NEW YORK (MainStreet) — Buying your first home comes with equal doses of trepidation and elation with the knowledge that you are sinking your hard-earned money into a single dwelling, possibly for the next 30 years.
Yet the yearning for your very own abode could defeat any remaining feelings of apprehension. Here are some tips to prepare you for one of the largest commitments you will encounter as a tax-paying adult.
Make sure to take all the expenses of owning a home into consideration. Don’t look past your monthly mortgage payment and budget other recurring expenses such as homeowner's insurance, association fees, taxes or private mortgage insurance. Strive to keep all these costs below 30% of your total income, said Jason van den Brand, CEO of Lenda, a San Francisco-based online mortgage company.
If you are purchasing the house with someone else, make sure you know their credit score. Even if you are buying the home with a spouse or a family member you know fairly well, finding out their credit score before you apply for a mortgage can make a difference.
When you apply for a mortgage with a co-borrower, the lender will look at the lowest middle score when giving you an interest rate, he said. There are three major credit bureaus and each one calculates your credit score a little differently. If your three scores are 760, 745, 739, then your middle score is 745. If your co-borrower has a middle score of 700, that is the score that will be used. “This could make a huge difference in the interest rate you qualify for and the amount of your mortgage payment,” van den Brand said.
Strive to save enough for a down payment to avoid private mortgage insurance (PMI). PMI costs between 0.5% and 1% of the loan value every year and easily adds another $100 to your monthly mortgage payment. On a $300,000 loan that is an additional $1,500 to $3,000 coming out of your pocket every year.
“This extra expense could end up being the difference between a mortgage payment fitting into your financial plan and making yourself strapped for cash,” van den Brand said. If you don't have the 20% for a down payment, but the total mortgage payment including PMI still makes sense financially, then move forward. When you build up equity, you can refinance the mortgage in a few years to get rid of the PMI.
Make sure the money you have for a down payment is set aside in an account that has been "seasoned," said Diana Hill, a real estate expert at Online Trading Academy, Irvine, Calif.-based education centers. Seasoned means you can show documented proof such as bank statements of the down payment for a minimum of three months.
Get your finances organized before applying for a mortgage. Start gathering all your paycheck statements, tax returns, investment account statements and bank statements. The more organized you are, the faster the process will be. This will also speed up the pre-approval process and the process of actually getting a home loan. “Getting all the paperwork together can be one of the biggest time drains so get it done before you start shopping for your new home,” van den Brand said.
It's important to have been in the same job for two years and have tax returns for the last two years, said Hill. Avoid changing jobs before you purchase a home, especially if it is a different field.
A survey from the Consumer Financial Protection Bureau showed that over 70% of home buyers only apply to one lender. This can be a huge financial mistake, van den Brand said. The survey also uncovered that rates can swing more than 0.5% for a conventional mortgage for borrowers with a 760 FICO score and 20% down payment.
“This is a huge multi-thousand dollar mistake,” van den Brand said. “Make sure you shop for a mortgage. Don't assume you'll get the best rate on a mortgage from your local banker or from the broker your real estate agent referred you to.”
Getting pre-approved from multiple lenders is not difficult either. You can also opt to get pre-approved once, but then shop around later. Getting pre-approved by multiple lenders within a 14-day period will only count as one credit pull and might impact your credit score by 5 points, he said. FICO put this in place to encourage people to shop around for a mortgage. The most recent FICO score ignores all mortgage or auto loan inquiries made within a 45-day window, said Keith Baker, a professor who teaches mortgage banking at North Lake College in Irving, Texas. Once the "window" has passed, loan inquiries are treated as one. “In an age of online financial services, it is easy to apply with many different firms when trying to find the best loan or rate of interest for a mortgage,” he said.
Avoid shopping for big ticket items before you close on your mortgage. Some stores like home improvement chains or furniture shops offer discounts or 0% interest for large purchases if you open a credit card account with them. Avoid opening too many credit cards in a short period of time. Lenders often pull credit reports right before the closing to make sure your financial situation has not changed since the loan was approved, said Kevin Gallegos, vice president of the Phoenix operations for Freedom Financial Network, a consumer debt resolution company. A new line of credit, or even having had a company check your credit rating, could cause your score to drop.
Build an emergency fund. Conventional wisdom holds that individuals need to save six to nine months worth of living expenses in an emergency fund. If that sounds daunting, start with the level of expense that causes you to rush to a credit card such as a car repair bill for $250 or a medical bill for $500. Your best bet is to have at least that amount available and build toward six or more months of living expenses, Gallegos said.
--Written by Ellen Chang for MainStreet