Purchasing your First Home: How to Choose a Mortgage
Most people dream of owning a home someday. It is exciting to imagine a place you can plant roots and call your own. But with any large purchase, buying a home can be overwhelming — especially for a first-time homebuyer. Do not embark upon this journey feeling intimidated. Rather, take the time needed to familiarize yourself with the process and pre-planning steps involved in buying a home. Here are a few steps to consider in your home buying journey.
Understand Your Credit
It is advised to check your credit report several times per year, especially before a large purchase such as a home. AnnualCreditReport.com provides a free credit report from each of the three credit reporting agencies each year. Always inspect your credit report for errors, and dispute and correct errors.
Credit scores range from low 300s to mid-800s, and help financial institutions determine potential borrowers risk level. A borrower with a high credit score receives more loan choices and better rates than a borrower with a low credit score. Those with poor credit should take the time to improve their scores before applying for a mortgage loan. The lower your credit score, the harder it is to receive a loan and the higher the Annual Percentage Rate (APR).
How Much Can You Afford?
Income is the biggest factor in determining how much home you can afford. A general rule suggests a reasonable sales price will cost between two to three times your annual gross salary. Because everyone’s financial situation differs, consider the many factors associated with homebuying to determine what you are truly comfortable spending.
Consider your overall financial picture.
Take into account your monthly gross income, living expenses and any long-term debt. If you have debt or other financial obligations, you may need to spend less on your home because you do not want to allow housing costs to rule your life. Decide what you can afford with this home affordability calculator.
Break down monthly housing costs.
Determine if the costs associated with home ownership works within your budget. Consider monthly payments that include mortgage payments (principal and interest), property taxes, homeowner’s association (HOA) fees, mortgage and homeowners insurance, repairs, renovations, etc. Decide your comfort level after utilizing online mortgage calculators to estimate your monthly payment.
Track your spending.
There are online tools such as Mint to help analyze your current spending habits. Create a projected budget and once these expenses are accounted for, do you still have money left over for savings, vacation or a college fund?
Determine your down payment.
A 20 percent down payment usually provides the best rates and options. Some lenders require private mortgage insurance (an additional monthly expense) if your down payment is less than 20 percent. However, there are loan programs that offer low down payment options, or zero down payment programs with the VA or USDA). There are many down payment options, so select the option that works best without draining your savings account. (Ref mortgage calculator)
Explore Loan Choices
While you begin shopping for your new home, you should begin exploring loan options. There are 15-year or 30-year mortgages with fixed or adjustable rates (conventional, Federal Housing Administration or other special programs). Consumer Financial Protection Bureau (CFPB) warns consumers to be aware of risky loan features such as balloon payments or prepayment penalties.
Meet with several reputable lenders and get at least two offers in writing and ensure you understand the costs and benefits of each. Compare mortgage loans, costs, APR and Total Interest Payments (TIP). From there, chose the best loan offer.
Gather Important Documents
Lenders require many documents when you apply for a mortgage. It is helpful to gather recent paystubs, documentation of additional income, two most recent bank statements, W-2 forms and federal tax returns for the previous two years, source of down payment, proof of your identity, Social Security number, Certificate of Eligibility (if using VA loan) and other requested documents.
Purchasing a home is an important financial decision that requires adequate planning. There are great local resources available to provide more detailed homebuyer education and counseling such as the Hawaii Homeownership Center. There are additional tools and counselors available at CFPB and U.S. Department of Housing and Urban Development. Take the necessary time to mentally and financially prepare for one of the biggest purchases you will ever make. Your dream can be reality with adequate education and preparation.
Want a little more help? Check out our eLearning modules on CONSIDERING HOME OWNERSHIP and MORTGAGES.