Tips for First-Time Home Buyers

first time buyer

So you’re thinking about buying your first piece of real estate? Or you’re considered a “first-time home buyer” simply because you haven’t owned a property in the past three years. Either way, congratulations! It’s an exciting time…and a nerve-racking one.

But before you even begin to comb through real estate listings and attend open houses, you need to make sure you actually qualify for a mortgage on your dream home. And I hope you took a moment to compare renting to buying just to make sure you’re cut out for it.

The following are some useful tips for both newbies (first-time home buyers) and seasoned home buyers alike who are looking to experience a home loan process with as few surprises as possible. Because those types of surprises aren’t fun.

First-Time Home Buyer Tip #1: Check Your Credit Report and Know Your Credit Scores!

  • Check all 3 of your credit reports from Equifax, Experian, and TransUnion
  • Several months before you apply for a home loan
  • Get all 3 credit scores from these bureaus as well
  • Fix anything that needs fixing ASAP

The first thing any prospective homeowner should do, especially a first-time home buyer, is obtain a free credit report and view their credit scores, either from AnnualCreditReport.com or via a free service of some kind, such as Credit Karma.  Nowadays, a lot of credit card issuers provide genuine FICO scores for free as well. In other words, you shouldn’t have to pay for anything!

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However, it’s important that you see all three of your credit scores because mortgage lenders pull all three and then use the middle credit score for qualifying purposes. You’ll need to know your credit scores from Equifax, Experian, and TransUnion to see the complete picture.

The Annual Credit Report website only provides consumers with free credit reports, which can be extremely helpful, but you shouldn’t apply for a mortgage without knowing your credit scores as well.

Put simply, you’ll need to get your hands on both your credit report(s) and your credit scores to ensure you know where you stand and to determine what your monthly liabilities are.

By liabilities, I mean things like credit cards, auto loans/leases, a current mortgage you have and will keep (if any), and any other loans that have a corresponding monthly payment.

Once you’ve got your credit report at your fingertips, you’ll need to determine what all those monthly expenses are. You will see a monthly payment next to each liability on your credit report. Add up all those payments and jot them down somewhere. This total and will be important when determining how much house you can afford.

While you’re at it, scan the credit report for derogatory accounts and clean them up as best you can. If you’ve got delinquent accounts, resolve them. If you see collections/charge-offs, call the associated creditors and ask to get them removed (or dispute them online). If everything looks good, you can move on. If not, you may want to work on your credit before applying for a mortgage and attempting to buy a house.

A credit score of 620 or higher is the recommended minimum you’ll need before beginning your property search, though there are FHA loans and other loan types that accept lower scores. Just know that the lower your credit score, the higher your mortgage rate, assuming you are able to qualify at all.

And as noted, mortgage lenders use the mid-score, so if your credit scores are 620, 580, and 610, they’ll use the 610 score for qualification purposes. So check your credit with all three bureaus!

*Important note: Do NOT open any new credit accounts of any kind or make any large purchases using your credit cards prior to or while applying for a mortgage. This includes buying that 4k OLED TV using a Best Buy credit card for your new crib. Doing so could tank your credit scores, resulting in a higher mortgage rate or potentially even a late stage denial. Wait until your loan funds to furnish your home!

First-Time Home Buyer Tip #2: See What You Can Really Afford

  • Learn how lenders calculate affordability
  • Get to know your DTI ratio
  • Use an affordability calculator
  • Consider down payment, closing costs, and reserves

Now that you’ve got your credit in order, it’s time to figure out how much house you can afford. This will be dictated by both the purchase price and those monthly liabilities we talked about.

Most banks and lenders allow borrowers to have a debt-to-income ratio up to 43%, though that number can vary based on the type of home loan and by lender. Read more about debt-to-income ratios.

If you take your total liabilities from your credit report and add them to your proposed monthly housing payment, then divide that number by your monthly gross income, you’ll come up with your DTI ratio.

Let’s look at an example:

$10,000 monthly gross income
$1,500 total monthly liabilities

We know from the above example that your total monthly payments including the new mortgage can’t exceed $4,300, or 43% DTI based on your $10,000 gross monthly income.

