If you’re reading this with a view for a guide to purchasing a new home after previously renting; congratulations! You’re finally getting ready to take the huge step on to the property ladder. No longer will you be spending ‘dead’ money on rent. Instead, every payment you make will go towards eventual ownership of the home.
The entire new house purchase cycle may seem extremely complex but in reality, there are a number of experts available to help you close the deal. Like any sensible individual with a view to buying a new home, you have probably been busily scouring the Internet looking for as much information as possible.
Rather than allowing you to spend wasted hours trying to find the most relevant details, we thought we would save you the trouble by creating a detailed home buying guide. The aim of this page is to give you as much information as possible to help you make the right decision and get a home that suits your needs and your budget.
Calculate What You Can Afford
This is the obvious first step on the road to home ownership. Once you’ve carefully calculated the maximum amount you can afford, you can save time by no longer looking at property outside your price range. Most financial experts believe in this rule of thumb:
Choose a home that is no more than triple your annual household income pre-tax
In other words, if you and your spouse earn $70,000 a year between you before tax, you shouldn’t realistically look beyond properties costing more than $210,000. However, if you have the ability to put 20% money down (the amount you pay upfront) and have no debt (or a very small amount), you could afford up to four times your annual household income pre-tax.
This means you could afford a home worth $280,000 (using the above figures) as long as you could pay $56,000 upfront. Now clearly, you’ll end up paying a lot more than that over a long term loan but the above is merely a quick way to find your ballpark budget.
Unless you’re extremely wealthy, you’ll need a loan from the bank called a mortgage. You agree on the length of the loan (often up to 30 years) and repay it monthly. Prior to the Global Financial Crisis, it was easier to get a ‘no money down’ mortgage which meant the bank loaned you 100% of the price of the home.
Nowadays, you’ll probably need 5-20% of the price up front which can be tricky for a lot of people. Yet even if you can get a mortgage with no deposit, there are several reasons to avoid it if possible:
- Higher monthly payments.
- A smaller bank loan.
- More difficult to qualify.
- Tougher to locate such a deal.
- More danger of foreclosure (because you probably don’t have savings).
If you can afford it, paying 20% upfront is your best option because you’ll:
- Qualify for a larger loan.
- Get a better interest rate.
- Avoid paying Private Mortgage Insurance (PMI). This protects the lender in case you fail to make payments and they have to sell the house for less than what was left on your loan.
Incidentally, if you borrow money from someone to make the down payment, the bank counts this as extra debt which will hinder your chances of getting the loan.
This is the amount you repay each month. A lot of people make the mistake of using basic online mortgage calculators which don’t include extra fees such as home insurance, tax, PMI and more. We would encourage you to use this mortgage calculator for an accurate result. The term of this loan is usually anywhere from 15-30 years. While a longer term loan ensures a lower monthly payment, you also pay a lot more in total interest.
There can be a huge difference in monthly repayments depending on the amount you can pay upfront and the interest on the loan. Using a $280,000 home with a 30 year loan as an example:
- 4% interest and 20% down would equal monthly repayments of $1,536.
- 6% interest and 20% down would equal monthly repayments of $1,810.
Over the term of the loan, you would pay over $98,000 more with a 6% interest rate!
Therefore, it is essential for you to get your finances in order before seeking a loan. The better shape you’re in financially, the better the interest rate you’ll receive. It can be a vicious circle, so make sure your finances are rock solid!
Get Your Finances in Order
Deal with Debt
Debt can really hurt your chances of receiving a good mortgage deal. Generally speaking, the bank wants your total debt to be at or less than 38% of your total income. For example, if you earn $5,000 a month, you shouldn’t have existing debt of more than $1,900 a month.
Therefore, if you have $1,200 a month in debt at present, the bank would assume you have a maximum of $700 a month that could be put towards mortgage repayments.
As a consequence, you better start paying off those debts right now! Begin by paying off the debt with the highest rate of interest (this is usually credit cards) before going after student and car loans. A good habit is to pay off your credit card bill monthly and never allow an end of month balance.
Hopefully, you have some money left over to begin saving for your down payment. Again, the more you can put towards the cost of the home, the better off you’ll be in the long run.
Improve Your Credit Score
Prior to the Global Financial Crisis, it was possible to get a mortgage with a credit score of just 580. Today, you’ll probably need a credit score of 660 although you may get a (not very good) mortgage with 620. If you want the best rates, you’ll need a credit score of 740+.
We already showed you the enormous difference a mortgage’s interest rate can make to the cost of your repayments. By boosting your credit score sufficiently, it may be possible to reduce your interest rate by 1% or so which will save you tens of thousands of dollars.
