Buying a Home for Beginners
Everything You Need to Know Before Buying a House
Buying a home is a huge piece of the American dream, but there’s a lot that goes into the mortgage process. Between all of the jargon and complex processes you’re expected to know, it can be extremely overwhelming. At Education First Credit Union, we’re here to help you make sense of it all!
The Basics
First, there are some basic terms and ideas you’ll need to understand before the home-buying process.
🔸Mortgage Terms: The mortgage term is how long a borrower has before everything must be paid back. The most common options are 15 or 30-year terms, but others may be available.
🔸Annual Percentage Rate (APR): This number represents your yearly cost of borrowing. It accounts for interest, fees, points, and more. It’s a more accurate representation than just the interest rate of what you’ll have to pay.
🔸Points: Also known as prepaid interest, points are the interest that you prepay when you close. Buying points is a way to lower your interest rate. Each point costs 1% of your mortgage and often lowers your rate by 0.25%, though that amount is not guaranteed.
There are two types of interest rates:
🔸Adjustable: Your rate will change with the market, meaning it could go up or down throughout your mortgage term.
🔸Fixed: Your rate will stay the same throughout your mortgage term, no matter how the market changes.
Down Payments and PMI
One of the biggest hurdles to buying a home is the down payment. This is a percentage of the total home cost that you’ll need to pay upfront. The lowest amount you can pay depends on what kind of mortgage you are trying to get. For example, an FHA loan typically requires at least 3.5% while a VA loan requires no down payment at all.
Regardless of what’s required, the more you can pay, the better. Paying more means that you own more of your home, your mortgage payment will be smaller, and you’re better protected from becoming “upside down” in your home, or owing more than it’s worth. Depending on the type of mortgage you get, you’ll likely be required to purchase Private Mortgage Insurance (PMI) if you put down less than 20%. This will protect the lender in case you become unable to make your payments.
Types of Mortgages
Below are a few of the most common types of home loans:
🔸Conventional Mortgage: Not backed by the government. It will usually have fairly simple, straightforward terms and lower closing costs. However, you may have higher interest rates or need to pay a higher down payment (often at least 3-5%). This loan is usually best for people with strong credit, as it will affect your interest rate.
Government-Backed Loans:
🔸FHA Loan: Backed by the FHA and meant for low to middle-income borrowers. It typically has a lower down payment (usually 3.5%). You’ll need a credit score of 500 or higher to qualify.
🔸USDA Home Loan: Backed by the US Department of Agriculture and only available in certain rural and suburban areas. If your new home is in an eligible area and you meet income requirements (there are caps fro how much you can make depending on the area), you won’t need to pay a down payment.
🔸VA Home Loan: Backed by the US Department of Veteran’s Affairs and, thus, only active service members, veterans, and some spouses. Typically, borrowers won’t need a down payment or mortgage insurance for this loan. Borrowers generally need a credit score of 650 or higher to qualify.
How Much Can You Afford?
Now that you have a better understanding of how a mortgage works, let’s form a baseline for what you can afford.
Check to see how much mortgage you can afford using our partner, Banzai’s Mortgage Affordability Calculator.
You can use this initial estimate to help inform your search by taking it to housing sites. This will allow you to get an idea of how far your money will go in your desired area. If it isn’t quite as far as you’d hoped, you may want to make some adjustments to your budget or do some additional saving before you’re ready to take the next steps. Once you’re ready, there are a few more things you’ll want to consider before you begin serious house hunting.
Pre-Approval
A pre-approval is an agreement from a lender that, as long as specific conditions are met, you’ll most likely be approved to borrow a defined amount at a certain rate.
In order to get pre-approved, you’ll have to fill out a mortgage application. If you are pre-approved, you’ll be given a letter that you can show to sellers to prove that you are serious. It may be hard to get your offer accepted if you don’t have one, so when you’re ready to start your search, you should do this first. Your pre-approval will usually be valid for 60-90 days.
It’s important to note that a pre-approval is not the same as a pre-qualification. Pre-qualification can help you know whether you are on track to be approved or not, but won’t add as much leverage to your offer.
The Mortgage Application
To determine if you qualify for a mortgage, the lender will need all of your (and your co-borrower’s, if you have one) personal and financial information, including bank statements, tax returns, pay stubs, and more. They’ll also consider various factors such as your DTI (debt to income ratio: how much debt you have compared to how much income you have), LTV (loan to value: how much you’re borrowing compared to how much the house is worth), and credit score. To finalize everything, an underwriter will review your application, credit score, personal information, and previous pre-approval to give you one of four possible outcomes: approved, conditionally approved, suspended, or denied.
How You Can Improve Your Approval Odds
🔸Boost your credit score. Get your credit report and check it, look for errors or places where you can make the biggest impact.
🔸Save for a higher down payment. The less risky you are, the better.
🔸Look into a house that is less expensive. Even if you feel confident that you can make payments for a house at the top of your price range, your lender may not agree.
🔸Don't make big purchases before you are approved. It can be a red flag to lenders that you aren't careful with your money.
Closing the Sale
Closing is when you seal the deal.
At this stage, you'll need to come prepared having reviewed the closing documents and, likely, with proof of homeowners' insurance. If you agree to all of the terms, you'll sign all of the documents to make everything official and pay your down payment, closing costs, and any pre-payments. Finally, when it's all said and done, you'll get the title and keys to your new home!