Purchasing a home can be a nerve-wracking process, particularly if you are a first-time home buyer. This blog can serve as a guide to help you put a plan in place to get through the stress of buying your next home! There a lot of different avenues that you can discuss as it relates to your new home purchase, we are going to focus on the financial aspects of your home purchase.
First thing – Personal Finances
Get your finances in check. The first thing that you want to make sure of is your emergency fund. 3 to 6 months of cash of expenses in your savings account is always recommended. The money that you have set aside for your down payment, furniture, moving cost, etc. needs to be in addition to your emergency funds bucket. Do you have enough liquid to put a sizable amount down on your home? 20% down is a great goal and target to put you in good shape in your new home. By striving to put 20% down on your home you are providing a solid start to your home equity. Home equity is the difference between the mortgage and the property value. For example, if you are purchasing a home for $400k and you put 20% down this would equal $80,000 then your mortgage balance would start out at $320k. Starting out with a good amount of equity is ideal as it helps you avoid unwanted fees like Private Mortgage Insurance, etc
If you are unable to put 20% down, it is not the end of the world. Sometimes couples have enough to put 20% down but closing cost prevents their ability to achieve this. Closing cost can sometime be $10k or more. That is okay, just expect that the mortgage company charge monthly for Private Mortgage Insurance or PMI. This is to protect the insurance company if you were to fall behind on your payments or potentially lose your home through foreclosure. Still doing the best you can to start off with 15% equity or more is ideal.
Debt to Income Ratio and Credit Score – these two items are very important in terms of qualifying for your home. A lender’s debt to income ratio is All debt (student loans, vehicles loans, credit card balances, etc.) to All income (W-2 wages, rental income, investment income, etc.) in the household, not just the prospective mortgage to income ratio. If you have low income and high debt this ratio would be a reason why you would not be able to get pre-qualified for a loan or the amount of loan that you can pre-approval for is lower than expected. Keeping your debt to income below 50% is ideal. Click on the link to calculate your existing debt to income ratio. https://www.zillow.com/mortgage-calculator/debt-to-income-calculator/
Credit Score looks at all the below items:
- Your Payment History
- The amount of money you owe
- The length of your credit history
- Types of credit used
- Your inquiries for additional credit
Most lenders require a score of at least 620 to qualify. If you have over 740 or better it is likely you get a decent interest rate. https://www.usbank.com/home-loans/mortgage/first-time-home-buyers/credit-score-for-mortgage.html
How much house can you afford?
This is a question we get all of the time from home buyers. Going into the home buying experience with the maximum amount you want to spend is ideal. The goal is to purchase a home that is lower than that number. In Texas, this can be hard given how high real estate prices have gone up in the last several years. However, the data is showing that prices are not rising as fast as they have in recent years due to a rise in mortgage interest rates. https://www.zillow.com/home-values/54/tx/
Having a goal of no more than 25% of your household gross income to be allocated to your new home is ideal. While some financial advisors go as far as 28%, we like 25% being used specifically for PITI (Principal, Interest, Taxes, and Insurance) and the remaining 3% be set aside for ongoing expenses associated with the house. (Ongoing repairs and maintenance) My wife and I purchased our first home in 2020 (we were blessed with great timing), and our goal was to be under 25% of our household income. We achieved that goal.
The key to keeping this in check is research. When you are working with the mortgage company or bank, make sure you have a clear idea as to what the monthly payments will be. How much is going toward principal and interest each month? If you have PMI, ask your mortgage company how much this will be each month. Research the property taxes in the county that you are looking in and be aware of the school districts, especially in the state of Texas. Property taxes vary widely based on the school districts in that area. Research home insurance rates in your area as well and talk with an insurance provider to get estimates. https://www.nerdwallet.com/mortgages/how-much-house-can-i-afford/calculate-affordability
Once you feel like your finances are in order, then it is time to work on getting pre-approval. Pre-approval is something that is necessary to begin the step of looking for houses. This is something that is harder for small business owners vs. salary employees. Small business owners may have to provide information on the viability of their business. (Profit loss reports, payroll reports, balance sheets, etc.) Salary employees typically just have to provide W-2 documents or most recent paystubs. Below is a short list of documents typically needed:
- Proof of Income
- Employment Verification
- Proof of Assets
- Credit History
- Debt to Income Ration
- W-2 Statements
- Pay stubs
- Bank statements
- Tax returns
Getting pre-approval does not mean that your loan will be approved once you find your home. Other items could cause problems for getting approved for your loan. Appraisal on the property, title company confirming no claims or liens against the property, home conditions, etc. https://www.rocketmortgage.com/learn/mortgage-preapproval
Getting pre-approval will provide you with a good picture of your mortgage options and show your agent you’re a serious buyer. Once you are pre-approved, it is time to get serious on your search for your new home! Be sure to check out part two of this blog post!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.