Things that hurt your credit score include:
- Late payments
- Liens (even if paid)
- Credit card balances at or near the credit limit
- Unpaid debts
You should ask prospective lenders what credit score they use because there are several different ones available. Once you have this information, you can get in touch with a credit reporting agency (Experian, Equifax or Trans Union) and get the relevant information.
What If I Have Bad Credit or None at all?
If your credit score is low, here are a few ways to clean it up:
- Stop Making Late Payments: The older a late payment, the less of an impact it has on your credit score. If you can go a couple of years without missed payments, your score could improve by 50 points!
- Settle Delinquent Accounts: An unpaid debt is even worse than a late one!
- Correct Errors: If you find that the CRA has made mistake, get in touch immediately. Additionally, make sure that negative information 7+ years old is deleted as this is the law (except for bankruptcy which is 10 years). For newer negative information, contact the CRA and ask them to include your side of the story; a written summary explaining the situation could help and certainly won’t hurt.
The good news is that if you do nothing to hurt your credit score for an extended period of time, it can build quite rapidly.
If you don’t have a credit score, you need to apply for a credit card. Typically, bank loans and credit card repayments are the best way to build credit. You can get a DISCOVER card fairly easily or apply for a Visa or MasterCard.
To avoid getting into unnecessary credit card debt, be sensible with expenditure. For example, only use it to pay for groceries and ensure you pay everything off by the end of the month.
All about Loans
The bank acts as the lender and requires you to repay your mortgage monthly. Failure to make payments on time will see your home repossessed. The most popular loans are 15 year and 30 year loans. The shorter loan results in a lower total payment but the monthly repayments will be higher. With longer loans, you have a higher overall payment but benefit from lower monthly repayments and you can purchase a more expensive home.
There are typically three loan types:
- Conventional: This is a standard loan and is a better option than an FHA loan if you have a good credit score and can pay at least 5% down.
- FHA: This is a government backed loan which is easier to qualify for than a Conventional loan and you can get one with just 3.5% down. The bank lends you the money but the government acts as guarantor for part of the loan if you default. There is also a clause that allows you to borrow money for repairs/modernization. On the downside, there is more red tape so not every seller will agree to an FHA loan.
- VA: This loan is for veterans only and can be had with No Money Down.
You’ll usually need to meet the following criteria in order to get a loan:
- The ability to pay at least 3.5% down.
- A credit score of at least 660.
- Monthly income that is three times your monthly mortgage payment.
- Evidence of at least two years working in the same job or field. Basically, you need to prove that you have a solid and reliable income stream.
If you don’t meet all of the above, you could do the following:
- Meet lenders to find out what you are eligible for.
- Use a mortgage broker to find you a deal.
- Get a friend/family member with a good credit score to co-sign the loan.
- Ask the owner to finance some or all of the property’s cost.
Finding a Lender
If you like your current bank and have a good relationship with it, you could speak to a loan officer and fill in an application. This is not a commitment to take the loan and while you may pay a higher rate than if you shop around, it might be worth it if you like and trust the bank. Otherwise, the best option is to use a site like Zillow to find the best mortgage lender for your needs.
The loan application can be long and complex; especially if you’re self employed. After processing the application, the lender will check your credit report. Then it will use all this information to decide if it wants to lend you money and if so, the type of terms.
Always shop around and consider at least 2-3 loan offers before making a decision. Even then, it is worth trying to negotiate a better deal.
By the way, lenders can give you a Pre-Qual letter if they have approved you. This is a great document as it shows realtors and sellers that you’re serious about buying a house.
Unfortunately, banks will give you what seem like confusing choices when offering a mortgage. Choose the wrong one and you’ll pay a lot more over the term of the loan. Here is a quick overview of the two main options:
- Fixed Rate: The interest rate stays the same for the entire mortgage term. This is an excellent option if interest rates are low at the time you purchase the house.
- Adjustable Rate: Banks usually try to sell you an adjustable rate mortgage when interest rates are low. With this option, your interest will rise and fall with the prevailing interest rate at the time. Banks will offer an attractive fixed rate for a couple of years to sweeten the deal but don’t fall into the trap.
Unless the fixed rate option is very high (up to 10%), it is typically a better deal than its adjustable counterpart. At the very least, you know what to expect in terms of repayment every single month.
Finding the Right Home
Finally, the moment you’ve been waiting for (and congratulations for reading this far). As fun as it is to window shop, your search only begins in earnest when you’ve received pre-qualification from at least one lender.
Should I Use An Agent?
Agents can cost up to 6% of the home’s purchase price but in return, you receive valuable information, advice and help throughout the process. The seller pays the agent fees so if you don’t use one, you may be able to negotiate a lower sale price. There are buyer and seller agents; whether you use a buyer’s agent is entirely up to you. Typically, if you are new to the process, it is worth using their expertise.
