Almost two years ago, I became a homeowner.
I had no idea what I was getting myself into when Kate and I decided we were ready to buy a home. I naively thought there wouldnâ€™t be much to it. Visit some open houses, talk to the bank, sign some papers, and boom, Iâ€™d have a piece of the American Dream.
Boy, was I wrong.
Buying a home is a complicated, multi-step process. Down the road we plan to devote entire posts to many of the steps along the way. Today, however, weâ€™ve set out to provide you with the big picture of what to expect when buying your first home. It’s basically theÂ roadmapÂ I wish I had when I was neck-deep in the process.
It should be noted that each state (and country) has vastly different laws regarding real estate. This is a rough idea of the process, but especially when it gets to working with realtors, making offers, and the closing process, things can look quite different. Research you own stateâ€™s or countryâ€™s processes.
Determine If Buying Is Right for You
Before you start attending open houses and munching on free cucumber sandwiches, you need to figure out if buying a home is even the right move for you. It’s a big decision that comes with huge time and financialÂ commitments. When figuring out whether buying makes sense right now in your life, take into account your finances as well as your future plans. For help in thinking through the pros and cons, check out our guide on whetherÂ you should buy a home or rent.
Get Your Financial House in Order
Once you decide to move forward, it’s time to get your financial house in order to prepare for buying a physical one. Here are some things to consider doing:
Start saving for a down payment.Â If you haven’t already, start saving for aÂ down paymentÂ on your mortgage. Most traditional mortgage brokers require that you have at least a 20%Â down paymentÂ to qualify for a mortgage. Even if you’re able to secure a Federal Housing Administration loan (FHA loan â€“ for first-time home buyers only), you’ll still need to have at least a 3.5%Â down payment (some loans will require a 5% down payment. Â For a $250,000 mortgage, that means you’ll need at least $8,500 in the bank, and that doesnâ€™t include all the other costs that go along with buying a home, as weâ€™ll find out later. That’s nothing to sniff at. Start saving today.
Get a copy of your credit report and credit scores.Â When a bank decides whether to loan you money for a home, one of the things it’s going to look at is your history as a borrower. They want to know that they can trust you to pay back this massive amount of money they’re about to give you. To determine whether you’re creditworthy, the bank or mortgage broker is going to look at yourÂ credit report and credit score.Â Before the banks pull your report and score, it’s a good idea to take a look at them yourself to ensure that there aren’t any errors that could hurt your chances for securing a mortgage. Errors to look for include accounts that don’t belong to you, wrong addresses, incorrect payment status, andÂ remediedÂ delinquenciesÂ not reported as such. If you find any errors, take action to correct them as quickly as possible as they can sometimes take a long time (and be nigh near impossible) to fix.
If you don’t have any errors on your credit report, but your credit score isn’t that hot, start taking steps to improve it like paying your bills on time and reducing the amount of debt you owe.
Gather financial documents.Â When you apply for a home mortgage, your financial life is going to be put under a microscope. You’ll have to provide enough documentation to prove that you’re financially capable of paying back a large loan. I wish I had done this step earlier in the process and not waited until I was actually applying for a loan. Despite having most of my financial documents digitized, it was still a choreÂ corrallingÂ them together. Below are the documents you’ll likely need when applying for a mortgage:
- W2 statements (or 1099 income statements) for the last two years
- Federal tax returns for the last two years
- Bank statements for the last few months
- Recent pay stubs and proof of other income
- Proof of investment income
GetÂ pre-qualifiedÂ for a loan.Â Call up your bank and ask to getÂ pre-qualified for a loan. When you getÂ pre-qualified for a loan a bank takes a cursory look at your financial status and tells you whether you’d be able to qualify, and if so, roughly how much of a mortgage you can get. This can give you a rough idea of how much house you can afford when you’re out looking. GettingÂ pre-qualified is quick and easy. You can usually do it over the phone or even online. One important thing to understand is that getting pre-qualified for a loan doesn’t guarantee that you’ll actually get a mortgage for the amount the bankÂ pre-qualifies you for. That number can change as the mortgage broker takes a deeper look at yourÂ finances.Â Again, it’s a rough estimate.
Start Shopping for a Mortgage
One thing I wish Kate and I had done earlier in our home buying process was shopping for a mortgage. While we wereÂ pre-qualified, we didn’t start mortgage shopping until we actually found the home we wanted. There are a few advantages to starting the mortgage shopping process sooner rather than later, like negotiating a better mortgage rate or gettingÂ pre-approved (which is different than being pre-qualified â€“ read on) for a loan. When it comes to picking a mortgage, we could write several posts about it (and we will in the future), but for now, letâ€™s move on with the big-picture overview.
