Created with the help of our mortgage loan experts and lending partners, the home.loans team has compiled the ultimate guide to buying a home. Though designed for first-timers, we strongly believe that anyone in the market for a new home should start with this guide. That's how confident we are that it will be your most valuable resource before, during, and even after the home buying process.
Begin your home buying journey armed with the knowledge and confidence needed to get the home you've been dreaming of, with just the right rate for your new home loan.
Prepare for the Home Buying Process by Organizing your Financial Profile
The first thing prospective home buyers should do is establish and organize their financial profile. Knowing the exact state of your finances takes a little work, but in the long run, getting properly acquainted with your financial profile is key to a successful home purchase. To better understand your financial position, there are a few things you should get together.
Understanding Your Credit
Your FICO credit score is the most important number you'll be asked for during the entire process. So, what is a credit score?
A credit score is basically a numerical value between 300 and 850 that represents a person's creditworthiness based on all available credit and debt files associated with that person. The scale is divided into levels that dictate the strength of your credit. These credit levels are typically broken down as follows:
Credit Score Breakdown
|Bad Credit||Below 600|
You can check your credit score by using a couple of different methods:
- The first (and most common) way to check your credit is through one of the major credit reporting bureaus, like Equifax or TransUnion. These sites provide "hard pulls" of your entire financial history, not just your credit score. Important note: Hard pulls require authorization and can actually lower your credit score. So, this type of inquiry is not recommended for borrowers who are unsure of their general credit standing.
- The second method is to use a website like Credit Karma. These smaller credit check options are considered "soft pulls" and are typically part of a larger background check. Because of this distinction, soft pulls don't show up on your credit report. By extension, they don't affect your credit score in any way. Using a soft pull method is always recommended for first-time home buyers who are also checking their credit for the first time.
When you get the results of either the hard or soft pull, the first thing to do is review the report for errors. Check it against any personal records you may have to ensure that there are no discrepancies. In particular, make sure that:
- All personal information is correct.
- Any credit applications are accurate.
- The dates on the credit report are correct and dated no earlier than seven years ago.
- Any late or unpaid payments are accurate and match your records.
If your credit report checks out, then you can count on the accuracy of the credit score provided to you. Many loan products have different credit requirements, so be aware of your credit score throughout all home loan processes.
If your credit score isn't at the desired level, there are a few ways to boost it by a few extra points. Note that these methods take time, and there really isn't a quick fix for poor credit. But, if you're looking to buy a house, taking your time is one of the best things you can do to ensure that you're happy with the mortgage agreement you end up with. Credit scores can be boosted by:
- Making debt payments on time, and never missing a payment
- Paying more than the minimum payment amount
- Having a decent mix of debt obligations (i.e., car loan, credit card, store credit, etc.)
- Paying off debts
- Keeping a low balance on any open credit lines to lower your debt-to-income ratio
Your credit score can be your best friend or your worst enemy when buying a home. We advise that you take all the time you need to understand and boost your credit score as much as possible before beginning the home buying process.
Know Your Budget
With your credit figured out, the next most important thing in building your financial profile is to find out how much house you can afford within your budget. To do this properly, first create or outline your monthly budget. A good budget details the following:
- Cost of living – Expenses like groceries, clothing, and transportation fall under this category.
- Non-discretionary expenses – All of the debts and bills you're required to pay, like electricity, medical expenses, phone service, rent, auto loans, etc.
- Discretionary expenses – The little things you choose to spend money on add up. Try to figure in an estimated amount that you spend on yourself or others each month.
- Savings – Any money you put aside for the future; if you don't have anything to put in this category, you should definitely start before buying a home!
Being able to see where your money goes, and how much money you have to use for mortgage payments, is truly helpful for figuring out how much money you can afford to borrow.
Start Saving Money
With a good idea of what your budget looks like, you can begin planning for your big home purchase.
