Tips for First-Time Home Buyers

So you’re thinking about buying your first piece of real estate? Congratulations!

But before you even begin to comb through real estate listing and attend open houses, you need to make sure you can actually qualify for a mortgage. And I hope you actually took a moment to compare renting to buying.

The following are useful tips for both newbies and seasoned buyers alike looking to experience a loan process with few surprises.

Check Your Credit Report and Know Your Credit Scores!

The first thing any potential homeowner should do is obtain a free credit report and view your credit scores, either from AnnualCreditReport.com or via a free trial of some kind.  Some credit card issuers are now providing genuine FICO scores for free.

However, it’s important that you see all three of your credit scores because mortgage lenders pull all three and then use the median score. The Annual Credit Report website only provides consumers with credit reports, which is extremely helpful, but you shouldn’t apply for a mortgage without knowing your credit scores as well.

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

Also 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.

A credit score of 620 or higher is probably the minimum you’ll need before beginning your property search. Just know that the lower your credit score, the higher your mortgage rate, assuming you are able to qualify at all.

*One important note: Do NOT open any new credit accounts or make any large purchases using your credit cards within a few months before applying for a mortgage. This includes buying that plasma screen on a Best Buy card for your new crib. It can drive your credit score down needlessly which will result in a much higher interest-rate.

See What You Can Really Afford

Now that you’ve got your credit in order, it’s time to figure out how much you can afford. Most banks and lenders allow borrowers to have a debt-to-income ratio up to 45%, though that number has probably dropped post-mortgage crisis. Read more about debt-to-income ratios.

By taking your total liabilities and adding it to a monthly housing payment, and dividing 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 can’t exceed $4,500, or 45% DTI based on your $10,000 gross monthly income.

So if you already have $1,500 in total monthly liabilities, you can add a housing payment of $3,000 a month. That doesn’t leave much room in this market.

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

Loan Scenario:
$550,000 purchase price
$440,000 loan amount
6.25% interest rate

Mortgage Payment:
$2291.66 monthly interest-only payment
$572.92 monthly taxes
$128.33 monthly insurance
$2,992.91 total monthly housing cost

In the above scenario, a prospective homeowner making $10,000 in gross income a month can barely afford a $440,000 loan making just the interest-only payment. What does this tell us?

It means there are a ton of homeowners out there living paycheck to paycheck and overstating income to qualify for homes they simply can’t afford, at least in the eyes of banks and lenders that require borrowers to keep their DTI below 45%.

And you should never assume you’re qualified for a mortgage simply by being able to make the interest-only payment.  You should be able to afford the fully-amortized payment, and any payment rise if it’s an adjustable-rate mortgage. Otherwise you’ll need to lower your loan amount and live within your means.

[Which mortgage is right for me?]

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.

Document Rental History and Assets

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

Most lenders ask that you verify your last 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 on the borrower.

Liquid assets are always helpful when applying for a loan, and are almost always a necessity for a first-time homebuyer. Make sure you have an account with at least two months PITI (Principal, interest, taxes and insurance) available.

Also make sure the money in said account has been there for at least two consecutive months to ensure that it is seasoned. Banks and mortgage lenders don’t give much weight to unseasoned assets, as any friend, relative, or even a mortgage broker or loan officer can easily dump assets into your account before you apply for a mortgage to boost your net worth.

It’s also important to sock away money for your down payment 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.

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. Ask if the loan carries a prepayment penalty and for how long? Get all the facts 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 will be a comfortable process with few surprises. It might not be perfect, but if you follow these rules you should save some money and reduce stress!

Let’s review key tips for first-time home buyers in a condensed format:

  • Order a free credit report and view your credit scores
  • Review your credit and clear up any derogatory accounts
  • Do NOT open any new credit accounts or make any large purchases before/during loan process
  • Calculate your total monthly liabilities
  • 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 in a verifiable account
  • Do your interest rate homework
  • Get pre-approved
  • Shop around with multiple banks and lenders, not just the one that pre-approved you
  • Lock your mortgage rate when you’re satisfied to ensure it doesn’t fluctuate

Read more: How to get a mortgage.