So if you already have $1,500 in total monthly liabilities thanks to auto loan and some credit card debt, you can add a housing payment of $2,800 a month.

Let’s look at the same example with the proposed housing payment, including property taxes and homeowners insurance, based on current mortgage rates:

Loan Scenario:

$300,000 purchase price
$240,000 loan amount
4.25% interest rate

Monthly Mortgage Payment:

$1,180.66 mortgage payment
$312.50 monthly taxes
$85 monthly insurance
$1,578.16 total monthly housing cost

In the above scenario, a prospective homeowner making $10,000 in gross monthly income can easily afford a $240,000 loan, factoring in the property taxes, homeowners insurance, and their other monthly liabilities.

They would have a DTI ratio around 31%, which is great because it’s well below the maximum, and also provides a buffer in case mortgage rates rise from application to rate lock, or if any estimates wind up running higher than expected. This happens frequently.

Always make sure you leave some room and don’t buy more house than you afford. Aside from financing costs, homes come with a lot of maintenance. Keep those in mind and use a cost calculator to factor in things like gardening, utilities, pool service, etc. into the equation.

For the record, I used a 20% down payment in the example above. Many first-time home buyers come in with significantly less. As such, their mortgage payment will be higher for a variety of reasons.

If you put down less than 20%, you’ll have to pay mortgage insurance, your loan amount will be larger (obviously), and your mortgage rate will probably be higher as well (to compensate for additional risk).

For example, FHA loans require just 3.5% down payment, but carry both an upfront mortgage insurance premium and an annual premium. Fannie Mae and Freddie Mac have similar loan programs that require an even lower 3% down payment.

So your DTI can easily shoot higher if your down payment is minimal, greatly limiting how much you can afford. Consider that when determining an appropriate purchase price. A mortgage calculator worth its salt will include all these potential costs.

[See: Mortgage Affordability Calculator]

A lot of prospective homeowners out there live paycheck-to-paycheck and have very little set aside in savings. In the eyes of banks and lenders, this simply isn’t good enough. If you want to borrow a few hundred thousand dollars, be prepared and set realistic expectations.

You should be able to afford the fully-amortized mortgage payment, and any payment increase if it’s an adjustable-rate mortgage. Otherwise, you’ll need to lower your loan amount and do better to live within your means.

So now you’ve got an idea of what you’ll be able to afford. There are a number of mortgage calculators out there that will give you a better idea of what you can qualify for.

It’s also important to budget for closing costs, while leaving an emergency fund in place to ensure monthly mortgage payments can be made if/when something unexpected comes up.

[Which mortgage is right for me?]

First-Time Home Buyer Tip #3: Prepare to Document Rental History and Assets

  • Make sure you can document rental history
  • For the most recent consecutive 12-month period
  • Be sure your assets are seasoned for at least 2 months
  • And in verifiable accounts that you are willing to share with the lender

Now that you’ve got your credit profile in check and you know what you can reasonably afford, you’ll need to make sure you’ve got a verifiable housing history and seasoned assets.

Most lenders will ask that you verify your previous 12 months housing history. You can do this with cancelled checks or a VOR (Verification of Rent) from your landlord. This is important to determine the payment shock effect (if any) on the borrower.

Liquid assets, such as those readily accessible in a checking or savings account, are always helpful when applying for a home loan, and are almost always a necessity for a first-time home buyer.

However, funds in a retirement account such as a 401k or Roth IRA may also work. Make sure you have savings to cover at least two months PITI (principal, interest, taxes and insurance for the proposed mortgage payment), down payment, and closing costs available.

Also make sure the money has been in a verifiable account for at least two months to ensure it is seasoned. Banks and mortgage lenders don’t give any weight to unseasoned assets, as any friend, relative, or even an unscrupulous mortgage broker or mortgage loan officer could easily dump money into your account before you apply for a mortgage to boost your net worth. Same goes for mattress money, it won’t fly!

