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Tips for first time homebuyers

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Home ownership is the heart of the American Dream. Owning a home provides stability for your family, defines your place in the community and empowers you to accumulate wealth through credit, home equity and retirement savings. Being a first time homebuyer is one of life’s most exciting achievements – and most daunting challenges. In this article, we’ll share some proven tips that will help you weigh your options, avoid mistakes and make your American Dream come true.

Who is a first time homebuyer?

You might think that a first time homebuyer is just someone who has never owned a home. But that is not the only qualification. The U.S. Department of Housing and Urban Development (HUD) defines a first time homebuyer as any individual who:

  • Has had no ownership in a home for three years.
  • Formerly owned a home with a spouse, but is now single.
  • Owns a residence that is not fixed to a permanent foundation.
  • Owns a home that cannot be made compliant with building codes.

Preparing to be a first time homebuyer

To be a first time homebuyer, you need a stable job with a satisfactory income, a good credit score, an acceptable debt-to-income ratio and a cash down payment. These requirements will have to be fulfilled before you can start looking for your first home.

Work smart. Is your job in a stable industry with a path to earning more responsibility and income? Great! If not, then you should evaluate your job as a mortgage lender would, with an eye to your long-term ability to meet your obligations. If your job is fun and rewarding, but seasonal or subject to swings in the economy, consider moving to a career with more stability.

Pay your bills on time. Your credit score is just as important as your income. Lenders know that past performance is the most accurate predictor of future behavior. Don’t avoid using credit. Rather, you want to show a stable history of borrowing and repayment. If you made some youthful mistakes and have bad credit; don’t despair. Get your bills paid off and work to rebuild a history of paying on time.

Control your spending. When evaluating your ability to handle a mortgage, lenders also look at your debt-to-income (DTI) ratio, which is the total of your monthly debt payments (auto loan, credit card, student loan, etc.) divided by your gross income. For example, if your monthly debts are $1,000 and your gross income is $5,000, your DTI is 0.2, or 20 percent. Generally, lenders are looking for a DTI of less than 36 percent, and in some cases may be required by law to not write loans with too high a DTI.

Start saving early. Usually, a down payment ranges from 0 percent to 20 percent. For the U.S. median home price of $375,000, 20 percent is $75,000. It takes the average buyer 6.5 years to save the down payment.

While you are working and saving…

Monitor your credit score. Errors in credit reporting are not uncommon, so review your credit accounts annually with the three main reporting agencies: Experian, TransUnion and Equifax. You are entitled by law to a free copy of your credit report once a year. You will see many offers online for a free credit report. However, the only site authorized by the Federal government is annualcreditreport.com .

Save more. In addition to the down payment, you will have closing costs of 2 percent to 5 percent of the home price (more about closing costs later), as well as moving expenses depending on your distance from the new home and whether you can stay with friends or relatives until your move-in day. You also don’t want your plans thwarted by a job loss or a health crisis. Set aside an emergency savings account.

How much mortgage can you afford?

For a rough estimate, use 28 percent of your gross monthly income. For example, with an annual household income of $90,000, your monthly gross is $7,500, and 28 percent of that is $2,100. Bear in mind that your monthly housing cost will include mortgage principal, interest, property taxes and insurance (PITI), as well as any fixed homeowners association fees.

You can use this rough estimate to browse listings on Zillow, Trulia or Realtor.com, which typically include monthly payments. For a more accurate estimate, online calculators provided by Forbes, NerdWallet and Investopedia use your monthly debt payments, current mortgage interest rates and your anticipated down payment to show you exactly how much you can afford.

Government programs for first time homebuyers

New homebuyers are important to cities and states because you support the local economy and help increase the city, county and state base of taxation, which pays for schools and other community resources. Governments at all levels want to encourage homeownership through programs that help with mortgage qualifying, down payment assistance and other support.

Some government programs are available only to first time homebuyers. For an overview of homebuying programs in your state, start with the links on this page to the U.S. Department of Housing and Urban Development.

Know your rights

The dream of home ownership belongs to every American. Since 1968, The Fair Housing Act has prohibited discrimination based on race, religion, national origin, sex, family status or disability. Fair and equal access to neighborhoods, homes and financing is guaranteed to every American.

Following the 2008 mortgage crisis, a new Consumer Financial Protection Bureau was formed to help consumers understand mortgage options and avoid costly surprises. Four older disclosure forms were replaced with two easier-to-use forms: Loan Estimate and Closing Disclosure. The new CFPB rules also require lenders to give you three days to review your numbers and ask questions before you close.

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Weigh your mortgage options

Although it may seem counter-intuitive to shop for a mortgage before you find a home that you want to buy – this is the correct order. Getting a preapproval shows you the price range you should be shopping, and a mortgage preapproval letter shows sellers that you are a serious buyer, ready and able to close a deal.

