Home Financing Made Simple
Are you financially prepared to buy your first home?
Learn how to establish your financial stability before you enter the home market, as well as the steps to procuring a home mortgage.
Buying your first home can be equally as exciting as it is intimidating. You cannot wait to have a place of your own, but the large financial investment it entails leaves butterflies in your stomach. This article will be a short reference guide to the step-by-step planning and execution of your financial preparedness, including the application for and securement of a mortgage loan, in the endeavor to purchase your first home.
Step 1 – Identify Your Dream Home
Before we dive into finances and loans, it is a good idea to focus your home search. Identify your dream home by listing your long-term goals, ideal floorplan, and desirable features and amenities. Do you want a traditional single-family abode? Or do you and your spouse hope to have children, and so need a residence with room to grow? Will you stay rooted in the same city, state for good? Or can a career change promote you to live and work on the other side of the country? Do you love to cook, and so desire a gourmet kitchen with top-grade appliances? Consider what you are looking for in a home before shopping the market, so you can save time in your search and maybe focus your price range.
Step 2 – Establish Financial Stability
Prior to shopping the market, you should review your gross income versus your total monthly debt obligation and confirm your state of financial stability so as to ascertain how much home you can really afford. Using Lennar’s Home Affordability Calculator, you can estimate the home price you can pay in the city of your choice; the calculator will also guesstimate how much you could owe in property taxes and homeowners insurance, as well as monthly mortgage fees. Please note, however: The elements of a mortgage strongly depend on a lender’s findings during pre-approval, a process we will later discuss in this article.
Step 3 – Set a Budget
While navigating the road to homeownership, you will encounter several expenses beyond the home price. If you have not done so already, now is the time to set a budget so you can pay the following:
- Earnest money is your initial deposit to the seller to show your good faith in the intent to purchase the home; if the transaction of sale is finalized, the earnest money goes toward your down payment.
- A down payment is 3% to 20% of the sale price paid in cash at the time of the home purchase; the higher the down payment, the lower your monthly mortgage payments will be.
- PITI stands for the four components of a mortgage payment:
- Principal is the balance of a loan
- Interest is the lender’s fee for the license to borrow the money
- Taxes relate to property taxes
- Insurance points to property insurance and private mortgage insurance (PMI)
Experts recommend your mortgage costs no more than 25% to 30% of your yearly income.
- The home inspection fee is paid prior to the down payment and gives you a written disclosure of any faulty construction, product installment, and system operability of the property.
- A home appraisal fee is paid at closing, and the appraisal is required by the mortgage lender to determine a property’s value versus its sale price; if the value is lower than the price, the lender can refuse to fund your purchase.
- Closing costs include the home inspection and appraisal fees, as well as several other charges, depending upon location, the property you buy, and the loan type you choose.
In addition to these expenses, you should factor in the costs of moving, shopping for home furnishings, utilities, as well as homeowners association fees; and, it is always a good idea to establish an emergency fund for surprise maintenance and renovations.
Learn more about budgeting for a new home here.
Step 4 – Know Your Loopholes
First-time homebuyers may be entitled to tax deductions, credits, and other breaks not available to existing homeowners. In her article, “7 Tax Breaks Every First-time Homebuyer Must Know”, former financial advisor, Sarita Harbour, tells her readers, “The tax landscape changes yearly (and)…the government provides tax breaks for existing and new homeowners to incentivize buying homes.” She goes on to explain the inner workings of each tax break listed here:
- Home mortgage interest deduction
- Mortgage interest credit
- Mortgage points deduction
- Tax-free IRA withdrawals
- Property tax deduction
- Home improvement tax breaks
- Home energy tax credits
Remember, a tax deduction reduces your taxable income, while a tax credit counts against what you owe on your tax bill.
To learn of all tax exemptions available to you as a new homeowner, review Publication 530, Tax Information for Homeowners, published by the Internal Revenue Service (IRS).
Step 5 – Get Pre-approved for a Mortgage
Once you ascertain your financial stability, you want to shop for a mortgage. Lennar’s affiliated mortgage company provides the most appropriate loaning options to suit a homeowner’s needs. When you approach a lender for a quote (i.e., an outline of costs that includes your monthly mortgage payment, mortgage points, application fees, appraisal fees, underwriting fees, and other dues paid at closing), you will be pre-qualified by the lender. Pre-qualification is a non-binding process in which you provide preliminary information to the lender concerning your income, monthly dues, and assets, so they can estimate how much you may qualify to borrow. Please note: Your pre-qualified sum will not carry much weight with the builder or seller, as it is not a guaranteed figure. To get your foot in the door of the home of your dreams, you must get pre-approved.
Pre-approval is a more in-depth examination of your finances and current credit rating, performed by the lender, to determine if you really qualify for the loan and/or the maximum amount the lender is willing to lend you. You will have to provide the lender with the documentation they require to verify your residential history, employment, income, assets, and personal debt. Each lender will also ask to pull your credit report to check your creditworthiness, and while most hard inquiries hurt your credit score, the credit bureaus show some leniency if you are shopping for a mortgage. The bureaus recognize that all mortgage-related queries end in you committing to a single loan contract, and so view multiple inquiries as a single credit pull in a focused period of time, typically 14 to 45 days.
