Are you looking to buy your first home? If you are, we’ve prepared this eight step complete guide to buying a home, to help you along the way. To make sure the guide is completely comprehensive, we’re including extensive sections on both the financing part of the process, as well as home selection and closing.
By the time you’re finished reading this guide, you’ll have everything you need to know to work through the home buying process with a minimum of stress.
Step 1: Get Your Finances in Order
Buying a house is a major undertaking, one that should never be taken casually. There are a number of factors that can affect your ability to qualify for a mortgage, and it’s always best to get those in line before you even look at properties.
- Get a copy of your credit report. You can get one from each of the three major credit bureaus (TransUnion, Equifax and Experian) for free at a site called AnnualCreditReport.com. Go over your credit report carefully, and make sure all the information on it is accurate. If you find errors, dispute them before applying for a mortgage.
- Pay off some debt. Mortgage lenders will include your fixed monthly debts when calculating the mortgage you qualify for. If you have too much debt, work to pay it off before you apply.
- Get your income documents together. Lenders will need copies of your most recent pay stubs, W2s for the past two years, copies of recent bank statements, and copies of your most recent tax returns if you are either self-employed or earn a significant amount of commission income.
- Get your down payment money together. Lenders carefully track money movements once you apply. Make sure you’re certain where your down payment funds will be coming from. It’s always simplest to have the necessary funds in one bank account, because it results in easy verification and no questions. You can also do a rough estimate of how much money you’ll need. For example, if you plan to purchase a $300,000 house, and you want to put 20% down to avoid private mortgage insurance (PMI), you’ll need $60,000 (if you don’t know what PMI is, don’t worry – we’ll explain everything you need to know about it later in the article).
By taking each of the above steps in advance, you’ll be better prepared for the mortgage financing part of the homebuying process.
Step 2: Sit Down with a Mortgage Lender
Naturally, you can skip this step if you’re able to pay cash for the full purchase price of the home. But if you need financing (let’s face it, mos of us do), you’ll need to work with a mortgage lender before you even start looking at homes.
The purpose of meeting with the lender is primarily to get a mortgage pre-approval. That will not only determine how much financing you qualify for, but it will also let you know what conditions you’ll need to meet before closing.
Even more important, a mortgage pre-approval is often a requirement by real estate agents. They want to know you’re a qualified buyer before they even begin working with you. It’s even more important once you decide to make an offer on a property. The seller will also want to know you’re fully qualified to purchase the home, so that he or she is not wasting their time in a transaction that will never close.
The mortgage pre-approval process will work something like this:
- You’ll provide the lender with your name, address, and Social Security number. They’ll use this information to run a credit report.
- They’ll generally ask for income documentation, including recent pay stubs and W2s.
- Armed with the above information, they can make a reasonable determination on how big a loan you’ll qualify for, and approximately what the rate and terms will be.
The lender can then issue a written pre-approval letter, which will typically have an expiration date of 30 days. It’s important to realize that a pre-approval is not a final approval. It will likely include several conditions that you will need to meet before closing, such as providing evidence of down payment funds, and obtaining a property appraisal.
Step 3: Select a Mortgage Program
There are three basic types of mortgages you may qualify for: FHA, VA and Conventional. Here are the specifics of each:
|Mortgage Type||Best For|
|FHA Mortgage||People who don't have much money to put down payments|
|VA Mortgage||Qualified active duty military personnel and veterans|
|Conventional||People who have strong credit and high incomes|
These are mortgage is that are insured by the federal government through the Federal Housing Administration. They are generally best for people who have small down payments, since they permit down payments as low as 3.5% of the purchase price. They also tend to be more flexible with credit issues.
The maximum loan amount for 2018 is $453,100, but it can be as high as $679,650 in certain high-cost counties.
FHA charges two types of premiums for mortgage insurance. The first is upfront mortgage insurance premium, which will be 1.75% of the loan amount in most cases. If your mortgage amount is $200,000, the premium will be $3,500. However, this amount will be added to your loan amount, which means you’ll pay it over 30 years.
