First-Time Homebuyer’s Guide: Part 1
Reality Check
Buying a house is a BIG deal, whether it’s your first or fifth home. Although no two homebuyers or situations are the same, this First-Time Homebuyer’s Guide provides a general formula for successfully navigating the process.
The first step is to honestly evaluate the reasons you want to buy a home. Is it a solid financial decision or a matter of status? If you think it makes sense to make life’s biggest purchase, the next thing to review is your personal financial picture, including your credit score, savings and debt-to-income ratio.
Reality check ----------> Find a mortgage ----------> Find a home ----------> Apply----------> Close
Decide why you want to buy a house
Before you decide to buy a new home, you’ll need to decide why you want to buy a new home. There are a few good reasons and a few bad reasons for seeking home ownership, and taking human nature into account is essential.
Bad reasons
- Optics—At cocktail parties and on dates, “homeowner” sounds better than “renter.”
- Flipping—Generating a profit from buying, improving and selling a property is a risky proposition that even seasoned veterans don’t always navigate successfully.
Good reasons
- Long-term investment—Real estate is generally a good investment, simply because it is a limited resource within an ever-growing population.
- Regular monthly payments—As a renter, you never know if your rent will increase after the lease expires. As a homeowner, you monthly payments are more predictable.
- Creative freedom—As a homeowner, you can decorate, landscape and renovate however you want.
- Being part of a community—If building and maintaining meaningful relationships and feeling a part of the community is important to you, owning a home creates that sense of belonging.
Review your finances
Now that you’ve established why you should buy a new home, it’s time to decide if you should buy a new home. Only you know how responsible you’ve been with money, and whether you can afford the expenses and shoulder the obligations of owning a home. The following 4 factors involved in this decision include:
1. Credit score
- If you pay bills on time or ahead of time, you’ll have a much better chance to be approved for a mortgage and have access to the best rates and products on the market.
2. Savings habits
- When you’re a good saver, it shows lenders you have both the means and solid habits of a wise, responsible borrower.
3. Debt-to-income ratio
- Your income won’t matter if you’re overburdened with debt, even if you make a lot of money.
4. Future expenses
- Are you expecting a child? Do you have a parent or in-law who is sick or disabled? Take time to determine your future ability to pay the mortgage.
Understanding your credit scores
With good credit, you’ll benefit from lower rates, lower costs and less restrictions. To learn more about your credit scores, read on.
How is your credit score created?
Every time you pay off debt, you improve or maintain your credit score. Every time you make a late payment, your credit score suffers. After you submit a mortgage application, don’t impact your score negatively by making big purchases, applying for a credit card or neglecting your bills.
What is FICO and "the three bureaus"?
FICO originally stood for Fair, Isaac and Company, with the ‘and Company’ now ‘Corporation.’ In 1958, engineer William Fair and mathematician Earl Isaac introduced a credit scoring system designed to predict the behavior of borrowers. The system evolved and is now used by the three major credit-reporting agencies: TransUnion, Experian and Equifax.
Why are your credit scores different?
There are a number of possible explanations as to why your scores may vary among the credit bureaus:
- Each bureau may calculate your credit using slightly different methods.
- Some of your credit history may not be recorded by one or more bureaus.
- Lending institutions report to each bureau at separate times.
How can you improve your credit score?
Make timely bill payments so that your credit score moves in one direction: up. Whether it’s a $35 utility or a $17,000 installment on the new yacht, paying after the due date will ding your score.
What credit score should you aim for?
The FICO system is based on a score range of 300 to 850, with 300 the poorest and 850 the best score possible. A credit score of 740 or higher will make a powerful statement to lenders, essentially telling them you’re a sure thing as a borrower.
Should I try to increase my credit score during the home-buying process?
The best thing to do with your credit score when buying a home is to maintain it by paying regular bills on time. Making a big purchase with the intent of building credit could actually have the opposite near-term effect by negatively affecting your debt-to-income ratio. When you’re looking to buy a home, DO NOT make big purchases, open other credit accounts or let monthly bills slip.
Know how much you can afford
Determining the living expenses you can afford per month will give you an idea of your home’s price range. It’s useful to think in terms of worst-case scenarios to give you an idea of what you can handle financially if you suddenly get unlucky.
Budgeting 101
Putting your budget on paper provides a good place to start when figuring out what you can afford. Take your after-tax earnings (called disposable income), add up your payments and outgoing costs (living expenses), subtract the latter from the former, and voilà! One shiny new dollar figure (discretionary income) you can slice up into savings and spending according to your lifestyle.
Homeownership extras
Owning a home comes with expenses that don’t affect you as a renter. Four elements, abbreviated as PITI (mortgage premium and interest, taxes and insurance), make up your monthly payment as a homeowner. Other additional homeowner expenses include closing costs, repairs, landscaping, pool maintenance and HOA fees if applicable.
Murphy’s Law
“Whatever can go wrong, will go wrong.” Murphy’s Law means that as a homeowner, it’s important you maintain emergency funds to account for unexpected problems.
In next week’s First-Time Homebuyer’s Guide…