Where to get a mortgage. Â
Start your mortgage shopping with your personal bank or credit union. They often offer good rates for long-time customers. But don’t stop there. Hop online and use a web-based mortgage rate finder likeÂ Bankrate.com. You’ll find dozens of mortgage brokers to choose from. Itâ€™s worth considering local institutions as well versus just big banks. As with anything, they often provide a personal touch of service that you wonâ€™t find elsewhere. If you decide to work with a realtor, theyâ€™ll also often have good recommendations or lenders they routinely work with.
What type of mortgage is right for you?
You have several choices when it comes to picking out a mortgage. Each type has their pros and cons.
Fixed-rate vs. adjustable-rate loans. The most common type of mortgage is a fixed-rate mortgage. With a fixed-rate loan, the rate stays the same over the life of the loan. The big pro with fixed-rate loans is the peace of mind that comes with knowing that your monthly mortgage payments won’t fluctuateÂ dramaticallyÂ from year to year.
On the other hand, adjustable rate mortgages, orÂ ARMsÂ as they’re often called, have an interest rate that changes based on what happens to interest rates in the economy as a whole, which can be good or bad. If interest rates drop, your mortgage payment should drop. But if they go up, your payment can quickly get out of hand.Â ARMsÂ are tempting for first-time home buyers because their initial rates are lower. And because monthly payments onÂ ARMsÂ are typically lower at the beginning of the life of the loan, they can also be easier to qualify for. The problem withÂ ARMsÂ is that you’re taking a big gamble. If interest rates go up, you may end up paying much more than if you had gone with a fixed-rate mortgage.
30-year vs. 15-year. This refers to the number of years it takes to pay off the mortgage. 30-year mortgages are the easiest to qualify for and are the most common. 15-year mortgages are much harder to qualify for and have higher monthly payments because youâ€™re paying off the house in half the time. TheÂ obvious benefitÂ is that you pay off the loan and build equity faster than you would with a 30-year mortgage. If you have a goal to pay off your home as quickly as possible, just get a 30-year mortgage and pay extra. Making just one extra payment per year on a 30-year mortgage can reduce the life of the loan by five years. If you ever have to cut back onÂ mortgageÂ payments, you won’t be stuck with the highÂ minimumÂ monthly payments that come with 15-year mortgages. Just make sure you get a 30-year mortgage that doesnâ€™t have prepayment penalties.
Balloon mortgages. Stay away from them. The way they work is that you make small monthly payments for a fixed number of years — usually five to seven — and then you’re required to pay off the loan in one giant lump sum. Balloon mortgages got a lot of homeowners in financial trouble during our recent housing crisis. Folks who thought they’d be able to sell their homes before the lump sum came due were stuck in homes they couldn’t find a buyer for. Consequently, they couldn’t pay their mortgage, which in turn resulted in foreclosure and bankruptcy.
Look into FHA loans.Â An FHA loan is a home loan insured and backed by the federal government. FHA loans offer low down payments and lower interest rates than traditional home loans. They’re geared towards first-time homeowners who might not have cash to pay the full 20% on aÂ down payment. To apply for a FHA loan, you’ll need to find a FHA-approved lender and meet a few requirements.Â There are some downsides to FHA loans. First, youâ€™re required to purchase an upfront mortgage insurance premium of 1% of the total loan. You also pay a modest fee with each monthly payment for the life of the loan. Check out the Housing and Urban Development’s website for more info about applying for an FHA loan.Â
GetÂ pre-approved for a loan.Â
Whether you go for a 30-year fixed or a 15-year ARM, your goal should be to getÂ pre-approved for a loan.Â Pre-approval is a step aboveÂ pre-qualification. According to the Consumer Financial Protection Agency, when you’reÂ pre-approved for a loan, “the lender has evaluated your creditworthiness and has committed to extending you a loan up to a specified amount.” To getÂ pre-approved, you’ll need to provide a lender with pay stubs and W2s and two to three months worth of bank statements. When a bankÂ pre-approves you for a loan, they’ll issue you a letter that you can show sellers during the negotiation process. Buyers withÂ pre-approval often have a leg up on buyers who don’t. Put yourself in the seller’s shoes. Who would you rather say yes to? The guy with a letter from the bank that says they’ll pay the full amount for the home or the guy who has nothing but his word that he’ll be able to afford the house.
Pre-approval isn’t a guarantee that you’ll get the loan in the end. There’s a chance that something will pop-up in the moreÂ thoroughÂ loanÂ underwritingÂ process that will cause the lender to change its mind. Think ofÂ pre-approval like getting engaged. It’s aÂ commitment, but until you get married (i.e. actually get the mortgage) each party can still back out.