To find the mortgage that is best for you, it is important to learn a little about the main forms of mortgage lending, each of which has different requirements for down payment and other features.

FHA, VA, USDA or conventional loan?

FHA loans are guaranteed by the Federal Housing Administration, allowing down payments as low as 3.5 percent.

VA loans are guaranteed by the Veterans Administration. They are only for active duty or veteran military service members, starting at $0 down.

USDA loans, guaranteed by the U.S. Department of Agriculture, are for farm and rural home buyers, also starting at $0 down.

Conventional loans are not guaranteed by any government agency. Some loans for first time buyers require only 3 percent down.

A key takeaway on the size of your down payment

Question: If there are mortgages available for no money down, why is the typical down payment 20 percent?

Answer: Mortgages with less than 20 percent equity typically require private mortgage insurance (PMI) to offset the higher risk taken by the lender. The premium is paid each month with the mortgage payment. While you may have the ability to ask to remove the PMI once the amount paid reaches 20 percent of the value of the home, this is not guaranteed.

By making a down payment of 20 percent, the buyer reduces the amount financed and eliminates the requirement for mortgage insurance. On a $300,000 home, this would reduce the monthly mortgage payment (principal and interest) by about $300 per month and would avoid mortgage insurance premiums of $125 to $250 per month for 30 years.

How to shop for a mortgage

Once you determine the right choice among FHA loans, VA loans, USDA loans and conventional loans, the next step is to choose the best lender. HUD offers a PDF booklet, “Looking for the Best Mortgage,” with advice on shopping for mortgages, comparing multiple lenders and negotiating the best deal.

Don’t be intimidated by the word “negotiating.” Once you’re qualified, you can pick and choose between offers.

Compare multiple lenders quickly and easily online

You can compare loan terms and interest rates at websites such as BankRate and LendingTree. There are also direct mortgage services from familiar names (QuickenLoans, RocketMortgage and Ally Bank). Many popular lending websites are reviewed by financial journals such as Forbes and Kiplinger.

If you prefer to work close to home, local banks and credit unions may also offer excellent rates and terms. The important point is that you take the time to thoroughly compare the loan terms, costs and fees for each lender you are considering.

Let them know you’re shopping

Mortgage loan companies are in a competitive market. To get their best offers, let lenders know you’re shopping. To make shopping easy, use a tool like the mortgage comparison worksheet on page six of the HUD booklet. This will allow you to compare interest rates and estimated monthly payment, as well as loan costs such as origination fee, discount points and PMI premiums. Don’t forget to compare closing costs such as appraisal, inspection, survey and title search.

The HUD worksheet will also give you some questions to ask.

  • Is there a penalty for paying off the mortgage early?
  • When is the interest rate locked in? Is the rate fixed?
  • If the rate is adjustable, what index does the lender use?

The answer to just one of these questions can make one particular loan offer the most (or least) favorable.

How to shop for a home

The first step to finding your dream home is to write down your must-haves and nice-to-haves. Whether you work with a realtor or go house-hunting on your own, you want to start with houses that fit your basic requirements and preferences.

  • The first consideration is price, which you just determined through mortgage pre-approval.
  • Do you want a single-family home, townhouse or condo? What about a mobile home?
  • How many bedrooms and baths do you need? Do you need a home office or in-law suite?
  • Do you want to work with a new home builder? Are you able to renovate an older home?
  • Do you need to be close to public transportation, a particular school or your workplace?

Build a detailed wish list

Once you have decided what kind of home you want and where it should be located, put some thought into your must-have and nice-to-have features.

With your requirements and preferences for type of home, location and features, you can use the filters on real estate web sites to narrow your search for the best fit. You can also provide your wish list to a real estate agent, who will have many tools to find listings that will fit your criteria.

Real estate agent standing outside of house

How to choose a real estate agent

As with any other service, the way to locate a good real estate agent by reputation.

  • Ask your friends whether they have worked with an agent who did a great job.
  • Search the realtor.com agent database and sort results by “Highest Ratings.”
  • Search other customer review resources such as Yelp, Google and Facebook.
  • While house-hunting, snap a photo of agent signs in your target neighborhood.

Once you have three prospective agents who look promising, give them a call. Let them know that you are considering other similar agents and would like to ask them a few questions.

Questions for prospective real estate agents

Think of four or five ways a real estate professional can help you. Here are some suggestions:

  • “My price range is $275,000-to-$300,000. What’s going on in that market right now?”
  • “I am a first time buyer. How would you work with me to help me make an offer?”
  • “Do you have a network, a recommended home inspector, closing agent and so on?”
  • “Based on my wish list, which neighborhoods do you think we should consider?”

The exact questions are not as important as taking the time to interact with each candidate. During this process, you may have a strong feeling of connection with one of the agents. If you do, this is the right partner to walk with you on the winding and sometimes bumpy road to a successful closing. If you don’t have that feeling about any of your candidates, go back and search for three more.

