As simple as it sounds, it’s hard to overstate how important it is to begin home ownership with a solid understanding of your financial options and how much house you can actually afford.
QuickenLoans, Wells Fargo and Bankrate.com all say that too often, first-time buyers end up biting off more than they can chew because they aren’t aware of all of their options or don’t fully understand the potential consequences of their decisions.
Getting Started: Do your research
As soon as you decide that you’re interested in being a homeowner, begin researching real estate and home listings in the area you would like to live. Find houses that interest you and fit within your potential price range, and pay attention to how long they stay on the market and any price changes. Just because you find a home on a search engine doesn’t mean that it’s still for sale, so pay close attention to the status of that home to see how long it is taking for that home to go under contract.
This will help you have a grasp of housing trends that may affect you and your options as a buyer.
Figure out what you can afford
If you are going to take out a loan, most banks have requirements as to how much you make versus how much you can reasonably afford to spend on a dome. This figure is expressed as a percentage called your debt-to-income ratio.
Most lenders use the federal guidelines for DTI, which is 36 percent for the typical loan, and not to exceed a max of 45 percent total. So, add up your pre-existing monthly debt and add that to the price of your future mortgage and express it as a percentage of your household gross income to get your DTI.
If you are under the 36 percent mark, this will greatly increase your chances of getting an acceptable loan.
Additionally, many companies and websites offer online mortgage calculators homebuyers can use to figure out what they can comfortably afford.
Financing: The loan approval process
When you apply for a loan, the loan officer and underwriter will look at four basic aspects of your application and financial situation.
- Ability to repay: This is basically the 36 percent DTI. Lenders want to be able to see that you can afford to pay for the loan before they issue it to you.
- Credit history/likelihood of repayment: The bank determines if you can afford your payments, but it also wants to be sure you will actually make them. Your credit score and payment history in regard to other debt (credit cards, student loans) will be determining factors.
- Value of the home: The bank isn’t nearly as interested in how much the home will cost as opposed to how valuable the home is. If you are buying a home at $200,000 that the appraiser’s valuation determines is valued at $180,000, they will most likely not lend you more than $180,000.
- Down payment: The bank will want to verify that you have the money to make a down payment (usually 20 percent). If you do not have the funds for a 20 percent down payment, you will likely have to pay private mortgage insurance and have higher mortgage payments.
Lending options beyond 20% down payment
A few non-traditional lending options are available for potential homebuyers who cannot afford to make a 20 percent down payment.
- FHA Loan: FHA loans are a great option for first time buyers who might struggle to meet the 20 percent down payment option. FHA loans can offer down payments as low as 3.5 percent and low closing costs.
- VA Loan: Similar to the FHA loan, VA loans are alternatives to homebuyers who might not be able to afford a down payment. Since the loan is guaranteed by VA, it gives lenders more flexibility to work with buyers. VA loans are only available to service members or veterans who have served one complete contract of their military service.
- Variable Rate Loan/Adjustable-Rate Mortgage: A staple since the 2008 housing crash, the adjustable-rate mortgage has an interest rate that periodically adjusts to match market conditions, meaning rates of the loans will rise or fall based on current lending rates instead of remaining static.
These loans are attractive to both lenders and buyers, because some of the risk is moved from the lender but also offers an opportunity for a buyer’s mortgage payment to drop if interest rates fall. These types of loans are much more regulated in today's market than they were prior to the housing crash of 2008, and a thorough look at this option may be advisable for the right buyer. These loans also tend to allow a higher DTI since the rates are flexible.
There is plenty more to learn about being a first-time homebuyer, but if you do your research, figure out what you can afford, and take on a loan you can actually repay, you’ll be one of the happiest first-time homeowners on the block.
Be sure to also talk to more than one lender, and don’t forget your local banks and Credit Unions who may have programs tailored for your needs or certain professions.
This story was written for our sponsor, Raleigh United Real Estate.