The second is the monthly mortgage insurance premium, which will be included in your monthly mortgage payment. For most mortgages, this will be 0.85% per year. That will be $1,700 per year on a $200,000 loan, or $141.67 per month.
In many respects, VA mortgages are the best deal in real estate financing. They’re only available for qualified active duty military personnel and veterans. But they offer 100% financing on purchases. That means you automatically have a 0% down payment requirement.
The general maximum VA loan limit is $453,100 for 2018. However, there are more than 200 counties in the US, classified as high cost areas, where loan amounts can be considerably higher.
Like FHA mortgages, VA loans also have an upfront mortgage insurance premium. But with VA mortgages, it’s referred to as the VA Funding Fee. Just as is the case with FHA upfront mortgage insurance premiums, the VA funding fee can be added to the mortgage amount, and financed over the life of the loan.
The most common VA Funding Fee rates are as follows.
Purchases, 100% financing:
Regular Military: 2.15% of the loan amount for a first-time use, 3.3% for subsequent uses.
Reserves/National Guard: 2.4% for first-time use, 3.3% for subsequent uses.
In addition to the zero down payment requirement, VA mortgages have another advantage over both FHA and conventional mortgages. They don’t require a monthly mortgage insurance premium. That means you’ll have a lower monthly payment for a mortgage of the same amount.
These loans are referred to as conventional mortgages because the mortgage insurance requirement does not involve coverage from either the FHA or the VA. Instead, mortgage insurance coverage comes from private insurance companies.
Conventional financing is typically funded by two quasi government agencies, the Federal National Mortgage Association – FNMA or “Fannie Mae” – and the Federal Home Loan Mortgage Corporation – FHLMC or “Freddie Mac”. But as is the case with both FHA and VA mortgages, you’re not actually dealing with the agencies when you take a mortgage. Instead, you’re actually applying through a bank or mortgage company.
Conventional mortgages are generally better for people who have stronger credit and higher incomes than would be the case for an FHA loan. They would also be for purchasing investment property or second homes, since neither property is eligible under FHA or VA financing.
Conventional mortgage amounts are the same as they are for FHA, $453,100 in most areas, but up to $679,650 in certain high cost areas.
Conventional Mortgage Insurance
Conventional mortgages also have a different mortgage insurance arrangement than either FHA or VA. Unlike FHA or VA, they don’t have an upfront mortgage insurance requirement. But unlike the VA mortgages, they do have a monthly requirement. This is referred to as “private mortgage insurance” or PMI.
The calculation of PMI for conventional mortgages is more complicated than it is for FHA. As you’ll see in the screenshot below conventional PMI premium rates vary by different factors, including:
- Loan term
- Fixed or adjustable rate mortgages (ARMs)
- Your credit score (this is another compelling reason to have the best credit score possible before applying for a mortgage)
(Source: MGIC Rate Card)
Let’s work an example based on a $300,000 mortgage, assuming a 5% down payment (95% LTV), on a 30-year fixed rate loan with a credit score between 700 and 719.
If 30% coverage is required, the annual premium factor will be 0.78%. The annual premium will be $2,340 ($300,000 X .0078), or $195 per month, which will be included in your monthly mortgage payment.
Funds to Close
Unless you’re going for a VA mortgage, you’ll need to have the down payment available for the property. But you’ll also have to pay closing costs and escrows.