There are some amazing home loan options on the market that boast zero down payments or low closing costs. So, it's easy for first-time home buyers to believe that all they need to buy a new home is good credit. But we at home.loans strongly recommend that any home buyer (first time or otherwise) begin saving money for down payments and closing costs before they begin shopping around for a home loan.
It is possible to get a home loan with zero down payment or low closing costs. But, it's also very unlikely that you'll be getting the best possible rates or loan terms. The safest bet is to plan accordingly, and save up for a down payment of between 5% and 20% of the house you're planning to buy—as well as between 2% and 5% for closing costs.
No one likes to pay large amounts of money out of pocket, but a good down payment helps to show lenders that you're a low-risk borrower who'll make payments on time, and who deserves better rates. Paying closing costs up front prevents those fees from being rolled into your total loan amount and raising your monthly payments.
How Much House Can You Afford?
Knowing your budget is mainly to help you determine just how big of a mortgage loan you can afford. Remember that mortgages are long-term loans; while no one can see the future, it's always a smart move to plan ahead for it. Home loans can easily be the largest monthly payment an individual or household is required to pay. When determining the affordability of a home, there are a few key things to look at:
- Income – The amount of money that you make regularly is the first thing you want to establish. This includes wages and income from any investments you've made.
- Expenses and debts – Add all of your unavoidable monthly expenses. Include cost-of-living expenses, all of the bills you pay, any credit lines you're responsible for, and all other outstanding debt obligations.
- Savings – Money that has been or can be put aside. This would be used to cover the upfront fees like closing costs, mortgage insurance premiums (MIPs), and the down payment where applicable.
- Credit – Your credit profile greatly affects the interest rate you're eligible for, which in turn affects the monthly payment you're required to make.
When you've accounted for all of the above, it becomes a matter of simple math: subtract your total monthly expenses and debts from your monthly income, and see what's left over.
Whatever home loan agreement you choose, this is the amount that you have left over each month to make your principal and interest payments.
Luckily, using home.loans makes these calculations a bit easier. While browsing available loan programs and rates through our site, all you have to do is input the necessary data into our nifty mortgage calculator. You'll find out whether your prospective monthly payments can be comfortably subtracted from this amount.
How Lenders Look at Your Budget
Lenders use the same information in a slightly different manner. They'll take the above figures and use them to calculate a borrower's debt-to-income ratio (DTI). Your DTI is calculated by dividing your total monthly expenses and debts by your gross monthly income. The result represents your debt-to-income ratio, which is expressed as a percentage.
Generally, lenders use what's known as the 36% rule when considering your loan eligibility in relation to your DTI. The 36% rule stipulates that your total debts shouldn't exceed 36% of your monthly income. While some lenders can still offer competitive rates for borrowers with DTI ratios of up to 43%, the golden DTI ratio is any number below 36%.
Any money that fits into the savings category is your available out-of-pocket cash. You may not need to come out of pocket depending on the loan program, but it's never a bad idea to make a down payment when you can afford to do so. Also, most loan programs incur closing costs that you won't want to be rolled into your principal amount. (That will only increase your monthly payment obligation.)
Another factor to account for in your budget is mortgage insurance. Though not all loan programs require it, many do. MIPs are mandatory for FHA loans, while most conventional loans require private mortgage insurance (PMI) when the expected down payment of 20% isn't met. Either way, mortgage insurance can be a costly addition to any mortgage loan and, by default, increase your monthly expenses.
As for credit, that's mostly scrutinized by lenders as they try to determine the rate of interest that you're eligible for. Having bad credit may even cause lenders to require that you pay mandatory mortgage insurance on top of the monthly loan payments.
Preapproval for Your Home Loan
While optional, getting preapproved for your home loan can be extremely beneficial for a first-time home buyer. A mortgage preapproval letter is basically a document originated by a lender after evaluating your financial profile. It states the amount you're eligible to borrow for your home loan. Many home buyers skip this step, but a preapproval letter is nothing to take for granted! It's especially invaluable when searching for your future home.
