For many of us, a home will be the single largest purchase we will make during the course of our lifetime. Buying a home requires an understanding of all the factors that will impact a potential purchase and savvy management of finances to close the deal.
Getting it done the right way, limiting emotion to the greatest extent possible, will serve you well. What follows is a one-year plan for preparing for homeownership.
Suggested activities during the first six months:
• Start saving and understand the different types of available loans
• Check and improve credit reports as necessary
• Determine your needs
• Determine the mortgage you can afford through budget analysis
Day 1 of Month 1, Start Saving: The down payment required will vary by loan type. With a VA loan, $0 down is required for eligible members (i.e. service members, veterans, and eligible surviving spouses). Another government program, the FHA home loan, requires a minimum of 3.5% down. With conventional loans, a minimum of 5% down is possible with a good credit score. However, if less than 20% is put down, the lender will likely require Private Mortgage Insurance (PMI) which will increase your monthly mortgage payment. The more money you put down, the better the chances of securing a loan and avoiding PMI.
Month 1, Check Your Credit Reports: A good credit report, generally considered to be a FICO score above 700, can be a valuable asset. With a higher score you can get a better interest rate on a loan. Even seemingly insignificant errors can result in a higher interest rate or cause you to be denied a loan completely. Therefore, check your credit report regularly for completeness and accuracy from all three bureaus (Experian, Equifax, and TransUnion). Free credit reports are available through Annual Credit Report, a government-approved site.
Months 2 – 3, Determine Your Needs: The home’s neighborhood, square footage, number of bedrooms, etc. will determine the cost. Spend some time researching different potential neighborhoods and evaluating how much house you really need early in the process. By doing so, you will get an idea of how much your desired home will cost and the amount needed for a down payment.
Months 4 – 6, Determine The Mortgage You Can Afford: Developing a budget – a spending plan for the money you earn – is critical for determining the mortgage payment you can afford. The first step in the budget process is to track expenses over a three-month period, identifying ways to decrease expenses – freeing up more money to contribute to savings for the down payment – and helping with determining the mortgage payment you can afford are two benefits to tracking expenses and budgeting.
Suggested activities during the second six months:
• Account for new expenses in your budget
• Continue to save, save, save
• Perform detailed research
Month 7, Account For New Expenses In Your Budget: You can expect larger bills and new expenses with a home. As a renter, some of your utilities (e.g. water) may be paid by a landlord, and those you pay now are likely to be higher in a larger house. Additionally, there will be new expenses such as property taxes, homeowner’s insurance, and maintenance. Be prepared to update your budget accordingly.
Months 8 – 10, Continue Saving: Along with your credit score, the amount you are able to save will be a key factor in determining if you will be able to afford a house. During this period, verify the anticipated amount of money you will have for a down payment as you will need that information when you speak with potential lenders.
Months 11 – 12, Perform Detailed Research: Get recommendations for potential lenders from friends and family. Evaluate your bank, other mortgage bankers, as well as credit unions. From these sources, identify at least three potential lenders. The lenders you have chosen will pre-qualify you for a loan based on your gross monthly income, total monthly payments (e.g. car and credit card payments, etc.), and credit score to determine the amount of the loan – and the interest rate – they would be willing to make to you.
With the costs of potential homes in mind and the offers from the lenders in hand, use an online mortgage calculator to determine what your monthly payment would be based on the loan amount, the down payment, the interest rate, and factors such as PMI if necessary. Doing so will reveal if you have enough money for a down payment on a home that meets your needs and if you can afford the monthly payments. If not, do not get discouraged. Now that you have started saving, managed your credit report, understand the process of picking a lender, understand how much you will need for a down payment, and identified the amount required run a home on a monthly basis, you are in a good position to buy a home at a slightly later point in time.