can mean a difference of over $1000 per year.
Despite these benefits, not all home buyers choose to shop around. The main reason for this is they often wait until the last minute (when they’re about to buy a home) and they run out of time. Starting early can help eliminate some of the pressure and allow potential buyers to find the best rate that works for them.
It’s also important to realize that interest rates don’t tell the whole story. Closing costs and origination fees vary between lenders, so it’s worth comparing to see which one will be lower.
Unless you plan on paying in cash, getting a mortgage pre-approval letter is a necessary step before your make a purchase.
The pre-approval letter comes from a qualified lender. It assures the seller and real estate agents that you have the means to purchase a house and are able to afford the monthly mortgage payments. Without it, most sellers and agents will not take you seriously. Producing this letter shows them you are an earnest buyer capable of making an offer on a home.
Getting the pre-approval letter involves filling out an application with the lender. They will typically run a credit check and ask for documents like your paystubs or W-2s, bank statements, investment account statements, and tax returns.
Find an Agent
Finding an agent is advantageous for several reasons. Their knowledge of the local market and different neighborhoods makes them a great resource for first time buyers. Agents thrive on connections, and they usually have a good network of people looking to sell their homes. They also have access to Multiple Listing Service (MLS), an enormous (and exclusive) database of homes for sale. The MLS even lists homes that haven’t shown up on the market yet or homes where the seller doesn’t want the sale advertised to the general public. In short, going through an agent means you may find a great house you never would have discovered otherwise.
Agents also specialize in finding homes with the exact features you’re looking for. Say you decide your future home must have a pool, an office, and a formal dining room. A good agent can take your requirements and filter through homes until they find something that meets your standards.
Agents are also usually up to date on local zoning requirements. Say you want to build an addition to a home. An agent should be able to tell you if it’s legal and what permits are required.
Having an agent means a lot of the legwork of searching for your home is taken care of. For buyers’ agents, it’s typical for them to be paid by the seller. So as a buyer, there’s no reason not to take advantage of an agent’s services.
Take Your Time...
Finding your next home isn’t something that will happen overnight. In most cases, be prepared for several weeks or months of searching and paperwork. Don’t let anyone (including sellers or agents) pressure you into a deal you aren’t excited about. And don’t be afraid to take your time finding the home that’s right for you.
...But Be Willing to Compromise
At the same time, remember that as much as you want to find the “perfect” home, each property comes with some drawbacks. Think of buying a house as a series of tradeoffs where you need to make compromises. Say you’re looking for a 3 bedroom 2 bathroom home in a good school district with a backyard and a pool. Perhaps you find a home in the district you want, but it’s over budget and only has 1.5 bathrooms. Or you might find a house with the layout you want in a different school district.
Keep in mind that your new home may not check off everything on your wishlist. Shopping around can help you determine what’s truly important to you and what’s realistic. Find a compromise you can live with and make your decision based on what’s available.
Buying a home is an exciting process. As you keep saving and start getting your financials in order, don’t be afraid to shop around for different lenders or agents. Get that magic pre-approval letter to pave your way to making an offer, but don’t feel rushed unless you know it’s right.
Lastly, remember that buying a home is an emotional decision. It’s normal to feel a little overwhelmed, but coming in prepared can help you navigate the waters as smoothly as possible.