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How to Finance Your First Home

how-to-finance-your-first-home-purchaseHow to Find the Perfect Home for You and Your Budget:  Dwell Residential’s 4-Part Series for First-time Buyers

Week 3

Taking that first step to buy your very first home can be scary and daunting. You want to find a home you will love but also afford. In our new four-part “how-to” series for first-time buyers, you’ll learn what to do every step of the way and how to incorporate our strategies with your own to find a home that is “perfect” for your budget and your lifestyle.


Here’s a weekly run-down of our “perfect home”-buying formula:

Buying a home is a major financial commitment that takes lots of pre-planning before you sign on the dotted line to make your dream of owning a home a reality. And, since most buyers need to finance their purchase with a mortgage, we are here to get you all set on what you need to know and what you need to do along the way.

Remember, getting financing is STEP 3 in the preparation stage of buying a home.  Need a refresher on the first two steps?

Week 1: 12 Questions to Answer Before You Step Foot in an Open House
Week 2:  The 3 Steps Most Buyers Skip When Buying a Home

When it comes to getting a mortgage to buy your first home, many buyers decide the price point of the house they want to buy before talking to a lender.  They’ll say something like, “we are going to buy a home for $500,000” and then they head out to open houses seeing homes in that price range.

That’s not the way to go about searching for a home and can not only make your home buying a miserable experience, but also could cause you to buy the wrong house!  Yikes!

Follow these steps instead:

1.) Decide what you want to pay per month before you talk to the lender.

Before you talk with any lenders, before you start searching for homes online and before you start going to open houses, you must decide what you want to pay per month for your new home.

The reason is twofold.

First, most lenders will approve you for more than you want to spend, so what you are approved to buy is irrelevant. Instead you should tell the lender what you want to pay per month for your new home (inclusive of condo fees, if any, taxes and insurance) and ask if you are approved to purchase that and what the purchase price would be  They will need one other piece of information from you in order to provide a price point, see step two below.

And two, if you are buying a condo or anything with an HOA fee or thinking about buying any of these two options, your purchase price will change based on the monthly fees of the community.  For example, the monthly payment for a $500,000 condo with a condo fee of $300 per month is going to be a completely different monthly payment than a house with no HOA fee.

So, first decide what you want to write your check for every month when it comes to your mortgage.   Not sure how to do this?  Conservative advice is to spend about 30 percent of your income on housing.  In areas that have high costs of living such as New York, San Francisco and the DC area, that number can creep up to 40 percent and still be okay.  Ask yourself if what you want to spend per month is in that range. If it is, you are A-okay.

We recommend doing it this way since focusing one big sales number or price range since it’s easier to comprehend since most of us budget for monthly expenses already.  By looking at your budget, you can compare future home expenses to your current rent expenses. That will help you determine an affordable mortgage payment.  The lender can then work backward to determine the correlating sale price.

2.)  Decide how much cash you want to spend on the transaction. 

In addition to what you want to spend per month, you need to know how much cash you want to spend on your purchase.  Will it include a gift from family?  A loan from your 401k?  Decide upfront how much cash you can put towards your home purchase.

A couple of things to keep in mind when you are thinking about how much cash you want to allocate to your home purchase:

  • Start with a dollar figure, not a percentage. We’ll work into percentages later when we have a sense of your purchase price. You may be able to spend a little less cash to hit one of the points the lenders like to see—for example, if it turns out that you have around 10% to put down, then putting 12% down won’t change your interest rate or really help anything from a loan standpoint, so maybe you save that extra 2% for moving expenses since it will do you more good as cash in hand than cash in your home.
  • Closing costs are going to run you between 2.5% and 3% of your home price so be sure to set aside some of your cash for closing costs, not just downpayment. Your lender can help you with this.
  • Don’t worry so much about putting 20% down.  There is a very traditional mindset that says you must put 20% down in order to avoid mortgage insurance and although that is accurate, these days there are so many great loan programs, especially for first time home buyers, that ease up on the mortgage insurance payments if you are buying your first home.  To learn more about why you don’t have to put 20 percent down if you don’t want to, read our article Should You or Shouldn’t You Avoid PMI 

So, now you have what you need to contact a lender—you need to know what you want to pay per month and how much cash you want to spend on your purchase.  With those two figures your lender can tell you exactly what price range to be looking at.  Once you receive this information from your lender, you can always make adjustments and see how that will change the price point, but you have to start somewhere, so start with ideal numbers for monthly payments and cash for your purchase.

 

BONUS SECTION:

When it comes to adjustments once you receive your price point from your lender, keep these tips in mind:

Dwell Residential’s mortgage “rules of thumb”

These are additional guidelines that you can use to help determine your mortgage payments. Remember, you still want to have some cash left over and not wiped clean each month.

  • You can afford 30% more in mortgage versus your current rent without changing your lifestyle. To figure this out, multiply your current rent by 1.33 to arrive at an affordable mortgage payment. For example, if you currently pay $1,500 per month in rent, you should be able to comfortably afford a $2,000 mortgage payment after factoring in the tax benefits of homeownership.
  • Every $10,000 change in your loan amount, whether that’s through increasing or decreasing your price point or increasing or decreasing your downpayment will only change your monthly payment by about $50 per month. Yep, that’s all! So, don’t worry as much about saving another year or two for an additional $10,000 to put down if you can swing an extra $50 per month instead.
  • Make sure you are looking at the entire loan picture — the program, the time period you are going to own the home, and the terms of the loan and how all of that creates the best financial position for you.  And remember, it’s not one-size-fits-all when it comes to mortgages, and working with a lender to go over the options available is important.  You should think of the loan summary and price points your lender gives you as rough drafts of the financing for your purchase until you find an option that suites your specific finances and situation.
  • The loan your friend gets is not the one you should necessarily get. These days, when it comes to financing your first home, there are SO MANY loan options available that you really need to focus on what’s best for your particular financial situation and goals.

Know your credit score since your score will also affect your mortgage interest rate. Your credit score is a major factor for lenders when determining your risk.  That means your score plays a big part in the type of loan you will be offered and its interest rate. The higher your score, the lower your rate.

Remember, a credit score has nothing to do with your income or investments. It’s based on how you’ve handled your credit card payments and other loan payments, like your car or student loan.  It also takes into account if you’ve declared bankruptcy, have a tax lien, or you’re being sought by a collection agency.

Having a score of 680 and above means you’ll have more options, lower interest rate, less down payment requirements. 620-660 is considered a fair score and lenders may work with you but may require more documentation to determine if they should take a risk and give you a loan. Below 620 is considered a poor score and many lenders will deny your loan application completely. You may have access to only one or two loan options, such as a FHA loan or a subprime adjustable rate mortgage (ARM).

If you still need to improve your rate, you may need to delay getting your home until it’s higher.

Do you qualify for any first-time homebuyer assistant programs?

Not knowing about first-time buyer programs from state and local programs can cost you!  That’s why we keep up-to-date on all such programs and provide details on requirements for income levels, locations, and more. This is free money so you might need to use less from your savings than you thought.  Many programs are for moderate-oncome buyers and will offer down payment assistance and/or cover closing costs.

How long do you plan to own?

Consider your current and future finances and also where you will be in 5 or more years.  There are several loan products that may be better for you than “go-to” 30-year fixed loan.

If you don’t plan on owning for more than 5 or 6 years, you might want to consider an adjustable-rate mortgage (ARM). Today’s versions are much more straight-forward, conservative, and safer for homeowners than the ones in the past.  These loans typically offer a substantially lower interest rate, saving you thousands of dollars while you live there.

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