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.

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

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

Tip #1: 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 middle credit 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.

Tip #2: 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 mortgage 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 mortgage 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.

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

Tip #3: Be Ready to 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 (if any) on the borrower.

Liquid assets are always helpful when applying for a loan, and are almost always a necessity for a first-time home buyer. 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 mortgage 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!

The Definition of a First-Time Home Buyer

One final note about first-time buyers. As I alluded to up above, some entities, like Fannie Mae, also 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.

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 the loan process
  • Calculate your total monthly liabilities
  • Determine how much you want to put down and if you want 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 in a verifiable account
  • Do your interest rate homework
  • 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 fluctuate
  • Get a better understanding of mortgage closing costs so you know what to expect in the way of fees

Read more: How to get a mortgage.



50 Comments

  1. Esmeralda Ortega July 11, 2017 at 9:32 am - Reply

    Last year I was going through FHA and had a plan set up to pay $150 a month for 6 months. I was able to make the first 3 payments but had to cancel due to my job closing down. My question is: is the money lost that I already paid? I feel like my question keeps being avoided. I received no help from FHA during this time. I could not follow through on my obligation. So am I entitled to a refund or can I pick up where I left off?

    • Colin Robertson July 11, 2017 at 9:47 am - Reply

      Esmerelda,

      I don’t really understand your question. What was the $150 going towards? And what did you cancel?

  2. ANNE March 28, 2017 at 4:08 am - Reply

    Question my husband and l want purchase a home as first time buyers we where thinking FHA. l have many credit cards l am getting my balance downs and about to pay a loan l have off so we can get our score ups. When we first sat down with a mortgage company, they said we wasn’t far from where we needed to be in score wise by doing this do you think this will help my husband and I. We want to be in our new home within a year from now.

    • Colin Robertson March 28, 2017 at 10:31 am - Reply

      Anne,

      Paying down balances can improve your credit scores a lot…it’s hard to say how much without knowing all the details but it is generally very helpful. It may also allow you to borrow more once you have less outstanding debt.

  3. kelsey February 14, 2017 at 1:34 pm - Reply

    I have a question – if I entered the program as a single first time homebuyer, and now am engaged, is it possible to add someone to this program with me? Or get approved for more based on there being additional income to the housing costs?

    • Colin Robertson February 15, 2017 at 3:38 pm - Reply

      Kelsey,

      Probably shouldn’t be an issue – though one thing you might have to worry about is having too much income if a program has maximum income limits. But keep in mind both borrowers don’t always have to be on the mortgage if it’s not favorable.

  4. Aly Chiman December 1, 2016 at 2:29 pm - Reply

    As a first time homebuyer this will probably be one of the biggest financial decisions you’ll ever make. Here are a few questions you need to ask yourself.
    How much debt do I have?

    Before you can take on a huge financial responsibility that a home is — you need to pay down, or you’re your existing debt load. Consider consolidating loans and getting rid of credit cards. Perhaps most importantly, you need to make sure that as you reduce debt, you increase your credit score. For more information, good contacts would be a financial advisor, a good mortgage broker, or your bank manager.
    Where will I be living in 2 to 5 years?

    If you are planning on being in a particular place for a short time (2 years or less), then renting may be a reasonable financial option. Buying and/or selling a home comes with associated costs. Your home may not build enough equity in 2 years to justify paying real estate and legal fees twice.
    What are the market conditions in your area?

    Because of appreciation, you will could realize an approximate increase in property value of 4-6 percent per year, that means over the next 5 years you’ll have a home that’s worth about 30% more than when you purchased it. This would provide additional cash to pay off student loans and other expenses, as well as building a good credit rating at the same time. The thought behind buying real estate is to get a head start on building up your financial future. If you are planning on being in a location for 2 years or more, then you should consider buying. Not only will your home increase in value, but you’ll be saving money on a monthly basis. Becoming involved in the real estate market becomes less scary when you educate yourself. There are benefits to being a homeowner, such as a stable lifestyle and watching your investment appreciate in value. Real estate has always had more security than the stock market, but unfortunately there is no sure way to determine the right time to buy, that decision should be based on personal factors and finances. But you don’t have to do this alone, a good broker or bank manager and a knowledgeable real estate agent will help.

  5. SAL October 30, 2016 at 7:32 pm - Reply

    Sir,

    First, THANK YOU VERY MUCH! I was a nervous wreck before coming across your helpful tips for first time home buyers. Financing has me more worked up than actually looking for a home.

    I was thinking about going through my credit union. Here is what they have to offer 1st time home buyers. Would this be an okay option to keep on my list as I look for a few more comparisons?

    Save with no money down, no PMI – private mortgage insurance, and a low fixed rate.
    Low fixed rate
    20 year term
    No down payment
    Maximum contract price of $200,000
    Existing Home construction in a platted subdivision only
    No mobile, modular, manufactured, log homes or metal constructed homes
    Owner occupied only
    Real Estate must be in Oklahoma
    No Private Mortgage Insurance (PMI) required.
    First Time Home buyer
    20 year fixed, 0% down payment, Rate 3.750%, APR 3.858%, Loan to value is 100%,

    • Colin Robertson October 31, 2016 at 7:24 am - Reply

      Sal,

      Rate seems pretty good, though it’s a 20-year fixed so payments will be higher than the typical 30-year loan term. But that means it’s paid off a lot faster too. Also PMI is just built into the interest rate despite not having to pay it directly when you put less than 20% down.

  6. Jasper Whiteside October 24, 2016 at 12:27 pm - Reply

    It’s interesting to see a number fixed to an acceptable debt to income ratio. It makes sense that a lender wouldn’t want to loan money to someone if all of their income is going toward paying debts. The lender needs to get their money back to make a profit. They aren’t going to make that investment if they have reason to believe that they won’t get it back.

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