Home ownership not only comes with certain tax advantages; it is a great way to start building a foundation of future wealth. If only figuring out  how to buy your first home weren’t so daunting! All those steps and paperwork, not to mention decisions about where you want to live and competition with other buyers in low inventory markets.
Buying your first home doesn’t need to be anxiety-provoking, though. You can make the process virtually stress free if you follow just a few simple steps to prepare and educate yourself even before you pick the real estate agent who will help you find the perfect home.
What’s the first thing you should do?
At least six months before you go to obtain a preapproval letter — even more if you have filed for bankruptcy or had a significant hit to your credit rating — you should begin to get your financial situation in order. Why? Lenders will carefully scrutinize your records to see if you are a safe risk, and prospective buyers can be denied loans or forced to pay higher interest rates if they don’t have the following:
- Proof of income and employment verification. Lenders require you to have W-2 statements going back two years. You will also need to provide at least two years worth of tax documents. Employees who work for a company will need to provide a letter of employment verification. If, on the other hand, you are self-employed, you should get ready to provide documentation in the form of invoices and tax records. Establishing a regular pattern of income up to two years before applying for preapproval is the best way for an independent contractor to ensure eligibility without significant assets.
- Proof of assets. This may include bank and investment account statements or a letter from someone who is willing to make you a personal loan. Banks want to know that you are able to afford the necessary down payment before they will agree to lend you money.
- Excellent credit. If you want to get the lowest interest rate possible, your credit score must be 740 or above. In order to qualify for the 3.5 percent down payment on a Federal Housing Administration (FHA) loan, you’ll need a minimum score of 580. Ordering your credit report in advance lets you fix any discrepancies before the bank sees the information. If your credit score is low, it may be worthwhile to build good credit before seeking loan approval. A lower interest rate can save you thousands of dollars over the term of the loan.
How much money do you need to have for the down payment?
The standard down payment on a conventional 30 year mortgage loan is 5-20 percent of the purchase price (not the list price) of the home. Twenty percent down is the loan-to-value ratio that lenders consider a safe bet; if you own 20 percent of the home, that is, your chance of defaulting on the loan constitutes what the industry feels is an acceptable risk.
You can borrow with less than 20 percent down. However, you’ll have to purchase private mortgage insurance (PMI) to cover the difference between your down payment and that 20 percent mark. This amount will convey a higher interest rate than the primary mortgage loan.
Government sponsored loans, such as Federal Housing Administration (FHA) and Veteran Affair (VA) loans, allow you to purchase a home with little or no money down. FHA loans allow qualified buyers to purchase a home with only 3.5 percent down; eligible veterans and their spouses may be able to buy their first home with zero percent down.
Why do you need to find out more about your target neighborhood?
While you are waiting to build good credit and saving for your down payment, it’s also a good idea to familiarize yourself with the local real estate market. Studying market trends, looking at neighborhoods, investigating school districts, and looking up walkability scores are all important steps you can take to become educated about the market before you narrow down a list of houses to look at.
The reason for this step is first time homeowners tend to get so emotionally invested in individual properties that the process of looking for a home becomes unnecessarily stressful. In other words, you pin all your hopes on that one special house and are crushed when you lose a bidding war or can’t get the list price low enough to make the place affordable.
Getting to know what is on the market and some of the factors that affect pricing in advance can help you to be more flexible about options and help you to figure out what is negotiable — Do you really need a fourth bedroom? — and what is set in stone. If you’ve decided that living in an excellent school district is a must, then you know in advance that you may have to compromise in other areas.
Doing your own research is no substitute for working with a professional real estate agent, whose experience, negotiating skills, and access to top-of-the-line data is invaluable, but it can definitely help to take the stress out of looking for your first home.
Highlights
“At least six months before you have your real estate agent obtain a preapproval letter—more if you have filed for bankruptcy or had a significant hit to your credit rating—you should begin to get your financial situation in order.”
“Studying market trends, looking at neighborhoods, investigating school districts, and looking up walkability scores are all important steps you can take to become educated about the market before you narrow down a list of houses to look at.”