Start Looking at Houses
Watch HGTV.Â I never watched a minute of HGTV before we started thinking about buying a home. But as soon as we decided to start looking, I was watchingÂ House HuntersÂ all the time. While the show is definitely staged, I actually found it to be helpful in getting an idea of what I wanted in a house and how the home buying process, in a very rough sense, worked. It can also help tamper your expectations, as you often find happy-go-lucky couples who just expect to instantly find their dream home and for everything to be perfect. Not how it works in real life. (Watch episodes online even if you donâ€™t have cable.)
Attend open houses.Â Browse through the real estate section of your local newspaper and find some open houses to attend on the weekends. You can also find listings on popular real estate websites and apps like Zillow, Trulia, and Realtor.com. Your goal at these initial open houses is to just get an idea of what you like and don’t like in a home. For me, I found this casualÂ reconnaissanceÂ to be immensely useful. For someone who had only lived in one home his entire life (my childhood home), I really didn’t have a good idea on the different types of layouts andÂ amenities possible in a home. Seeing several homes in-person helped me develop my preference. Open houses are also useful for scouting out possible buyer’s agents (more on that later).
Make a list of features your ideal home has and make a list of deal breakers.Â Once you have an idea of what you like and don’t like in a home, sit down with your spouse and make a list of the features in your ideal home, as well as a list of your deal breakers. What are the things you must have, and what are the things that you absolutely wonâ€™t live with? Housing and Urban Development has a nice little PDF to help guide you through the process. Make sure you and your wife are on the same page before you get serious about looking. It will take some negotiation and compromise, but the effort will be well worth it.
Decide whether you want a realtor.Â During the casual browsing phase of home shopping, decide whether you want a buyer’s agent. Kate and I initially wanted to buy a home without aÂ realtor, but quickly discovered that finding homes that fit our criteria was super time consuming. I was spending hours each week browsing homes online and setting up appointments to look at them. It started to get tedious, so we ended up hiringÂ realtorÂ Ray NashÂ to help us out. Ray was awesome. We told him our list of likes and dislikes in a home and the next day he created a customized database of homes to browse through. When a new house came on the market that met our criteria, he added it to the database so we could check it out. All we had to do was tell Ray which homes we wanted to look at in person and he set up the appointments to visit them. Ray saved us a boatload of time. It was also nice having someone hold our hand and guide us through a completely foreign process. As we moved towards actually closing on a home, Ray took care of setting up things like the appraisal and inspections as well as ensuring all the loose ends were tied up before closing day.
Now you might be asking, “Will I have to pay for the services of a buyer’s agent?” The answer to that is quite complex, but typically it’s theÂ seller, and not the buyer who pays the commission for the buyer’s and the sellerâ€™s agent’s services. However, the buyer and seller can negotiate the price of the home so that the buyer, in effect, pays for the commissionÂ of his agent. For details on how real estate agents are paid clickÂ here.
Narrow Down Your List of Homes andÂ RevisitÂ Them
It’s time to get serious about finding a home. Narrow down your list of prospective homes to three or four and revisit them. When you do,Â take along this checklist of things to inspect.
Make an Offer
Once you’ve found the home of your dreams, it’s time to make an offer. Before you do, know your “walk away” number — the price at which you’ll walk away from negotiations because it’s just too high. When crafting your offer, consider addingÂ contingenciesÂ like having broken appliances repaired at the seller’s expense. You can even ask that the seller throw in a piece of furniture into the sale. Everything is negotiable!
Some things that can help you get a “yes” on your offer include beingÂ pre-approved for a mortgage and being flexible on the closing date. In our case, being flexible with the closing date helped us snag a deal. The guy we bought our home from hadn’t found a new place yet, so we offered to put off the closing date for an extra two months so he could find a new home. We still had a few months left on our apartment lease, so we weren’t in a rush. The other folks interested in buying the house needed to move in ASAP. Flexibility won the day.
When you make an offer, the possible answers are yes, no, or a counteroffer. Don’t expect to get a “yes” on your first offer. Unless you’ve put up aÂ severelyÂ lowballÂ offer, the buyer will likely return with a counteroffer. You can either accept it or give another counter. If the seller decides to endÂ negotiationsÂ with you, lick your wounds and move on to the next house.