Closing costs generally range between 2% and 4% of the mortgage amount. They can be paid in one of four ways:
- By you
- By the seller (as “seller paid closing costs”, which are an inducement for you to buy the home)
- Split between you and the seller
- By the lender, who will pay the closing costs in exchange for a slightly higher interest rate on the mortgage (this is a common arrangement)
Closings costs include:
- Loan origination fee – generally 1% of the loan amount
- Application or appraisal fee
- Title search
- Title insurance
- Attorney or title company closing fee
- Miscellaneous fees by either the lender or closing agent
Escrows – called prepaid expenses in the mortgage universe – can vary by dollar amount, depending on the location and value of the property. They include:
- Real estate taxes, generally three months but it can vary
- A one year paid-up homeowner’s insurance policy
- Two months homeowner’s insurance premiums
The purpose of the escrows is so that the lender can collect required taxes and insurance in advance of payment due dates. These are generally paid by the buyer, but they can also be financed through the lender, again in exchange for a slightly higher interest rate on the mortgage.
Mortgage Loan Terms
There are two primary types of mortgage terms, fixed rate mortgages and Adjustable Rate Mortgages.
Fixed Rate Mortgages
Fixed rate mortgages are just what the name implies. Terms can range anywhere from 10 years to 30 years, and both the rate and the monthly payment will remain fixed throughout the term.
Adjustable Rate Mortgages (ARMs)
ARMs come in different varieties. The most common are the 5/1, 7/1 and 10/1 ARMs. The first number indicates the fixed rate term of the loan. For example, on a 5/1 ARM, both your interest rate and monthly payment are fixed for the first five years. Once that term is up, the loan converts to a one year adjustable.
Adjustments are based on a predetermined index, plus what is known as a “margin” – which is a markup on the index. ARMs have what are known as “caps” – limits to how high your loan can adjust.
For example, there may be a 2% cap on the first adjustment. If the initial rate is 4%, the rate won’t be able to is exceed 6% on the first adjustment. Typically, there will also be a 2% cap on subsequent adjustments. The second adjustment then can go no higher than 8% (4% + 2% on the first adjustment, + 2% on the second). ARMs also have lifetime caps. It’s usually 5%. If your initial rate is 4%, your loan rate can never go higher than 9%, even if market rates go all the way to 15%.
Fixed Rate Mortgages vs. Adjustable Rate Mortgages (ARMs)
If you plan on staying in a home for a long time, like at least 10 years, the 30-year fixed is the better choice. It removes any risk of significant interest rate and payment increases.
If you plan to be in a home no more than five years, you might want to take advantage of the lower rate offered on a 5/1 ARM.
Qualifying for a Mortgage
To qualify you for a mortgage, lenders use what are known as debt-to-income (DTI) ratios. There are two ratios calculated. The first is based on the new house payment itself, and the second is the new house payment, plus non-housing fixed debt.
Each ratio is calculated by dividing the debt number into your stable monthly income. If your income is $5,000 per month, and the new house payment is $1,200, your housing ratio (also called the “top ratio”) is 24% ($1,200 divided by $5,000).
If you also have $600 per month in recurring debt, that will be added to your $1200 new house payment, for a total of $1,800. Your total debt ratio is 36% ($1,800 divided by $5,000).
As a loose guideline, lenders adhere to ratios of “28/36” – no more than 28% of your income should go toward the new house payment, and your total DTI shouldn’t exceed 36%. However, those are just general guidelines. Lenders may exceed them if you have compensating factors, like excellent credit, or substantial liquid assets in reserve after closing.
To drill down a little bit deeper, your new monthly house payment includes the following components:
- Principal and interest on the new mortgage
- Real estate taxes, prorated monthly
- Monthly PMI
- Monthly homeowner’s insurance
- Homeowner’s association (HOA) dues, if required
- Other fixed housing costs, like flood insurance, earthquake insurance, or special assessments, prorated on a monthly basis.
Debts that will be calculated into the total DTI includes:
- Car loans
- Student loans
- Credit cards
- Child support or alimony
- Court-ordered payments, like wage garnishments
- The monthly carrying costs on other real estate owned
Once you’ve gotten everything taken care of up to this point, it’s time to start looking at properties.
