Welcome to home buying 101, your official guide to greatness. This resource covers everything from the mortgage process to inspections, closing costs, and more.
Think you’re ready to stop renting and finally buy your first home?
The process of finding the perfect house in the best neighborhood, and then qualifying for a home loan you can afford, can be overwhelming if you’ve never gone through it before.
So let this resource be your official cheat sheet to home buying 101.
How to Prepare for Buying Your First Home
Becoming a homeowner takes a lot more than wandering around open houses and saving cash for a down payment.
So before you begin the sometimes long process of closing on a home, determine if it’s really in your best financial interest to do so first.
Why Do You Really Want To Buy a Home?
There are upsides and downsides to buying a home versus renting.
While your mortgage payments may be cheaper than monthly rent, you’ll also be responsible for maintenance and repair costs should they come up when you own your home.
For more help deciding, consider reading:
- How Airbnb affects rent prices and home affordability
- [The pros and cons of renting versus buying]
- [Benefits to owning your home instead of renting]
When you’re absolutely sure you’re up for the task of homeownership, you have to learn your financial boundaries for the home of your dreams.
Figure Out How Much You Can Afford to Spend
A home purchase should be a sound long-term investment and not a financial burden. That’s why you never want to get yourself into a mortgage you can’t afford.
Luckily there are calculators online to help you determine a ballpark range for a home you can afford. All you have to do is plug in some basic information, such as:
- Your annual income
- An expected down payment amount
- Estimates of your current living expenses
Your debt-to-income ratio has a lot to do here as well.
The Consumer Financial Protection Bureau says anything higher than a 43% debt-to-income ratio makes it harder to secure a qualified mortgage[*].
Besides learning how to use a personal loan to eliminate your debt, you’ll also want to start budgeting for a sizable down payment by curbing your monthly expenses.
So get your money right by checking out these easy-to-use financial tools:
- [Personal Loan Calculator — tool coming soon]
- [Personal Debt Calculator — tool coming soon]
- [Home Loan Calculator — tool coming soon]
When you have an estimated budget, you’ll want to get pre-approved for a home loan before you start house hunting.
Get Pre-Approved for a Home Loan
Most people don’t have $300,000+ in cash sitting in an account to pay for a home outright.
So they have to take out a mortgage with a bank or lending institution.
The lenders will pay the sellers for the house. And then you as the borrower will pay the lenders back with interest until you pay off the cost of your home.
Sellers look more favorably upon buyers who are already pre-approved for a home loan. Gaining pre-approval shows you’re a serious buyer a lender has vetted and will allow to make a legitimate offer.
Since this process takes time, start it before house hunting or you may lose out on a home to a buyer who’s already done the preapproval legwork.
Lenders will weigh their risks of loaning you the money to buy your home by taking a deep dive into your finances to learn all about your:
- Sources of income (such as employment, investment accounts, assets, etc.)
- Credit history and credit score
- Debts such as student loans or child support payments
- Accounts in good/bad standing
Don’t be surprised if you have to submit paperwork like pay stubs, W-2s, bank statements, retirement fund information, etc. to gain approval and show your debt-to-income ratio.
Once these documents are in, pre-approval is usually quick and you’ll have an official letter to show sellers.
You’ll also receive a document known as a Loan Estimate within three days of applying for a home loan. This will outline a few estimated numbers for your mortgage, such as your:
- Interest rate
- Monthly mortgage payment
- Closing costs
Let’s talk about understanding these numbers so you have a better idea if certain mortgages are better for you than others.
Compare Your Mortgage Options
There isn’t just one type of mortgage; there are several you’ll need to decide between:
Conventional mortgages follow guidelines created by Fannie Mae or Freddie Mac and they have strict qualifications. You’ll only be approved for a conventional mortgage if you:
- Have a minimum credit score of 620
- A debt-to-income ratio lower than 36%
- Need a home loan under $417,000
FHA mortgages are backed by the Federal Housing Association and aren’t as difficult to gain approval for.
You don’t need amazing credit to qualify for one as most are approved with credit scores as low as 580. And you also don’t need to save up a large down payment either.
Lower down payments and more lenient credit requirements make FHA loans ideal for first-time homebuyers.
VA mortgages are insured by the Department of Veterans Affairs. Though they don’t require a down payment, VA home loans are only offered to:
- US veterans
- National Guard members
- Active-duty personnel
- Eligible surviving spouses of the above
Once you determine which type of mortgage you qualify for or want, you’ll need to figure out how you’re most comfortable paying the interest.
Understand Interest Rate Types for Home Loans
Similar to how you pay interest fees to use your credit cards when you don’t have cash to pay for your everyday purchases, you’ll have to pay interest on your mortgage. This is your lender’s fee for loaning you the money to buy your home.
This interest charge will be added to your monthly mortgage payments until you pay off your home loan.