Get the Purchase Contract
Once you get a verbal “yes” from a seller, the next step is writing up a purchase contract. The purchase contract essentially puts everything you negotiated verbally into writing. The typical clauses you see in a purchase contract include the following:
- Legal description of the property, including zoning information
- Purchase price andÂ terms of the sale
- Down payment to be held in escrow, and future payment structure
- Closing date — when the deed will change hands
- Any items included in the sale, such as appliances and furniture
- Disclosure ofÂ lead paint (lead-based paint disclosure form for buildings built before 1978) and other defects
- HomeÂ warrantiesÂ andÂ warrantiesÂ on appliances
- Commissions, if any
Your purchase contract will likely haveÂ contingencies that could void the contract if they’re not met. CommonÂ contingenciesÂ include passing the home inspection, the appraisal meeting the selling price, loan approval, and the title being free and clear.
Get Home Inspected and Appraised
After you’ve signed a purchase contract, your next step is to get the home inspected and appraised. As a buyer, you’re responsible for these costs, so have your checkbook handy. If you have a buyer’s agent, he or she will usually take care of setting up the inspections and appraisal for you.
We had two inspections done on our house. The first was a termite inspection to ensure that we 1) didn’t have termites, and 2) didn’t have any termite damage. The second inspection was a general inspection performed by aÂ certified home inspector. This is a prettyÂ thoroughÂ inspection. He’ll check the condition of the house’s heating and cooling systems,Â electricalÂ systems, plumbing, as well as the structural components of the home like the foundation, walls, and roof. He’ll then create a detailed report that includes things you should beÂ concernedÂ about. It’s good to be at the house during the inspection so you can follow the inspector around and ask questions that you might have. If the inspector finds any serious faults with the home, you’ll need to decide whether to re-negotiate with the seller or just walk away.
The mortgage broker will typically provide a list of approved appraisers that you can call to set up an appointment with. The mortgage broker wants to make sure that the home is actually worth what they’re lending to you. If the appraiser reports that the value of the home isÂ lessÂ than the contracted price, your lender will likely not give you the loan. They donâ€™t want to fund something thatâ€™s worth less than the amount of the loan. The appraisal contingency will allow you to either 1) renegotiate with the seller for a lower price or 2) walk away from the loan.
Shop for Homeowner’s Insurance
Assuming the inspection and appraisal came out fine, the next thing you’ll want to do is shop around for homeowner’s insurance. Your mortgage broker requires it before they’ll finalize your loan approval. Buying home insurance isn’t that hard. I asked my friends and family which insurance companies they used, called them all to get a quote, and went with the best deal. The cost of homeowner’s insurance (as well as property taxes) is typically rolled into your mortgage payment. The mortgage lender puts that money in an escrow account and pays the cost of homeowner’s insurance themselves.
Finalize Loan Approval
In the few weeks leading up to the closing date, your mortgage broker will be underwriting yourÂ mortgageÂ application. TheÂ underwriter will likely ask for more documents or they’ll have questions about the documents you’ve already provided. Because I’m self-employed theÂ underwriterÂ had aÂ lotÂ of questions for me. I had to make several trips to their office with stacks of financial documents. Just roll with the punches.
After weeks or maybe months of work, the big day has arrived: Closing Day. Closings typically take place at a title company’s office. Depending on the complexity of the sale, closing usually takes about an hour and a half. Because you’re a buyer, you’re going to have a huge stack of papers to sign and initial, so make sure to warm up those finger muscles. To ensure that the closing goes off without a hitch, make sure to bring the following items:
- A certified or cashier’s check.Â Federal law requires that you be told the exact amount of the check you need to bring to closing at least one day before settlement. You will have to pay the down payment, plus the closing costs — usually 3 to 5 percent of your home purchase price minus your earnest money deposit. The closing agent will tell you whether you need one check or two and to whom they should be payable.Â Do not bring personal checks or cash.Â
- Proof of insurance.Â The closing agent needs to see proof you have the insurance in effect on closing day. Your lender likely has a copy of your proof of insurance, but bring an extra copy just in case.
- Photo ID.Â The closing agent needs to know you are who you say you are. A driver’s license or current passport will do the trick.
- Your agent or attorney.Â Especially if you are a first-time buyer, you should have someone with you who understands the process and represents your interests. In some states, you’re required to have an attorney present. Check your local laws to find out if that’s the case for you.
- Purchase and Sales Contract.Â Just in case you need to double-check a detail against closing costs.
Congratulations! You’re a Homeowner
Once you’ve signed the last document and the closing agent has dropped the keys in your hand, you’re officially a homeowner. Congratulations! Go out and celebrate with a big juicy steak. As soon as you’re done, though, it’s time to start thinking about moving in. But thatâ€™s a subject for another post.
Any other advice to offer a first-time home buyer? Share it with us in the comments!