Step 4: Do a “High Altitude Search” of Prospective Properties
You can think of this as the education stage. Before you actually begin looking at properties, or working with a real estate agent, this is where you become familiar with the types of homes you want to focus on. At this point, you have your mortgage pre-approval , and your down payment, so you know exactly what your price range is.
Fortunately, with the Internet this is easier to do than ever. Websites like Realtor.com and Zillow.com make it easy to look at dozens of neighborhoods and hundreds of houses from the comfort of your own home.
You can zero in on several properties, or certain neighborhoods, which will also make the search a lot easier when you do begin working with a real estate agent.
Step 5: Choose a Real Estate Agent
Sellers often prefer to sell their properties without using a real estate agent. They expect to reap a higher return without having to pay a real estate commission. Because you’re the buyer, you’re not paying the commission, so using a real estate agent is usually the better strategy.
A real estate agent will have access to properties for sale through the local multiple listing service. They’ll also be able to help you narrow down your search for specific properties.
But perhaps most important, a real estate agent acts as a valuable go between during the often tense negotiating phase.
Once you select the home you’re interested in making an offer on, you give the terms to the real estate agent. The agent prepares the offer and any other necessary documents, then presents them to the agent representing the seller.
Back and forth negotiation takes place between agents, rather than face-to-face with the seller. This is important, because there are many different details, including sale price, seller paid closing costs, repair costs, and even certain items that may or may not be included with the property.
By using an agent, you’re relieved of the burden of having to prepare crucial real estate documents and negotiating directly with the sellers.
Step 6: Submit Earnest Money Deposit, Order a Home Inspecting, and More
Along with your purchase offer on the property, you’ll have to submit what’s known as an “earnest money” deposit. Depending on what’s customary in your area, this can be anywhere from $500 to several thousand dollars, and it will represent part of the down payment.
At this point, you should begin to formalize the mortgage process. You already have a pre-approval, so you’ll need to submit a formal application, and then supply any documents required by the lender. Do this as quickly as possible, just in case there any snags along the way. In a best case scenario, you’ll want to have a fully approved mortgage at least two weeks before the closing.
One of the most important steps however is to order a home inspection. This is a cost you will have to pay, and it’s well worth paying. It can range anywhere from $200 to $500, depending on the area and the value of the home. A professional inspector will inspect home for structural soundness, component functionality, code compliance, and any issues affecting safety and livability.
You’ll be provided with a formal home inspection report. Pay close attention to everything in it, and be prepared to negotiate needed repairs or cost reductions through your real estate agent.
The mortgage lender will also order an appraisal on the property, to determine its market value. Then they will order an infestation report, primarily to determine if there are any termite infestations or related damage. They also order a certificate to determine if a property is located in a flood or earthquake zone.
Step 7: Prepare for the Move
This is generally the most complicated part of the home buying process. After all, you’re basically moving your entire life from one home to another.
Unless you’re doing a self-move, select a reputable moving company. It’s best to get personal references, as well as to check ratings and complaints on the web. You can go to sites like Yelp, but also check more official sources, like the local Better Business Bureau.
Get estimates from several companies, to make sure you’re getting the best deal. Also, be sure that the moving company will transport all your possessions. Some put limits on certain items, like house plants, so you’ll need to be aware of those limitations.
Step 8: Close
This is the home stretch. If you successfully completed all the steps above, the closing should be nothing more than a signing ceremony. It should take nothing more than an hour, but it could be longer if there are complications.
Either the real estate agent or the mortgage lender will schedule the closing. It will take place at the office of either a title agency or an attorney. They will handle the preparation of all documents related to the closing.
As the buyer, you’ll be signing most of the documents at the closing, so you should arrive at the closing a little bit early.
You’ll also need to bring the funds for closing. This will generally require a certified check made payable to the closing agent, who will disburse the funds – including the mortgage funds – to the seller at the conclusion of the closing.
Once the documents have been signed, and the closing is over, you’ll receive the keys to your new home, and you’ll be ready to move in.