Step 6 – Know Your Loan Options
To save time when you approach a lender, it is a good idea to familiarize yourself with the loan options that may or may not correspond with your financial situation and goals as a first-time homebuyer. First, consider the timeframe in which you want to pay off your mortgage. The most common terms are 15-year and 30-year contracts. Often, homebuyers favor a 30-year mortgage because of smaller monthly payments; however, 30-year terms come with higher interest rates, and you pay more in interest over the life of the loan than if you were to take out a 15-year contract. You can use this Amortization Calculator to see how the principal and interest are paid off over the life of your loan, be it a 15- or 30-year contract.
All loans fall under one of two interest rate categories. Fixed-rate mortgages feature fixed interest rates for the entire term of the loan, while adjustable-rate mortgages (ARMs) have an initial rate that is set below the market rate on a comparable fixed-rate loan, and after a fixed period of time, the rate resets based on current market rates. Most ARMs come with caps to limit how high your interest can increase each adjustment period.
Loan types may be classified as government-insured and conventional. Government-insured loans guarantee a lender is repaid should a borrower default on paying their mortgage. FHA loans are financed by the Federal Housing Authority and allow you to make a down payment as low as 3.5%; however, if your down payment is less than 20%, you will be required to pay PMI with your monthly payments. VA loans, endorsed by the U.S. Department of Veterans Affairs, permit military personnel and their families to receive 100% financing for their home purchase with no mortgage insurance. USDA loans, supported by the United States Department of Agriculture, offer 100% financing to borrowers with low to moderate incomes to buy a home in designated rural areas.
Conventional loans are not guaranteed or endorsed by a government agency, and these loan types include the following:
- Conforming loans conform to the guidelines established by Fannie Mae and Freddie Mac.
- Non-conforming loans do not follow the guidelines set forth by government-sponsored enterprises, and those that go over the loan limits set by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation are called jumbo loans.
- Portfolio loans are serviced by the lender and held on their books for the life of the loan, rather than sold to investors.
- Subprime loans are marketed to borrowers with low credit scores and typically feature high interest rates and fees.
Step 7 – Get Through the Underwriting Process
After you have been pre-approved for a mortgage and made an offer on a home, you have to get through the loan underwriting process. As strange as it sounds, this is the step where you officially get approved for the loan. It is the responsibility of an underwriter to investigate and verify that you have represented yourself and your finances truthfully in your loan application. The underwriter will evaluate your credit, debt-to-income ratio, current debt obligations, and job history.
During the underwriting process, you will want to avoid shifts in your finance, such as changing jobs, taking out additional lines of credit, or increasing your debt. The underwriter will assess how great a risk you are based on your income and total debt obligation. If you accumulate more debt during the underwriting process, your credit score may drop, and/or a lack of sufficient income will increase your perceived risk.
Step 8 – Lock in Your Mortgage Rate
After you have chosen a loan type, it may be beneficial to lock in the interest rate on your mortgage. A mortgage rate lock is a lender’s promise that the borrower can lock in the prevailing market interest rate for a specified period of time – usually 30, 45, or 60 days, as the loan application is processed for approval. The earliest a borrower can lock in the rate is after the loan’s initial approval; however, it may be better to lock in the rate after you sign the purchase agreement and mov e to process the loan application.
Step 9 – Secure a Mortgage Contingency
A financing or mortgage contingency is a written provision in the home purchase agreement that says you and the builder or seller of the home agree that if you, the buyer, are unable to acquire the mortgage within a fixed period of time, the deal can be called off and your earnest money returned. Contingency clauses are designed to protect buyers from financial loss in the event a home purchase falls through, be it due to circumstances on the part of the buyer or the seller. Additional clauses to look for in your purchase contract include an appraisal contingency, home sale contingency, and home inspection contingency.
Sources: 5 Steps to Buying a Home That Won’t Bust Your Budget by Dave Ramsey; How Do I Buy a House? The Loan Process Explained by Kevin Graham; How to Get a Mortgage by Michael Burge
Additional Sources: 3 Tax Changes That Would Affect Homeowners by Kathryn Vasel; Homeowners: Use These Year-end Tax Moves to Save Ahead of Tax Reform by Sarah O’Brien; Credits for First-time Homebuyers by Gina Roberts-Grey; 7 Myths About the First-time Homebuyer Tax Credit by Trulia; Shopping for a Mortgage by The Federal Trade Commission; Shopping for Mortgage Rates by Investopedia; Pre-qualified vs. Pre-approved – What’s the Difference? by Brian O’Connell of Investopedia; How to Get Pre-approved for a Mortgage Home Loan by Brooke Niemeyer; What Documents Are Part of the Mortgage Process? by USBank; Documents Needed for the Mortgage Pre-approval Process by Brandon Cornett; Will Rate Shopping Hurt My Credit Score? by Credit Karma; Comparison of a 30-Year vs. a 15-Year Mortgage by R. Julius Mandelbaum; Mortgages: Fixed-rate Versus Adjustable-rate by James E. McWhinney; Fannie Mae: What It Does and How It Operates by Wendy Connett; What is an Underwriter: The Unseen Approver of Your Mortgage by Angela Colley; When to Lock in a Mortgage Rate by Zillow; When Should You Lock a Mortgage Rate? by Michele Lerner; What’s a Mortgage Rate Lock, Do I Need One and How Do I Get One? by Hal M. Bundrick; What You Need to Know About Mortgage Rate Locks by Scott Sheldon; Contingency Clauses in Home Purchase Contracts by Jean Folger; What is an Underwriter: The Unseen Approver of Your Mortgage by Angela Colley