Five basic steps to put you on the path to home ownership
There are few things that make you feel more like a bona fide Adult with a capital A than buying your first home. Now that you’ve decided where you want to settle down and separated your musts from your wants, the next step is actually purchasing the home, which is unsurprisingly not as simple as swiping your credit card (unless you’ve got a cool $100K lying around). Surveys show that prospective millennial homeowners aren’t treating the decision flippantly and are instead thinking more critically about their first home purchase, with 35 percent of potential homeowners intending their first home to also be their last, according to the National Association of Realtors.
Assuming you’ve selected your dream home, gathered all the necessary paperwork and checked your credit score, the final step to make your nesting dreams come true is choosing a mortgage plan, which comes with a lot acronyms and financial savvy we admittedly can use a helpful hand with. So we rung up Erin Lantz, VP and GM of mortgages for Trulia, who gave us a crash course explaining all the ins and outs of what the slightly tedious but necessary process entails. Ready to dive in? Your dream home awaits.
Step 1: Get pre-approved
To start the mortgage process, you want to get pre-approved. For that, you’ll have to substantiate the funds you’ll be using to pay for the monthly mortgage, which can include your monthly income pay stubs and any other liquid assets you may have, including savings accounts and retirement accounts if you’re eligible. The lender will then use all your amalgamated assets to calculate your debt-to-income ratio, which will help them assess your ability to pay back your loan.
Term to know: debt-to-income ratio. Your goal here is to reach a favorable DTI, which is calculated by dividing your existing debt (think credit card bills, student loans and monthly payments like car insurance), including your desired monthly mortgage payment, by your total gross income. You want a low debt-to-income ratio, with lenders favoring 28 percent to 33 percent.
The best way to have a manageable DTI is to answer: What house size (and mortgage) can I comfortably afford? Since the DTI calculates not just your mortgage but all your other monthly payments, Lantz says the most important thing is “to think about your mortgage within the context of your overall budget. Consider your lifestyle choices, like traveling, rearing kids or any health expenses.”
While you can marginally increase or decrease your monthly payments based on how much cash you put down, she says you should first figure out what your monthly spend should be. “That way the down payment will become a much smaller portion of the decision.”
Step 2: Pick between a fixed or adjustable interest rate
Your second goal is to achieve a low interest rate, which goes back to how much you want to spend monthly. You can pick between a fixed rate or one that can be adjusted over time. Typically a fixed rate, though stable, will have a higher interest rate than the initial rate offered with an adjustable loan. However, keep in mind that an adjustable loan is subject to change over time, potentially resulting in a higher interest rate overall.
Term to know: jumbo loan. Based on your state and county, Fannie Mae or Freddie Mac have decided what the loan limits should be (find your county’s specific loan limits here). Anything below the limits is called a “conforming” loan. Once surpassing that limit, you’ve now entered into a “jumbo loan,” which grants the lender more flexibility to structure the loan program to offer more varied jumbo products. “In order to qualify for a jumbo mortgage, you’ll still need to be able to afford a higher loan amount and a higher down payment because it’s a bigger loan,” says Lantz. “But the interest rate should be comparable. It used to be the case that the interest rate is a lot higher with a jumbo loan, but that difference has pretty much disappeared.”
Step 3: Choose between a government-insured or conventional loan
There are three types of government-insured mortgages, which are for veterans, rural residents with modest income and the more widely applicable: FHA.
Term to know: Federal Housing Administration loan. This loan is offered by the U.S. Department of Housing, and it’s an attractive loan, thanks to its very low-interest rates and lenient qualification requirements. You only need a minimum credit score of 580 (the average is 750) to qualify, and a down payment could be as low as 3.5 percent of the home’s purchase price (the average is 20 percent).
For first-time home buyers, while the pre-qualifications are much more feasible, there’s a catch. With an FHA loan, you’ll have to pay an upfront mortgage insurance premium, in addition to a monthly mortgage insurance fee.
But an FHA isn’t your only option when searching for low–down payment loans. Lantz says, “There are increasingly more lenders that are offering loan programs that don’t require 20 percent, so don’t fret if you don’t have the 20 percent down.” She suggests starting with Bank of America, Chase and Wells Fargo, who have all recently announced their own low down payment programs that are incredibly varied. “Shopping around is really important, especially in this scenario,” says Lantz.
“We see consumers often go with the first lender they spoke to, and a lot of the answers to these questions (Can I reduce my down payment? Can I lower my interest rate? Do I have to pay for mortgage insurance?) is: It depends. It really pays to shop around and find the lender that suits your needs,” says Lantz.
Step 4: Shop for the best homeowners insurance
Now that you’ve selected a mortgage plan, you’ll also need to factor in property taxes and homeowner’s insurance. While there isn’t anything you can do about your property taxes, you can (and should) shop around for the best deal on your homeowner’s insurance (not to be confused with your mortgage insurance from above).
Term to know: homeowners association. If you are joining a condominium, townhouse or gated community, there’s most likely a homeowners association fee you will be responsible for, which covers the building’s shared amenities and upkeep (think pool, gym or a doorman). There may also be fine-print requirements on how you need to maintain your home (such as window boxes) that could entail hidden costs.
Also keep in mind that most HOA fees do not cover the interior properties of individual units should any damage occur. You’ll still need to purchase separate homeowners insurance based on your specific needs.
Step 5: Make an offer
After considering all the monthly fees and shopping around for the best lender for you, you can then work with a real estate agent to make an offer. Should the seller accept, you head into escrow, the period of time between settling on a purchase agreement and the day you get the keys.
There are a couple things that must happen before you close, such as your lender getting the home appraised. This is to make sure that your home is truly valued at the price it’s being sold for. Next is a home inspection, which will fall on your shoulders. You’ll need to hire a professional inspector to do a noninvasive examination of the house. This is to make sure that there aren’t any serious issues to the home, such as faulty circuit breakers, structural cracks or water damage that may end up costing you more in renovations in addition to the purchasing price. Should the inspector find serious issues, you will be able to back out of the purchasing agreement and retrieve your deposit.
Term to know: escrow. Remember Joey’s meltdown in “Friends” when he couldn’t find Monica and Chandler’s “escrow” on the map? Escrow not only refers to the time it takes between the purchasing agreement and receiving the keys, it can also refer to a fiscal account in which a third party holds your down payment for the house. Once the house passes inspection, the third party will “close the escrow,” which will transfer the funds and any closing costs (such as real estate agent fees) to the seller and transfer the title of the house to you.
As a final tip, Lantz says while this is just the beginning of the road, you do want to think about the potential end: How long do you plan on living in this house? Lantz says the average homeowner lives in a home for five to six years, but most mortgage plans are on a 30-year fixed rate. Lantz says, “The chances of homeowners staying in a home for 30 years is really low, so that should help determine what kind of mortgage you want to go with.” The great news? “Rates for 30-year fixed plans are very attractive right now.”
We’ll be waiting for a housewarming invitation.
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By Sharon Yi, Domaine (TNS)