Looking at Properties
Here are a few quick tips on your house hunt:
- Look at Lots of houses: You could be living in this home for most of the rest of your life so now is not the time for an impulse decision!
- Take Your Time: Take at least three months to find a suitable home and frankly, it will probably take even longer. Once you find a candidate, take a lot of pictures and write down things you like and dislike about it.
- Think Long Term: Don’t reject a house because you don’t like the color of the walls! Remember, once you own it you can redecorate it in your image.
- Check out the Neighborhood: Do your research to find out details such as the crime rate, demographics, school system and access to amenities. Visit the neighborhood several times during days, nights, weekends and weekdays. Finally, don’t be afraid to speak with potential neighbors. You can get an idea of what they are like and also ask them what is good or bad about the area.
- Find out if the Property is Part of an HOA: Homeowners Associations have certain rules about what you can do with your property. They pay for certain maintenance costs but also charge a monthly fee.
Making the Offer
Once you have settled on a home, the seller must give you a Disclosure report. This outlines the faults and defects they are aware of and it is a crime in many states for a seller to not disclose any problems they are aware of.
If you want to buy the home you must make an offer to the seller. It may be worth using an agent for this process; in general, you will be advised to offer slightly below the selling price. Unless there is a danger of the home being sold in a ‘hot’ market, you should never offer above the selling price. Here are some things to consider when making an offer:
- Your agent’s advice.
- The amount the bank is willing to lend.
- What the house is actually worth.
- How badly you want the house.
The seller may accept the offer, reject it and come back with a counter-offer or completely reject your bid altogether. At this stage you have to decide whether you want to proceed with a higher bid.
If both parties agree on a price, you will both sign a contract. Obviously, you must carefully read the contract before signing it but it should not be an obligation to buy the house. However, the seller will take the house off the market and give you time to have it inspected and appraised.
Never sign a contract that obligates you to purchase the house!!!
After signing the contract, you can expect to pay ‘earnest money’ which is a good faith payment. You should get it back if the purchase doesn’t go through. By the way, you’ll also need a Title Company which handles the ‘earnest money’ and a few other issues.
Once you own a house you have its Title. It is usually worth getting Title Insurance to protect you against claims made on the property. For example, if the seller didn’t pay his property taxes, the burden will fall on you unless you’re insured.
At this point you’re required to have a Survey of the property. This is an official drawing which outlines the dimensions and lines of the home. This can cost up to $400 although it might be included in the Closing Costs.
Inspecting the Home
The next step is to hire a professional inspection company to thoroughly check the house to see if there are any serious structural flaws and they will give you a detailed written report. This might cost you at least $300 and you must pay it upfront. Don’t allow the bank to choose the inspector for you; go online and find a reputable one yourself.
The inspection will take a minimum of 60 minutes and you should be present so the inspector can show you any problems he finds and explain them clearly. Other optional inspections include one for termites and a hydrostatic test of the drain to check for leaks. The latter option is essential for properties that are 30+ years old.
If the inspector finds serious problems with the property, you can back out of the purchase as long as your contract enables you to do so. The FHA 203k program provides you with the money to make the repairs in the form of a loan. Another option is to renegotiate the fee with these issues in mind. The seller may agree to pay for the repairs or pay for the closing costs for example.
Otherwise, you should simply walk away and hopefully, your contract gives you this protection. If not, you’ll be forced to purchase the property.
If you still want to buy the home after the inspection, the next step is having the value of the home appraised. This action is taken by the lender as it wants to ensure the property is worth what you’re paying for it. Do you think your bank wants to loan you $250,000 for a home worth $200,000? Unfortunately, you have to pay for this service!
If the appraisal shows that the property is worth less than the loan, the bank won’t give you the money. At this stage, you either agree to pay the difference yourself, get the seller to lower the price or walk away. This shouldn’t happen as the value of the property should be well known by this stage.
Now you contact the bank and ask for the basic loan terms.
You also have to purchase homeowner’s insurance; your bank won’t give you the loan otherwise. This cost will simply be added to the mortgage by your lender.
It’s Closing Time!
Finally, the saga is almost at an end. This process involves signing a huge array of paperwork at the office of the Title Company. You pay the money and the Title Company ensures that the property is actually the seller’s, there are no claims against the property and a number of other minutiae.
Be sure to bring a check for the down payment and you may also need a check for the closing costs if they haven’t been included in the loan. Closing costs usually come to 2-5% of the purchase price which can be a considerable sum of money.
Ask your lender to wire the money straight into the Title Company’s account so you aren’t forced to carry a six figure check with you.
We hope you found this guide informative and would advise you to take into account the myriad of fees and costs associated with purchasing a home. Too many buyers only think of the down payment and mortgage repayments without realizing the costs associated with Agents, Closing, Appraisal, Survey, Inspection, and Attorneys.