The process of buying a house can be overwhelming, especially for first-time homebuyers.
To streamline the homebuying process, this guide compiles the tips first-time homebuyers need to know, from prequalification to closing and every step in between.
Step 1. Analyze Finances to Set a Budget
It is important for first-time homebuyers to assess their finances. This crucial step helps buyers to understand what they can afford in terms of mortgage loan amounts, interest rates, and purchasing price.
Calculate an Affordable Monthly Mortgage Payment
Using a mortgage calculator, borrowers can estimate an affordable monthly mortgage payment, which is one of the most significant expenses of owning a home.
First-time buyers should be prepared to allocate 28% of their monthly gross income towards paying off their mortgage.
A monthly mortgage payment can be calculated with the following:
- Principal Loan Amount: The amount that is initially borrowed.
- Interest Rate: A percentage of the principal amount the lender charges the borrower.
- Down Payment: A percentage of the home’s total or purchase price that’s paid upfront at the time of closing.
- Loan Term: Repayment period or time given to pay off the loan.
If the initial calculation is too high, prospective borrowers can opt for lengthier loan terms to reduce the monthly mortgage payment, however this will result in paying more interest over the course of the loan.
Another way to reduce the monthly mortgage payment is to increase the down payment amount. The ideal down payment to most lenders is 20% of the home’s purchase price.
Lenders will generally charge borrowers Private Mortgage Insurance (PMI) if they can’t place a down payment that’s 20% of the purchase price.
But some institutions offer financing options that bypass these requirements. HRCCU can offer first-time buyers up to 95% financing and no PMI — while still benefiting from competitive interest rates.
Assess Debt-to-Income Ratio & Credit Score
There are a multitude of factors that lenders take into consideration when determining the amount an applicant can borrow.
To determine home loan amounts, lenders look at a borrower’s debt-to-income (DTI) ratio and credit score.
DTI ratio is the total of the borrower’s monthly debt payments divided by their gross monthly income.
Because lenders expect a borrower to spend approximately 28% or less of their monthly gross income on a mortgage payment, the ideal DTI ratio falls between 28% and 36%.
A borrower’s credit score shows the repayment history and credit utilization — determining how much of a risk a lender may undertake should they extend a loan to the borrower.
On average, lenders largely favor borrowers with good credit scores, manageable to low amounts of debt, and a consistent monthly income.
First-time homebuyers who want to maximize their borrowing capacity should take the time to review their financial status within these contexts.
Ensuring your finances are in good standing can help with the next step in the homebuying process — prequalification.
Financial Assistance for First-Time Homebuyers
First-time homebuyers are eligible for certain financial assistance opportunities that are not available to repeat buyers.
Before moving on with the homebuying process, it’s important for first-time buyers to know the financing options that are available to them.
Select financial institutions offer financial programs specifically designed for first-time homebuyers. The first-time homebuyer program from HRCCU, for example, strives to make mortgages more accessible to its members.
With HRCCU, first-time homebuyers can enjoy multiple benefits such as — no application fee, mortgage applications can be completed online, and associated fees like administrative costs are minimal.
First-time homebuyers may also be eligible for government-backed loans from the following organizations:
- Federal Housing Administration (FHA): FHA-insured loans allow for a down payment of as little as 3% of the home’s purchase price for those with a credit score of at least 580.
- United States Department of Agriculture (USDA): USDA mortgages offer low-income, first-time buyers in rural areas the opportunity to take advantage of low interest rates and no down payment.
- U.S. Department of Veterans Affairs (VA): Designed to help current and past military service members or their families buy homes, those who qualify aren’t normally required to place a down payment. Participants can also have a DTI ratio as high as 41% and can receive grants to modify homes for disabilities that were contracted while in service.
Financing a home can be a big expense, but there are many assistive programs to help alleviate upfront or even long-term costs.
Step 2. Prequalify for a Mortgage
Those entering the housing market for the first time may find it to be very competitive. It’s not uncommon for a single property to attract many prospective buyers in a matter of hours after being listed.
To stand out from the crowd, it is important for buyers to prove they are serious and financially prepared to purchase the home. This can be achieved with a prequalification letter.