It’s also important to sock away money for your down payment in that same savings account several months, or even years, in advance. Most prospective home buyers have difficulty saving enough for the down payment, and sometimes miss out on their dream home as a result. So saving early and often is key to achieving the dream of homeownership.

You may also be able to use gift funds from an acceptable donor to cover your down payment, closing costs, and even reserves.

Now that you’re prepared, it’s time to be vigilant and proactive. Avoid predatory lenders and do your interest rate homework. Check out a rate sheet from the bank or lender that you’re being quoted from. Ask what the interest rate adjustments are if you’re looking beyond fixed rates. Ask if the loan carries a prepayment penalty and for how long? Get all the facts from your broker or loan officer before you sign anything. And once you like it, lock it!

[How to find the best mortgage rates.]

With all this preparation behind you, the loan flow should be a comfortable process with few surprises. It might not be perfect, but if you follow these rules and study up on how mortgage loans work, you should save some money and reduce stress!

The Definition of a First-Time Home Buyer

  • There are different definitions
  • But Fannie and Freddie consider a first-time home buyer
  • An individual who hasn’t owned a residential property in the past 3 years
  • Displaced homemakers and single parents may also qualify as first-time home buyers

One final note about first-time home buyers. As I alluded to up above, some entities, like Fannie Mae and Freddie Mac, define first-time home buyers as those who haven’t owned (sole or joint) a residential property during the three-year period preceding the date of the home purchase in question.

This means you can be a previous homeowner who just hasn’t owned for a few years, and take advantage of programs intended only for those buying their first home. So if you sold your old home three years ago, you might qualify as a first-time home buyer today.

Additionally, Fannie Mae considers displaced homemakers or single parents as first-time home buyers if they had no ownership interest in a principal residence (aside from joint ownership interest with their spouse) during this preceding three-year time period.

So if you just recently went through divorce, or another life event happened, it’s possible to earn the first-time buyer distinction even if you recently owned a home.

What types of mortgage loans are available to first time home buyers?

  • Conventional loans such as those backed by Fannie Mae and Freddie Mac
  • Government loans such as FHA, USDA, and VA loans
  • Proprietary loan programs offered by individual lenders and credit unions reserved solely for first-time home buyers
  • Down Payment Assistance Programs from state Housing Finance Agencies

As a first-time home buyer, you basically have access to the widest array of loan programs available, including those restricted just to first-timers.

This means you can apply for a conventional loan, such as those backed by Fannie Mae and Freddie Mac, including the 3% down payment loans offered by the pair.

Same goes for government loans including FHA, USDA, and VA.

Additionally, select lenders offer special financing to first-time home buyers, so you’ll have access to those loan programs as well.

Finally, you may also be able to take advantage of Down Payment Assistance (DPA) for down payment and closing costs via your state’s Housing Finance Agency.

In other words, you’ll have plenty of financing options if you’ve never owned a home before. Just make sure your credit score is in good shape and that you qualify otherwise to ensure you aren’t shut out.

The one caveat is that you might have to complete first-time home buyer education if you apply for one of these programs. But it’s generally a pretty short and easy course, and should make you a better borrower!

Key tips for first-time home buyers in review:

  • Order a free credit report AND view your three credit scores
  • Review your credit report and clear up any derogatory accounts
  • Do NOT open any new credit accounts or make any large purchases before/during the loan process
  • Calculate your total monthly bills/liabilities
  • Determine how much you are able to put down
  • If you put down less than 20% you will have to pay mortgage insurance
  • Figure out your DTI and subsequently what you can afford
  • Make sure you have a 12-month verifiable housing history
  • Make sure you have a seasoned asset account with at least 2 months PITI
  • Set aside money for a down payment and closing costs in a verifiable account in advance
  • Decide what loan type or loan program best suits you
  • Get pre-approved for a mortgage and obtain a pre-approval letter
  • Shop around with multiple banks and lenders, not just the one that pre-approved you
  • Compare mortgage rates extensively
  • Lock your mortgage rate when you’re satisfied to ensure it doesn’t increase
  • Get a better understanding of mortgage closing costs so you know what to expect in the way of fees
  • Breathe!

Read more: How to get a mortgage.

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