Now find your dream home

As you search online, house hunt on the weekends and review listings sent over by your agent, stick to your guns in terms of budget and other requirements. Your agent and your lender want to help you, but they also want to get to a sale. Your agent may find a great house that is just a little over your budget, and your lender may have qualified you for more money than you requested. Keep in mind that going over budget and winding up “house poor” will undermine the enjoyment of your new home. Be patient.

When you find a listing that seems to offer a fair portion of your wish list, the quick way to check it out is with a virtual visit. Many realtors provide 3D walk-throughs using Matterport and other camera systems that allow you to virtually tour a property. In other cases, the selling agent or the homeowner may agree to a smart phone tour using Zoom or FaceTime. These are great options if you are out of town or otherwise can’t arrange an in-person visit.

Request an in-person showing

There is no substitute for touring a property in person. You want your agent present at a showing, but you may want some time without the seller present. You need to be free to open doors and drawers – and to tell your agent what you’re thinking.

Check the neighborhood

If you think this might be your Dream House, take the time to vet some important details:

  • Use CrimeMapping to see police reports around the neighborhood.
  • Use FEMA and state elevation maps to determine the risk of flooding.
  • Use GPS to check your proximity to groceries, school, church and gym.
  • Take a walk. Ask the neighbors what they like or dislike about the area.

Make an offer

Huddle with your agent to get their experienced view of the seller’s asking price versus what you should offer. Under normal circumstances, you would factor in recent sales of similar properties, the condition of this particular home and of course, what you are willing to pay. However, some of these considerations may be dependent on the current housing market and competition.

A seller’s market may force you to bid against other buyers, so your agent may coach you on how to strengthen your offer with incentives over and above the seller’s asking price. These incentives might include:

  • Waiving the property inspection or other contingencies.
  • Allowing the seller to stay longer until their new home is ready.
  • Paying a premium over the asking price, to a specified maximum.
  • Including an escalation clause that tops other buyers.
  • Personalizing your bid with a sincere letter to the sellers.

Keep in mind, some of these incentives can have negative ramifications. For example, waiving the inspection may jeopardize your ability to recover from the seller if there is an issue, and allowing the seller to stay may term them into a tenant. Be sure to discuss fully with your agent and legal advisors as you make concessions. According to research from Zillow, the average home buyer makes just two offers before receiving an acceptance from a seller – so make sure your offer is serious!

Get ready to negotiate

Very often, the seller will counter your offer, asking for a higher price or for adjustments to the inspection or other contingencies. The seller’s agent will submit the counteroffer to your agent, and it is up to you to either accept or counter again. This is where your agent will bring all of his or her industry experience and sales ability to focus on closing the deal.

Keep your cool during this process. If you need to compromise or meet the seller somewhere in the middle, that’s fine, but keep your eye on what you want and can afford. If this deal is not right for you, you’ll be glad you waited for the right one. On the other hand, if this deal is the right one, it’s time to get ready for your closing.

The final steps

With a signed agreement, here are your final steps:

Order a home inspection. Unless you waived the inspection, this is your chance to double check that the property doesn’t have any hidden defects such as a bad foundation, leaky roof or termite damage.

Order an appraisal. A professional appraiser will compare the home to similar properties to assure your lender that the home is worth the amount of money you are borrowing.  If not, the loan may be denied. Should this happen, the seller may lower the price, or you can offer more in cash to rescue the deal.

Sign the mortgage. The lender will have you sign the mortgage, deed and various disclosure forms before issuing the proceeds of the loan as a cashier’s check or a wire transfer to the closing agent’s escrow account.

Get homeowners’ insurance. With the value of the property established by the sale and appraisal, you can shop for homeowners’ insurance, which will be required for the closing. As you complete these steps, report everything to your real estate agent and to the closing agent. You may also want to explore other insurance options for more coverage such as flood, windstorm or umbrella insurance to help insure your house and belongings. Talk to one of our personal insurance agents if you need help figuring out what homeowners’ insurance is best for you.

What to expect on closing day

Three days before the closing, you’ll receive a Closing Disclosure that looks like this example. Review it carefully and make sure that everything agrees with the Loan Estimate you received earlier.

There will be a lot of paperwork to sign. Until recently, this was done by hand in the office of a title company with the closing agent, buyers and sellers passing stacks of documents around a table. Today, the closing process is often handled virtually with buyers and sellers signing electronically.

To close, you will also need proof that you have arranged for homeowners’ insurance on the property.

Now for the last of our tips for first time homebuyers: when everything is signed, your closing costs are paid and the seller has a check for the proceeds of the sale, the closing agent will hand you a set of keys. Put the keys in your pocket, go home and open the door to your American Dream!

Not sure where to start? Talk to someone who wants to listen.

A great plan starts with a conversation. Let’s talk about what you need.

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