A prequalification letter is written proof that a lender is willing to extend a certain loan amount if the borrower’s offer is accepted by the home’s seller.
Although not an official mortgage approval statement, a prequalification letter testifies for the applicant’s borrowing power and ability to finance purchasing a home.
In turn, prequalified buyers are favored by sellers and lenders alike. Prequalification also forces first-time homebuyers to organize, analyze, and prepare their finances towards the goal of owning a home.
When entering a significant financial commitment like home ownership, preparedness, and an in-depth understanding of one’s finances is invaluable.
It also can help first-time homebuyers avoid making costly mistakes — like purchasing a home that is above their financial means.
Step 3. Begin the Search
Once a prequalification letter is acquired, first-time homebuyers can begin searching for a property within their budget.
While shopping for a potential home, buyers should consider other factors as well, like the age and layout of the home, the surrounding neighborhood, and any renovations the home may need.
Fixer-uppers, or properties that require a lot of landscaping and renovating, generally have lower purchase prices. This could mean a higher return on the investment should you choose to sell later.
But the cost to flip a fixer-upper into a dream home may be much more than what you’re able to handle or afford. It’s important to keep such things in mind when looking at properties.
At this stage of the homebuying process, first-time buyers may want to consider getting a real estate agent.
A real estate agent can help buyers navigate the market for reasonable selling prices and avoid or negotiate overpriced deals, which can help save the buyer thousands of dollars.
With lifechanging purchases such as a home, having an experienced guide like a real estate agent can help to simplify the process.
Step 4. Get Preapproved for a Mortgage
After finding the right home, it’s crucial to move quickly. Sellers may have their choice of offers, so it is wise to make the offer as enticing as possible.
Including a mortgage preapproval letter can make the offer that much more enticing.
Preapproval holds more weight than a prequalification letter in the homebuying process. Many sellers even make it a requirement for prospective buyers.
A preapproval letter is a written promise the lender makes to the borrower that a loan will be approved should the borrower’s offer be accepted.
To get preapproved, buyers must provide the lender with a completed, official mortgage application, a credit history check, and an estimated down payment amount.
The lender then performs an extensive financial background check to verify the borrower’s information.
After the background information is confirmed, the lender will provide written approval to extend a loan to the applicant. The statement will include borrowing terms, loan amount, and a projected interest rate.
Although this is not an official mortgage approval, a preapproval letter gives buyers more negotiating power with sellers and can help to expedite the closing process.
Step 5. Make an Offer
An official offer can be made once the buyer has their mortgage preapproved. For those working with a real estate agent, this process is relatively straight-forward.
The realtor can help draft an offer letter with conditions that ensure the buyer is protected legally and financially until the deal is closed.
In addition to including the home’s full address and the name(s) of the buyer(s), an offer letter should also contain:
- Purchase Price: This is the amount the buyer is willing to pay for the home.
- Contingencies: These are conditions set out by the buyer that the seller must complete before closing, such as a home and pest inspection of the property.
- Seller Concessions: Closing on a home includes its own set of fees, but seller concessions are closing costs that the seller can agree to cover — helping to save the buyer money.
- Mortgage Preapproval Letter: This is written proof that a lender is willing to extend a mortgage to the borrower so long as the deal is successfully closed. Homebuyers should also save a copy of the preapproval letter for their own records.
- Expected Closing Date: The buyer can propose a date by which the sale of the home must be completed.
- Move-In Date: Buyers can set a date for when they can begin moving into the home.
- Response Deadline: To save time, buyers should include a respond-by deadline for the seller.
There’s a lot of legal and financial conditions buyers should include in an offer to ensure they are getting what they’re paying for.
Having a real estate agent assist in drawing up an airtight letter can help keep the buyer from making an expensive mistake, like overpaying for a home.
Step 6. Prepare to Close
The final stretch in the homebuying process is closing the deal. By this stage, the seller has accepted the buyer’s offer.
But there’s still quite a bit that must be done to complete the transaction.
Firstly, in the interests of both the buyer and seller, an escrow account should be opened.
An escrow account is a bank account opened by a third party, usually either the seller’s or buyer’s realtor.
Held in the escrow account is the money and documents related to the deal, like the purchase agreement, or contract that outlines the conditions of the transactions, and the earnest money deposit.