24 Comments

  1. Abe July 3, 2013 at 2:40 am -

    The credit-related tips are the most important. You really need to know where you stand credit score-wise before applying for a mortgage. And you absolutely should not apply for any new credit (other than your mortgage) when trying to obtain a mortgage.

  2. Marian July 21, 2013 at 2:57 am -

    This would have been nice to know a few months ago. I opened up a new credit card before I started shopping for a home to put expenses on a 0% APR card so I’d have more cash in my account for a down payment. But my credit score has taken a dive as a result if accruing all that debt.

  3. Jenna July 28, 2013 at 12:43 am -

    How much do you typically need for a down payment as a first-time buyer? Does it differ from what you’d need if you already own a home, or purchased a home in the past?

  4. Colin Robertson July 31, 2013 at 3:21 pm -

    It depends. Most homeowners try to put down 20% to avoid mortgage insurance and obtain a lower interest rate, but plenty of buyers will come in with just 10% down or less. The FHA allows as little as 3.5% down payment, and there are select programs that require even less (or nothing down). It doesn’t really matter if you’re a first timer or not, just that you qualify otherwise based on income, job, credit, rental history, etc. However, there are state programs that offer incentives to first-time buyers, so inquire with a local housing counselor to ensure you don’t miss out on these programs.

  5. Clifford January 10, 2014 at 10:11 pm -

    Great tips! I’m currently looking to purchase my first home and feel a lot more confident now knowing most of these. Hope it makes the closing process a lot smoother. Now if only I could actually find a property!

  6. Stephanie Garcia January 15, 2014 at 8:52 pm -

    What is the easiest type of mortgage to qualify for as a first-time buyer?

  7. Colin Robertson January 16, 2014 at 9:55 am -

    FHA loans have the lowest down payment requirement at 3.5%, but they also have sizable mortgage insurance premiums, which could make it a more expensive option. So be sure to compare all your options from a down payment, qualification, and monthly payment standpoint.

  8. Sue January 17, 2014 at 7:54 pm -

    Thank you for the REALITY check. As I read the First-Time Home Buyer tips I started to laugh at my self because I know better but you get hooked in with the beautiful homes and future vision of living in one of these homes. Also I want to truly Thank you for the more then informative yet easy to understand info regarding this complex process.

  9. Colin Robertson January 17, 2014 at 10:18 pm -

    You’re very welcome Sue. It does get very emotional, which makes a difficult and time-consuming process all the more challenging. But you’ve got to stick to your guns to avoid winding up with too much house/mortgage, or a house/mortgage that isn’t right for you.

  10. Harlan January 30, 2014 at 11:21 am -

    It’s also advisable to pay off credit card debt a few months before the mortgage process if you’ve got a lot of debt. It will improve your credit score and DTI. Just make sure you have enough assets to do so. You’ll need plenty leftover for a down payment and reserves.

  11. Will February 21, 2014 at 2:34 am -

    Are mortgage rates lower or higher for first-time buyers?

  12. Colin Robertson February 21, 2014 at 9:44 am -

    Will,

    There’s no difference, though many lenders offer purchase specials, aka slightly better pricing for purchases as opposed to refinances, whether you are a first-timer or not. There are also special state-funded programs for first-time buyers that might result in lower closing costs or down payment requirements. Be sure to research them in your particular state.

  13. Claudio February 28, 2014 at 7:58 am -

    As you pointed out, it’s extremely important for prospective buyers to look at their TOTAL housing payment, not just mortgage, which is generally much, much cheaper. Mortgage rates are cheap, but insurance and taxes are not. Nor is HOA!

  14. Lhyn March 30, 2015 at 6:51 am -

    If it makes more sense saving a large down payment even if you have to wait longer to buy a home then do so. It would help to know the different loan programs requiring different percentages that will be best suited for you. What a higher or a lower down payment will mean for you can help you decide with confidence.