Having a preapproval letter lets lenders know just how serious you are about buying a home. It may even give you priority over prospective borrowers without preapproval letters. Lenders will also be able to give you more personalized quotes that fit your needs much more accurately. Plus, you'll know that the rates you ultimately choose won't break the bank in any way. It's a win-win!
The only drawback? The lender that performs the financial evaluation will most likely need to utilize a hard pull of your records, which will affect your credit score.
documents needed for a mortgage preapproval
Getting a preapproval letter requires a lender to scrutinize your financial history. To do this correctly, lenders often need the borrower to provide the necessary documentation. This includes but isn't limited to:
- Personal information (driver’s license, address, Social Security number, marital status)
- Recent statements from bank and investment accounts (usually the most recent 2 years)
- Employment information
- Recent pay stubs and W-2 income tax forms for the last 2 years
- Total monthly expenses, including bills paid regularly
- List of any assets (stocks, 401(k), IRAs, bonds, cash) and liabilities (any debt obligations like credit cards, student loans, or car loans)
- Profit and loss statements if you're self-employed
- Income from any rental properties
- If you're using a monetary gift from a relative to help cover the down payment, you must provide a gift letter
Gathering these documents ahead of time will take away tons of stress at closing, as many of these documents are also required for the final steps.
Know Your Home Loan Options
Before you start searching for lenders, familiarize yourself with the various types of mortgage options available. It's great to keep an open mind throughout the home buying process, but that doesn't mean you can't start with an idea of what you want. After all, mortgage loans are long-term affairs. Knowing the different loan programs and interest rate types can only benefit you while shopping around for a home loan.
The first thing you want to do is decide whether you want a fixed-rate mortgage (FRM) or an adjustable-rate mortgage (ARM). No single product is better than the other; it just depends on what you're looking for in your home loan. For those unsure about ARMs and FRMs, here's a quick breakdown …
Typically sold as a "hybrid ARM," adjustable-rate mortgages have a structure that allows the interest rate that you are charged to fluctuate alongside an index rate such as the LIBOR or Constant Maturity Treasury index. With a hybrid ARM, you have an introductory period with a fixed-interest rate that's usually much lower than other loan options. After that introductory period ends, the rate can be assessed by the lender (most likely annually) and reset to match the index rate. Most lenders set interest rate caps that prevent the rate from passing an agreed amount both during the assessment period as well as over the life of the loan.
This is the standard home loan option. A fixed-rate mortgage has an interest rate that doesn't change throughout the life of the loan. Many borrowers choose fixed-rate mortgages for the simplicity alone. If the average market rate is low at the time of your closing, you could potentially lock in a low interest rate for loan terms of up to 30 years! FRMs enable homeowners to have steady monthly payments that never change.
Loan Products: What Are My Options?
Then, of course, there are the different loan products to consider. Besides the plethora of unsecured conventional home loans offered by lenders, there are a bunch of great home loans programs offered through various sources that might be perfect for you:
Home loans guaranteed by the United States Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) are easily one of the best mortgage options for first-time home buyers. Since these loans are secured by the government, lenders are much more lenient with borrower requirements for FHA loans. First-time home buyers may find low credit requirements and down payments as low 3.5% for FHA mortgage loans.
For United States Military veterans or active duty first-time home buyers, there may not be any better mortgage option than a home loan secured by the United States Department of Veterans Affairs. Servicemembers and their families have access to home loans that require zero down payment or PMI. Lenders are also extremely flexible with borrower DTI requirements.
First-time home buyers that live in more rural areas can turn to home loans secured by the United States Department of Agriculture (USDA). USDA home loans are unique to households that are located within designated areas, and are meant to enrich rural communities by providing viable housing options. USDA loans come with zero down payment requirements, lower required MIPs, and more flexible credit terms than conventional or FHA loans.