You can choose which type of interest rate plan you want to follow:
Fixed interest rates mean your rate of interest never changes. If you lock in a 5% interest rate on a 30-year loan, you’ll pay the same rate every month for 30 years. This consistency keeps your monthly payments relatively similar month-to-month over the life of your loan.
Adjustable rate mortgages, or ARMs, offer a low, fixed interest rate for an introductory period of time. After those first five, seven, or 10 years, the interest rate will then become flexible and change with the market.
So you may have a 4% interest rate for the first five years of your ARM, but after that time your monthly payments could increase or decrease depending on the economy.
The benefit here is if you’re not planning to stay in your home very long, you get to take advantage of interest rates lower than those offered on fixed-interest loans for your short period of time.
You can then refinance to a fixed-rate mortgage later if you decide to stay. That means you won’t be subject to fluctuating interest rates which could make your mortgage payments much higher.
Speaking of time, you’ll also need to determine how long you think you’ll need to pay off your mortgage.
Determine Your Mortgage Terms
A mortgage term is the amount of time you agree to keep making payments until you pay off your home loan.
Generally the shorter the term, the higher your monthly payments. However, shorter terms also mean paying less in interest overall.
There are two common mortgage terms:
15-year terms mean you’ll divide up your mortgage into 12 monthly payments over 15 years with interest. You’ll pay off your loan faster and save money in interest despite higher monthly payments.
30-year terms mean you’ll have lower monthly payments, but you’ll also be paying interest for double the time of a 15-year term.
Another factor which will affect your mortgage rate and how much you pay in interest is your down payment.
Save Up for Your Down Payment
A down payment is the amount of your own money you’ll contribute to buy your first home.
Certain loans like VA and USDA home loans do not require a down payment while others like FHA loans require a minimum down payment of 3.5%.
Many buyers save between 10% and 20% of the sale price of their house to use as a down payment.
You can then deduct your down payment from the cost of the house to reduce your loan amount, which may open up lower interest rates.
A higher down payment also shows lenders you have a vested interest in the house you want to buy, which lowers risk for them.
A buyer putting $20,000 of their own money into a house may be less likely to default on their loan than someone who only dropped $1,000 for it.
Plus, if you put down less than 20% on some mortgages, you may be required to pay private mortgage insurance (PMI), which will add extra costs to your monthly mortgage payment.
With all these financials out of the way, it will finally be time to get to the fun part of buying your first home: house hunting.
Find a Real Estate Agent and Your Dream Home
But you still need a competent realtor to find homes that meet your criteria before they hit the market, show you inside those homes, negotiate for a fair market value on your behalf, and file all the necessary paperwork.
If you live in a hot real estate area with lots of competition from buyers, a realtor in your corner will make sure you don’t miss out on homes or overpay for one.
You can always ask your lender for a recommendation if you don’t know a real estate agent in your neighborhood.
And when you find the one house with everything on your wishlist in the right school district, you and your realtor will make an offer and cross your fingers the sellers accept.
If they don’t you can either renegotiate or hit the open house scene again. But if the sellers accept your offer, you’ll need to prepare for the official approval of your mortgage and the home closing process.
The Final Stretch: Home Loan Approval and the Home Closing Process
Even if you’re pre-approved for a mortgage, you’ll still need to go through underwriting before your loan is finalized.
Here’s where an underwriter will assess the risk of your loan for a mortgage lender.
He or she will be the one to vet you as a borrower and the house you plan to purchase.
To find out if you’re financially responsible for the loan, an underwriter will take a serious look at your:
- Income and employment history
- Financial assets
- Credit score and debt-to-income ratio
Make sure to have your pay stubs, W-2s, and bank statements for the last two years handy to give your lending company a complete picture of your financial health.
Next an underwriter will want to make sure the property you’re planning to purchase with the lender’s money isn’t overpriced or a potential money pit.
So you’ll need to schedule a:
- Home inspection
- Pest inspection
- Property appraisal
You’ll also want to shop for homeowners insurance at this time.
When all this is done, you’ll be ready for closing day.
During a home closing, you’ll sign all the paperwork to transfer the property from the sellers to you as the buyer.
You’ll receive the keys to your new house in exchange for closing costs like your escrow and down payment.
Check out Everything You Wanted to Know About the Home Closing Process here.
Then it will be time to pack up your stuff, change your address, and throw a housewarming party for all your friends, family, and new neighbors.
Home Buying 101: Homework and Assigned Reading
Choosing the right mortgage is one of the most important long-term investments you’ll ever make.
So just like shopping around for the right car, phone, or laptop, you don’t have to go with the first one you see. You should compare home loans from multiple lenders to score the best interest rate for your mortgage.
Our editors have done the hard work to put together this year’s best mortgage companies to help you determine which one is right for you.