The Five Steps You Need to Take Before Buying Your First Home – Part I

The Five Steps You Need to Take Before Buying Your First Home – Part I

Buying your first home can be intimidating and a bit overwhelming, but the truth is, it doesn’t have to be. Armed with the right information and a clear roadmap of what you need to do before you begin searching for your new home, you can have a great first-time home-buying experience.

In this two-part article, we’ll walk you through the process so that you’ll know exactly what to do when buying your first home. In Part 1, we’ll cover the steps you should take before you even begin to look at homes (and why these steps are so important). In Part 2, we’ll discuss the pre-approval process and what you need to do before you make an offer on your dream home. 

So let’s get started…

First, Review Your Credit History

Your credit score is one of the most important factors in determining whether or not you qualify for a home loan. Your credit history is essentially summed up in a numerical score called your credit score which represents the risk you pose to creditors – or to a mortgage lender in this case. According to the Consumer Financial Protection Bureau – or CFPB, which is a U.S. government agency that regulates banks, lenders, and other financial service companies to ensure that they are treating consumers fairly, a credit score is a predictor of how likely someone is to pay back a loan on time. Generally speaking, the higher your credit score, the better your chances of qualifying for a loan.

Before you begin shopping for your home and speaking with a lender, it’s a good idea to check your credit history and credit score to make sure there are no errors or surprises. There are several different resources you can use to check your credit for free including the following:

• equifax.com – access your Equifax credit report once a year
• freecreditreport.com – access your Experian credit report once a year
• transunion.com – access your Transunion credit report once a year
• annualcreditreport.com – access all three credit bureaus from this one resource once a year

Once you review your credit reports, look for inaccuracies such as payments that are reported late, accounts that aren’t yours, collection accounts, and other issues that could be impacting your credit score. 

Credit scores range from 300 which is considered poor credit to 850 which is considered excellent credit. To qualify for a mortgage, a credit score of at least 500 is needed for a government insured loan while a minimum credit score of around 620 is needed for a conventional loan.  For the best interest rates, generally a credit score of 760 or higher is needed.  Keep in mind that these are general guidelines and each lender has their own set of guidelines and exceptions. It’s best to speak with a lender to determine eligibility and the best program for your unique situation.

Check out our blog, All About Your Credit Score for detailed information about how credit works and ways to improve your score. 

Know the Numbers – It’s Not Just About the Down Payment

Once you have your credit squared away, it’s a good idea to do a deep dive into the numbers. The costs associated with buying a home (buyer costs) are not limited to just what’s needed for the down payment. There are additional fees such as closing costs, points, pre-paid taxes and insurance, and other fees that you should be aware of. In this section, we’ll break down the most common fees associated with purchasing a home.

Upfront costs

As the name suggests, these are the fees paid upfront or out of pocket once your offer on a new home has been accepted by the buyer. Some of the most common upfront costs include your deposit, also called your earnest money, closing costs, and reserves which aren’t necessarily costs, but savings balances that remain after you close on your purchase to ensure that you can still pay your mortgage if your income is disrupted.

The down payment required on a home depends on the loan program, type of property you’re buying, your credit history, and the purchase price – among other factors. For a government-insured FHA loan, you could put down as little as 3.5 percent.  With a conventional loan, you could put down as little as 3 percent or as much as 20 percent and even more. There are other programs such as VA loans and USDA loans that enable you to purchase a home with no down payment as long as you and your property meet the specific eligibility requirements.

Closing costs are all the fees associated with obtaining home financing. As a general rule of thumb, closing costs range from 2 to 6 percent of the amount you are financing.  For example, if you purchase a $500,000 house and put 10% down, closing costs on the remaining $450,000 loan amount would be between $9,000 and $27,000. Some of the more common closing costs include the following:

• Application or credit check fee – some lenders charge a fee to initiate the loan application or to check credit. Application fees can range from $0 to $500 and credit check fees are generally less than $100 per applicant
• Appraisal fee – the cost of getting the home appraised. Costs vary by area and can range between $500 to $1000 or more depending on the size and location of the property
• Home inspection fee – the fee for having a professional review the condition of the home such as the foundation and structure, drainage, plumbing, heating and air conditioning, roof, walls, windows, and many other items to ensure that the home is in good condition. Like an appraisal, there are several factors that determine the fee including size and time of home. A home inspection fee can range from $300 to $450 or more
• Origination or underwriting fee – this fee is an administrative fee charged by the lender for providing loan processing and underwriting services and is usually about .5% to 1% of the financed amount
• Points – sometimes called discount points, this is a fee that buyers pay to lower the interest rate. Essentially, it enables the borrower to “buy down” the rate by paying a fee upfront. A point is 1 percent of the financed amount
• Title insurance and title search fee – these fees are collected by the title company to ensure that the home’s title is clear, meaning that no one else can lay claim to the property. Title insurance protects you as the new owner from any claims brought on that were not discovered during the title search
• Other fees – some loan programs have additional fees that are required to be paid such as mortgage insurance, funding fees, and other program-specific fees

Reserves

When qualifying for a mortgage, it’s important that you have enough savings left over after the down payment and closing costs so that you have emergency funds available to pay your mortgage in the event that you have a loss of income or a significant unexpected expense. Lenders typically require that you have at least two months’ worth of   mortgage payments available in your savings or checking account but it could be as much as six months’ worth.

Impound or Escrow Account

In some cases, usually for no or low down payment loans, the lender requires you to set up an impound or escrow account. This is a separate account maintained by the lender or lender’s loan servicing partner to collect monthly property tax and insurance (if applicable) payments. It’ a forced savings account in essence that ensures that enough funds will be available when property taxes and your insurance premium are due. These payments are made for you by the loan servicer which ensures that they are paid on time. The amount that is required to place into your escrow account depends on the month that you close relative to when property taxes are due, and there are usually two additional payments collected to mitigate any shortfalls in your account. The full insurance premium is collected up front plus two or three months in reserve for a total of 14 to 15 months’ worth of payments. There’s no need to worry about the exact amount as it will be calculated by your lender at the time of your loan; just be prepared for this additional requirement.

Below is a chart that may help you understand the typical costs associated with purchasing a home. We are using a purchase price of $500,000 and 10% down*. 

Purchase Price	$500,000
Down Payment Percentage	10%
Financed Loan Amount	$450,000
Principal and Interest Payment	$2,994
Down Payment Amount	$50,000
Closing Fees	$15,750
Reserves (2 months)	$5,988
Impound / Escrow Account (Property Taxes + Insurance)*	$7,875
Estimated Total Funds Required	$79,613

*Assumes interest rate of 7%, closing fees of approximately 3.5%, property tax rate of 1% and annual insurance premium of .35%

As you can see, the funds needed to purchase a home go beyond just having enough for the down payment. Closing fees, reserves, and establishing an impound account can really add up.

The next step once you’ve reviewed your credit history and have taken a deep dive into the numbers is to find a lender and get pre-approved. Continue to Part II of The Five Steps You Need to Take Before Buying Your First Home to learn more.