Also known as the good faith deposit, the earnest money deposit is a sum of money the buyers put down to further demonstrate their serious intentions of purchasing the home.
Before signing anything, however, first-time homebuyers will want a legal aid to review the purchase agreement.
Oftentimes, real estate agents can recommend lawyers who specializes in real estate.
An attorney can analyze the purchase agreement to ensure the conditions are reasonable, like home inspection contingencies, proposed move-in date, and seller concessions.
If problems are found, the buyer and seller can renegotiate the agreement before signing.
Once the document is reviewed and all issues are accounted for, the buyer can sign with peace of mind.
Secure a Mortgage
With the offer accepted and the purchase agreement signed, homebuyers can focus on officially securing a mortgage for the home.
Usually, the purchase agreement allots a certain amount of time for buyers to search for and attain a mortgage.
The types of mortgages a homebuyer can access largely depends on several factors, namely:
- Credit Score: A critical component to getting approved for a mortgage, those with credit scores between 580 and 620 should look into government-insured loans, as conventional loans tend to require a credit score of 620 or higher.
- DTI Ratio: Most lenders extend to borrowers with a DTI ratio that’s below 36% of their gross monthly income, so buyers with a high DTI ratio should prioritize paying off their most sizeable debts.
- Employment History: Proof of a consistent source of income is provided through a borrower’s employment history. Lenders tend to favor borrowers who have held the same job for several years.
- Assets and Income: Bank statements, paycheck stubs, W2 statements, and tax returns can all serve as proof to lenders of a borrower’s financial assets and income.
There are two main types of home loans — a fixed-rate mortgage and an adjustable-rate mortgage (ARM).
Buyers who choose a fixed-rate mortgage will pay an interest rate that remains consistent throughout the loan’s term, even if the current market rate fluctuates.
With an ARM, the interest rate changes over the course of the loan’s term but is initially set below the market rate. As the market fluctuates, so does the ARM.
First-time homebuyers are more likely to upsize to a bigger home as their needs and family size increase, so an ARM is a better choice under such circumstances.
This is because an ARM could save buyers money should they choose to resell within a few years, while the initial rate is still low.
But if a buyer doesn’t wish to resell or favors the predictability of having a locked interest rate, then a fixed-rate mortgage may be preferable.
Get the Home Appraised & Inspected
Before approving a mortgage, lenders will have the home appraised to ensure the property is worth its listed value.
This protects the lender in the event the borrower defaults on the loan and must hand the home over as collateral. Generally, the buyer is responsible for covering the cost of the home appraisal.
If the home is found to not be worth its listed value, the lender can choose to lower the mortgage amount or disapprove the loan altogether, so a home appraisal can make or break the deal.
Acquire Homeowners Insurance & Complete Title Work
In addition to a home appraisal, lenders also need proof of homeowners insurance before approving the mortgage.
On average, the buyer is required to pay several months of homeowners insurance upfront prior to being able to close on the house.
The buyer’s real estate lawyer or realtor then hires a title company to verify the financial background of the home and have it insured. Such activity is called title work.
Buyers should not skip this step, as once the home is transferred to them, any issues like unpaid taxes on the property, become their problem, unless the title work is fulfilled.
Step 7. Arrive on Closing Day to Sign
Homebuyers who have reached this stage in the process have had the property appraised, acquired homeowners and title insurance, secured a mortgage, and completed inspections of the property.
With everything in order, the buyer, seller, real estate agents, and lawyers can meet in person on a specified date — known as the closing day, to sign the paperwork and transfer ownership of the property to the buyer.
Once all the dotted lines have signatures, it’s official. This marks the final step in the homebuying process.
Finance Your Dream Home with HRCCU
The path to homeownership can be long and arduous, but HRCCU provides mortgage options that can help both first-time and repeat homebuyers finance their ideal home.
As a credit union, HRCCU puts the interests of its members first by offering great financing opportunities at competitively low interest rates.
Whether it’s a mortgage for a starter home or unlocking the full potential of your home equity, those who choose HRCCU can borrow with confidence.
To learn more about our financing options or how we can help assist you in purchasing the home of your dreams, contact us today.