  15. Brenda May 9, 2015 at 4:01 am -

    2 questions/issues:
    1. My son is a 1st time home buyer and was told that he didn’t have enough credit, ( The only credit he has is from 2 vehicle purchases that he has paid off) — it was suggested he get a credit card — Any other advice?

    2. The house he wants to buy is a fixer upper and is only $45,000.00 – Chase said they would only approve for a mortgage that is greater than $60,000.00 — Are you aware of anyone that approves mortgages for less than $60,000.00??
    Thank You!

  16. Colin Robertson May 11, 2015 at 10:39 am -

    Hi Brenda,

    It can be difficult to get financing on smaller loan amounts like that, so perhaps shopping around a bit more (think credit unions, mortgage brokers) might help. It is also tricky to get a mortgage with very limited credit history, though a lender may be able to use alternative credit like rent, utility, and other bills that don’t show up on a traditional credit report. If none of that works co-signing may be necessary. Also have him look into state housing programs.

  17. Donna May 12, 2015 at 2:25 am -

    I have 20% to put down, but I need my mom to Co sign so I can include her income to mine. I know fha will allow co-borrowers, but is there a conventional loan I can qualify for? It would save me so much not paying that monthly insurance. I’m just wondering what options I might have?I thought Freddie Mac did? I think the loan might have to be manually underwritten. I’ve been reading a lot trying to educate myself, but you can’t always believe what you read.

  18. Colin Robertson May 12, 2015 at 10:26 pm -

    Donna,

    Fannie Mae’s DU (automated underwriting) does not consider the income of a non-occupant co-borrower, and manual underwrites allow a max DTI of 43% using only the occupying borrower’s income. If you want to go conventional, Freddie Mac does allow non-occupying co-borrower income but specific rules may vary from lender to lender.

  19. Donna May 16, 2015 at 12:22 pm -

    Do you know a lender in Maryland that will do conventional loans that allows my mom’s income and not to live in the home. I have 20% to put down and both have good credit. I just need that extra income to get me the amount I need. I don’t want to pay PMI if I don’t have to. FHA will require it for the life of the loan no matter what I put down. Maybe I should get a arm and then refinance in a couple years to conventional and then put 20% down. Do you have any suggestions or know any lenders in Maryland that can help me. Everyone I’ve talked to said conventional won’t allow non occupant Co borrowers. I already have a home I just need to make a decision which way I’m gonna go. I’m trying to save and have the cheapest payment system as possible.

  20. Colin Robertson May 18, 2015 at 2:54 pm -

    Donna,

    I can’t vouch for any individual lenders. Best to do your own research and shop around.

  21. cindy June 29, 2015 at 3:55 pm -

    I have a foster daughter that lived with me from 15-18 years. She is now 30. We were closing on the 25th of June but underwriters needed an extension due to survey issues. They fixed it but now they are saying that we have to have 12 months of cancelled checks. We do have 12 months of deposits but not checks. Also I did sign a VOE. Broker says well I don’t think its going to work because of …..(Yes that will be considered a non arms-length transaction because you have a pre-existing relationship prior to her being your tenant.) I am the seller and she is the buyer. HELP!!

  22. Colin Robertson July 1, 2015 at 2:14 pm -

    Cindy,

    Did you ask the lender if proof of deposits to your account and monthly withdrawals from her account would suffice? Basically showing the paper trail from/to the accounts. Your bank doesn’t scan the checks when they are deposited?

  23. Jessi July 7, 2015 at 5:37 pm -

    I’d like to bring down my debt to decrease the DTI. But by doing so it would cut into my savings for the downpayment. Do you recommend I decrease my debt by using what I’ve saved?

  24. Blove July 22, 2015 at 6:31 am -

    I have 2 car payments and I am in the process to buy a house, can I add them to the mortgage loan and how that’s gonna affect me?

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