Millennials have become notorious for NOT buying homes. In our opinion, it has more to do with broad economic conditions, and social preferences, rather than a lack of interest in buying a home. Millennials are simply delaying big life events such as purchasing a home, getting married, and having kids, longer than previous generations. Regardless, we all eventually aspire to buy a home. The first time home buyers guide will provide a step by step outline of the process and tips along the way to ensure you make the most of your first purchase, avoid any setbacks, and enjoy your experience!
Before you begin your search, ensure you have a healthy credit score for a mortgage, determine what you can afford in the area you want to live, and set aside funds for a down payment.
Healthy Credit Score
Your credit score is essential to you receiving a loan for a home purchase. Two sites we recommend for a free check are Credit Karma and Credit Sesame. You’re entitled to a free credit report once per year from each of the three credit bureaus (Equifax, Experian, and TransUnion). Review the report and make sure there aren’t any errors.
A credit score of 740 or higher qualifies for the best interest rate from most lenders, and a score of 620 or lower in most cases won’t qualify you for a loan. A few ways to beef up your credit score prior beginning your home search:
- don’t open any new lines of credit (credit cards, car loans)
- pay off credit card debt
Determine what you can afford
When lenders are reviewing your application, they’ll look at your debt-income ratio. This is simply your monthly debt payments/gross monthly income. If your debt to income ratio is higher than 43% it’ll be much harder to get approved for a mortgage.
Secondly, look at your budget. What’re you currently paying for rent and utilities? DO NOT assume that your mortgage and utilities will be the only payments associated with home ownership. Other expenses you may run across are:
- closing costs (ranges from 2-5% of final sale price)
- homeowner’s insurance
- property taxes
- repairs and upkeep
- furnishing the home
- homeowner’s association fees
Can you afford these added expenses on top of what you’re currently paying for rent? With this in mind create a budget around what you’d comfortably be able to afford.
Funds for down payment
Funds held for down payment should be held in a savings account as opposed to being invested. If you’re hoping to buy a home within 1-2 years, it’s not worth the risk of investing the money hoping to achieve higher returns.
You can draw up to $10,000 from your 401(k) or traditional IRA to put towards a first-time home purchase without penalty as well. Although, we don’t necessarily recommend funding this way if you have the cash built up in savings. Let the investments accumulate in a tax-advantaged account and pay for a down payment with after-tax money.
Typically, a 20% down payment will get you the best interest rate and avoid private mortgage insurance (PMI) costs. A PMI is a monthly premium that is used to protect the bank in the event you default on the loan and the value of your home declines. Another option is an FHA (federal housing administration) loan. FHA loans allow buyers to qualify through less stringent standards, at attractive interest rates and lower down payment (as low as 3.5%). Though the buyer must pay for insurance for the lifetime of the loan.
In most cases, the conventional loan is the better choice if you have a quality credit score and sufficient funds for down payment.
Spend some time on your own or with your spouse attending open houses, and researching online to prioritize needs vs wants. Location, schools, open floor plan, big kitchen? There’s a lot to think about. If you go into your search with some concrete ideas of what you absolutely want, it’ll help your agent narrow the search.
Mortgage lenders require a pile of paperwork during the approval process. Use this checklist to prepare for what they may ask for.
- W-2 forms for the past 2-3 years. If self-employed, business tax returns
- Recent pay stubs
- Personal tax returns for last 2-3 years
- All loan statements (credit cards, student loans, car loans, child support, etc.)
- Bank, brokerage, and retirement account statements
- Addresses for roughly the past 5 years
If you’re used to using online portals like Zillow, Trulia, or Redfin you can get introduced to an agent in the area you’re looking. Friends and family are also a reliable source to ask for a referral. The key here is you’ll want an agent that solely represents you as the buyer. An agent representing solely the buyer’s side will act in your best interest. They’ll also help find suitable homes, negotiate the selling price, schedule the inspection, and facilitate the closing paperwork.
Fees for an Agent
There is a cost of working with a buyer’s agent. As the buyer, you won’t pay directly out-of-pocket for the agent’s services, rather he and the seller’s agent will work it into the selling price of the home. The buyer’s agent will typically receive anywhere between 2.25% and 3.5% of the selling price. In a way, the seller is paying the fees, however, the buyer is really the only person bringing money to the table.