While not as common among first-time home buyers, jumbo loans are for home purchases that exceed the national loan conforming limits accepted by Fannie Mae and Freddie Mac. Lenders that offer jumbo loans can set their own eligibility requirements. But, because borrowers interested in jumbo loans tend to have decent credit scores, the interest rates are quite reasonable. Home purchases that require jumbo loans also have dedicated refinancing options available.
With your budget on hand, and your new-found knowledge of the different loan programs available, you're more than welcome to experiment with the home.loans mortgage calculator to see your possible monthly payment amounts.
Choosing a Lender
Armed with the knowledge of the different types of home loans and loan programs, you can now confidently begin shopping around for lenders and the rates that they offer.
A common mistake that first-time home buyers often make is to consult with only one lender. While you may love what the first lender offers, getting a second and even third offer can potentially save borrowers thousands of dollars!
Even with all of the advice and connections we offer, we firmly believe that home buyers deserve to find the best possible mortgage solution tailored to their needs. The only way to find such a great deal is to browse through many lenders until you're sure you've found the one that works best for you.
Remember, every household and situation is different, and what works for some may not work as well for others. Consult with as many lenders as you feel comfortable with, and discuss the loan options that appeal to you. Your best mortgage solution exists, and the home.loans team is here to help you find it!
The Closing Process
If you're sure you've found the perfect deal and the right loan program, then you can move on to the closing phase. Closing can be a lengthy process—but don't worry, you're on the home stretch.
Working closely with your realtor and lender, you'll want to have all of the necessary documentation on hand. Be sure to always have a portfolio with your documents ready during the closing process. For good measure, here's a checklist of the items you should bring:
Closing Documents Checklist
|Social Security card/number|
|Bank statements (last 2 years)|
|Investment statements (last 2 years)|
|W-2 income tax forms (last 2 years)|
|Profit and loss statements (if self-employed)|
|Total monthly expenses, including bills paid regularly|
|List of assets (stocks, 401(k), bonds, cash)|
|List of liabilities (debt obligations, credit cards, student loans, auto loans)|
|Income from Rental Properties|
|Gift Letter (if using gift money for down payment)|
If you went through the preapproval process early on, you should already have these nearby. But you never know what lenders have to double-check or re-evaluate, so it's a smart move to carry them to each meeting.
Hopefully, at this point, you can also provide your down payment if you have one ready. If you've saved enough up to this point, then you're good to go. Alternatively, many loan programs allow the down payment to come from other sources like family or friends (provided that there's a written letter to accompany the monetary "gift").
If none of the above applies, and a down payment is required, there are a few down payment assistance programs that first-time home buyers qualify for, or even a piggyback loan as a last resort. Some lenders offer these piggyback loans at closing as a type of second mortgage to help with the down payment. But, keep in mind that this is only more money that you're expected to pay back monthly—and with a separate interest rate.
The Homeowner's Last-Minute To-Do List
The closing process also includes some activities that should be completed.
Inspection and appraisal.
If it hasn't been done already, now's the time to have the home you're set to buy inspected and appraised. The inspection is mandatory for some loan programs like FHA loans, but it's always a good idea to have it done regardless. Home repairs and renovations can be costly, so it's good to know what you're getting into, and what must be fixed before finalizing the deal and moving in. Aside from that, most lenders want the property appraised to protect their investment, so this too must be done at closing.
Title search on the property.
Another important thing to do would be performing a thorough title search on the property before signing. This ensures that only the seller has a claim on the property. Once papers are signed, it's incredibly hard to fix any mistakes, so be sure that the property you're about to buy is in good standing and is being sold by the rightful party. Title insurance should also be considered, as it covers the homeowner in the case of a loss of property due to legal defects. (It's a rare occurrence, but entirely possible.)
Mortgage insurance should also be taken care of during the closing process. Some loan programs require MIPs as part of the deal, and are set up through the lender. PMI is usually required for conventional loans when a 20% down payment isn't met. PMI is a type of mortgage insurance provided through third-party insurance companies as arranged by the lender.
Once all of these items are completed, the down payment is taken care of (if applicable), and the papers are signed, you are officially a homeowner.