Robert Smith fits the profile of a savvy first-time homebuyer perfectly. A 34-year-old financial analyst from Buffalo, N.Y., he and his family had grown sick of living the renter's life. So two years ago he decided to test the market and find a townhouse for his growing family. But despite his financial aptitude, he quickly ran into a setback.
"We found a place we liked and ran the numbers," he says, but the young couple soon discovered that they had underestimated the burden of their college debt. They were forced to back out.
Robert's lesson goes to the heart of what every first-time homebuyer needs to know -- buying a home means so much more than paying a mortgage.
The first step toward buying a home takes place months before walking into your lender's office. It's crucial to check your credit score at least three to six months ahead of your mortgage application, says Rod Griffin, director of Public Education at Experian. You can request a free copy of the report from each of the three credit bureaus (Experian, TransUnion and Equifax) at annualcreditreport.com.
Even if you don't have sterling credit (generally a FICO score of 720 or above), the most important thing to do is to take stock of what the figure means. "Every score is educational," says Griffin. "It's more about why the number is than what the number is."
This is especially true since there are different proprietary scales used to gauge credit: the Vantage score, for instance, ranges from 501 to 990, while the FICO score runs from 300 to 850. Make sure to read the accompanying credit report to understand what your score actually means. It's also important to check for errors in the report, which can have a negative effect on your credit, and ultimately, your mortgage rate. One in four reports has an error serious enough to prevent homebuyers from getting credit, according to the U.S. Public Interest Research Groups. So get your reports well in advance of the house hunt.
A generation ago, it used to be the norm to put 20 percent down, but with the market in its current state of flux, many first-time homebuyers are finding ways to pay just 3 to 5 percent of the total cost upfront. Federal Housing Act (FHA) loans increasingly have become a popular option for first-time buyers, says Greg Herb, regional vice president of the National Association of Realtors. These competitively low-interest loans are ideal for buyers with less than perfect credit, and because the Department of Housing and Urban Development (HUD) minimizes the risk of default for lenders on these loans, borrowers are only required to put down 3.5 percent of the cost--a far cry from the traditional 20 percent down payment.
Still, there are advantages to paying more at the start. A larger down payment ultimately means smaller monthly bills down the line. Also, if you purchase a conventional loan (i.e.: one that is not backed by a federal agency), paying 20 percent or more upfront will eliminate the need to pay Private Mortgage Insurance (PMI) charges. PMI is insurance for your lender that can be paid upfront or in monthly installments, and is designed to offset your lender's risk in the case that you've paid less than 20 percent on your home. It can cost around $55 a month per $100,000 financed. While it's important to note that FHA loans also carry mortgage insurance with a down payment of under 20 percent, their low barriers to own still make them a good choice for first-time buyers.
Your debt-to-income ratio (DTI) is the percentage of your gross monthly income set aside for paying debts. While some loans may qualify you for up to 50 percent of your monthly gross income, it's advisable that you use no more than 30 percent, says Joe Adamaitis, a mortgage banker in Sarasota, Fla. Be realistic about how much you can pay, because an unexpected event could tear a hole in a tight budget.
If, for example, you have a $5,000 gross monthly income, Adamaitis gives this scenario: After taxes, you might actually clear around $3,600. If you expect to owe 30 percent of your gross monthly income, that's $1500 a month, leaving you a grand total of $2,100 to live on. At this rate, your 30 percent debt is actually cutting into 42 percent of your monthly income, after taxes. So when calculating your budget, be completely honest about your spending habits, even if lenders say you qualify for more.
Finding the perfect home can have a lot to do with finding a compatible real estate agent, especially in today's evolving mortgage landscape. "The person you choose will quarterback the whole process for you," he explains. It's crucial to be in contact with an agent before starting the home search, "because you might be looking at x when all you can afford is y." First-time homebuyers should make it clear what features they're looking for and how much they're willing to spend.
There are, however, certain questions that Fair Housing laws prohibit agents from answering, such as where to find religious centers in the area, the quality of the school systems, and crime rates. Be proactive in speaking with members of the community and inquire about the issues that matter most to you. For parents, search public sex offender registries, which can be found online, to see if there are high-risk areas in the neighborhood. In most states, agents must disclose whether violent crimes occurred on a property within a set number of years, but not so with suicides -- find your comfort level and do your research.
Sellers can price a property however they see fit, but that doesn't mean homebuyers should pay a ridiculous cost. "Get your agent to pull all the comparable sold properties that occurred in the last six months," says Adamaitis. "How many were short-sales? How many were foreclosures? Then gauge by square foot the comparable cost."
At signing, the buyer should demand that the contract be contingent on an objective appraisal of the house, Adamaitis says. Look into the history of the home and make sure there aren't any liens against the property. You should be able to negotiate with the seller to make any necessary repairs to the house before closing on the deal.
Contingencies vary by state, but you should certainly inspect the home for possible lead paint, radon, and structural issues. Depending on which contingencies your state recognizes, these flaws can provide grounds to cancel the contract without penalty, and get back the earnest money deposit you put down at the start of negotiations.
Beginning to end, you can expect the entire process to last around four to five months, says Herb. Of course, with as much great inventory on the market as there is, it's not unusual for homebuyers to find something within two to four weeks.
On a brighter note, Robert jumped back into the house hunt a little wiser this year and closed on a three-bedroom townhouse for him and his family in about four month's time. The real journey starts at the end of the month, though -- when his first bill arrives in the mail.