LendingTree is a good place to start looking online for mortgage comparisons. As I went through the process it came up with 4 different lenders, and their rates for a 30 year, 15 years, and a variable rate loan.
Another option is to go directly to a mortgage broker. Your agent will more than likely have a few recommendations. Mortgage brokers can simultaneously shop for the best rates available from various lenders. As with any service they do charge a fee for loan origination, and/or processing fees. Mortgage brokers have individual contracts with the banks they work with, so make sure to ask for the lowest possible rate they can find.
If you have a great relationship with your personal bank, you may want to speak with a lending agent there. They’ll only provide access to loans from their bank, however, there’s a chance they could offer lower rates if you are a long-time client, and/or have significant assets there.
Now that you have your buyer’s agent and mortgage lender, you’re ready to get pre-approved for your loan. Having all your paperwork and budget on hand at this point saves a lot of time. Be prepared to present all the paperwork to your mortgage lender, with this information he/she can provide a maximum loan amount. Just because you are given a $500,000 max doesn’t mean you should automatically shop within that range. Use your monthly budget and what you determined as needs in your home as a reference so you aren’t borrowing more just because you can. You’ll remain in a comfortable financial position if you adhere to your guidelines.
After you’ve gotten pre-approved for your loan the serious shopping begins. A pre-approval means you’re a serious candidate to buy a home, and sellers will treat you accordingly. If there are multiple offers on a single home, sellers will most likely pay more attention to people who have already got pre-approved.
Pre-qualified vs Pre-approved
If you’ve started the home buying process before you’ve probably heard both these terms. While sometimes used interchangeably, they have different meanings. Getting pre-qualified is simply informational, and should only be used as a reference for how much you POTENTIALLY may be able to borrow. Getting pre-approved means you will get a letter of commitment from the lender stating how much they are willing to lend. There are still a few hurdles to overcome before they will give their full commitment, but this is a much more serious commitment than getting pre-qualified.
You’ve found the perfect home and the seller has accepted your offer. The closing period can take anywhere between 30-45 days. During this period, you aren’t required to get the home inspected, but it’s highly recommended. The second item to take care of is to apply for home insurance.
If you have no idea where to look for a home inspector ask your agent for a referral. A home inspection can cost anywhere between $250 and $500 but well worth it if any problems are identified. If the home inspector finds something structural, mechanical, or materially wrong with the home that wasn’t previously known, you can negotiate with the seller to repair, or decrease the offer price accordingly. Usually, this language is written into the contract.
The final piece is to purchase homeowner’s insurance. A standard insurance policy will offer the following:
- Personal liability: this covers the liability associated with someone getting injured while on your property. It also covers property damage as a result of a covered accident.
- Contents Coverage: protects items in your home. This includes furniture, clothing, and other personal belongings.
- Dwelling Coverage: provides insurance for the actual structure of your home. It includes fire, hail, theft, and vandalism coverage. If an event occurred that resulted in total loss of your home, it would help pay for the rebuild up to the policy limit.
In addition to the basic coverage you receive through your homeowner’s insurance, you have the option of purchasing additional coverage. These include but are not limited to flood, earthquake, water backup of sewer, other structures (insurance for buildings not attached to your home), and replacement cost-plus insurance (increases the policy limit in the case of total loss for rebuilding your home).
Within the final few days of closing on the home do a quick walk-through of the property to ensure that nothing has changed. Review all the financial documents to ensure they’re in good order and everything is accurate with your agent. Finally, secure a cashier’s check or wire the cash needed for the final purchase. Congratulations on your first home purchase!
It can be difficult determining what fit’s into your budget when looking at purchasing a home. If you’re interested in taking a comprehensive look at your finances to understand what you can comfortably afford, schedule a free consultation with us today.
Levi Sanchez is a CERTIFIED FINANCIAL PLANNER™, BEHAVIORAL FINANCIAL ADVISOR™ and Co-Founder of Millennial Wealth, a fee-only financial planning firm for young professionals and tech industry employees. He is an avid sports fan, personal finance and investing geek, and enjoys a great TV show or movie. His mission is to help educate his generation about better money habits and provide financial planning services to those who want to start planning for their future today!