Should you get a house or apartment, mortgage or rent, and how much can you comfortably afford to spend on housing? Buying a house is one of the most significant financial decisions most people make within their lifetime. It’s important to be proactive about saving up your money, being prepared, and having access to all the right resources and information to make your home buying journey a success.
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Buying a Home
Buying a home and taking out a mortgage is likely among the biggest financial decisions you’ll make in life. It should be exciting, but can get overwhelming at times if you don’t have the right knowledge and tools – especially if you’re a first time home buyer.
It’s important to do your research, think things through, and make your first home purchase count. Think of your home as an investment – if you secure a great deal on your first home and build equity in the property while living there, you’ll be in a great spot when you sell it and move on to your next home!
If you’re ready to buy a house you should follow these steps:
- Figure out your needs and wants. At this point you should be identifying things like what you need to have in a house, how long you plan to live in the house and how you’re going to pay for the house.
- Determine your budget. If you don’t have a budget, you need to create one as soon as possible. You’ll want to make sure you can fit a mortgage payment in your monthly expenses. Most lenders do not want your mortgage taking up more than 20% of your monthly income.
- Finalize your finances. You’ll want to double check your credit, start saving or set aside a down payment and start putting money aside for future renovations or closing costs.
- Shopping for a lender. You should never take the first pre-approval you are given. You should get at least 2 or 3 as you’ll find other mortgage companies will give you a better offer.
- Request a pre-approval. Before you even bother shopping for a house you will want to get a pre-approval. This will tell you exactly how much money you have to use for a house. Most sellers or realtors won’t even bother with you unless you can provide a pre-approval.
- Find a real estate agent. If you’re a first time home buyer you will want a real estate agent. They will make sure you’re making all the right moves and help protect you in the process.
- Go house hunting. At this point you’re ready to go house hunting and attend open houses. You should already know how much you can afford and your realtor should be feeding you houses and helping you sift through the bad deals.
- Pick a house and make an offer. Now that you’ve found your house you need to make an offer. Ideally you’ll have the highest offer or be the only offer and you will win the house. However, you should be prepared for the worst and be ready for a bidding war.
- Getting a home appraisal and inspection. Before the paperwork gets finalized you’ll want to make sure the house is selling for the price it should be and there are no hidden problems.
- Adjust the offer. If issues arise you will want to adjust your offer. A realtor can help you navigate through this.
- Close on the house and sign the paperwork. If everything checks out then you are ready to close! There will be a meeting where you review all of the paperwork, give an earnest check and sign.
What is a Mortgage?
A mortgage is a purchase agreement between a borrower and lender to repay the value of a home plus interest in agreed upon installments, using the home as collateral.
Mortgages are a lot like most loans at a high level. They include interest rates, terms, down payments, approvals, and other loan essentials. With the home being considered collateral in mortgage loans, you run the risk of losing your home if you fail to repay your loan as agreed upon in your mortgage contract. This process is similar to repossession in things like car loans, but in home ownership this process is called foreclosure.
Pros and Cons of a Mortgage
Pros of Getting a Mortgage
- Mortgage debt is low interest.
- Mortgage interest is tax-deductible.
- A mortgage helps you buy into a long-term investment.
- Mortgage payments tend to be smaller than rent payments.
Cons of Getting a Mortgage
- A mortgage is one of the largest amounts of debt you will take on.
- If you default or can’t pay you will lose your home.
- Interest rates constantly change so if you aren’t buying at the right time you could be paying a higher rate.
- Your property value may decrease over time instead of increase based on the market so you could be overpaying for a house.
- If you include interest over the life of the loan you’re paying back thousands more than you took out even at a low interest rate.
Types of Mortgages
There are several different types of mortgages, each holding their unique pros and cons. Ultimately, it is dependent on the borrower’s unique situation as to which mortgage type is best suited for them.
Factors that make up different types of mortgages include the type of rate, the term or length of the loan, whether or not the loan is backed by the United States government, and the size of the loan amount.
There are two common rate types that are used in mortgages: fixed and adjustable (ARM). Fixed-rate mortgages are more common, but often come with a slightly higher interest rate than ARMs at the time of signing. A fixed rate mortgage is exactly as it sounds – the interest rate is fixed. An adjustable rate mortgage is where the interest rate changes through the life of the loan as the market changes.
How to Qualify for a Mortgage
Depending on the type of mortgage you are taking out, there are different requirements that borrowers must meet. These mortgage approval requirements are primarily based on a few key factors:
- Credit Score – A conventional loan requires a credit score of at least 620 but the higher your score the better. There are some loans that go as low as 580.
- Debt-to-Income Ratio (DTI) – A lower debt-to-income ratio will improve your approval odds drastically. Many lenders will accept up to around 45% of your income going to debt but you should really try to be 20% or less.
- Down Payment – Your down payment is based entirely off your financials but the type of loan you use may require more or even no down payment. If you can you should be putting down at least 20% of the value of the house.
Down Payment for a Mortgage
A down payment is cash paid upfront by the borrower towards a loan. This is not financed by a lender and can be beneficial in securing the best rates and terms, as well as simply needed for approval in some cases. Down payments are often required in many types of loans such as mortgages and auto loans.
Minimum down payment required by mortgage loan type:
- Conventional Loans: 1%
- Jumbo Loans: 10%
- FHA Loans: 3.5%
- VA Loans: 0%
- USDA Loans: 0%
A lender may require a down payment to help mitigate risk. A down payment puts the homeowner in a spot to invest more into their home lowering the risk and loss of the lender if the homeowner defaults on payments.
If you put down a larger down payment, 20% or more, you can avoid extra fees like PMI, get a lower interest rate and often remove several fees lenders add to the closing cost.
How to Refinance a Mortgage
Refinancing a mortgage is when a homeowner initiates a new loan that replaces the original mortgage with updated rates and terms. The goal, of course, is to claim better rates and terms than what you initially received with your mortgage.
Reasons to refinance:
- Being able to obtain a lower interest or removing an adjustable rate.
- You have improved your credit or paid off debts.
- You want to change the loan duration and terms.
- You want to cash-out and get money back for what you’ve put into the loan already.
Whether or not you refinance is ultimately up to you. The thing to keep in mind is that when you refinance, even during a cash-out refinance, you will be extending how long you’re making payments. You should also know that you will need to come to the table with money to close to cover closing costs and fees.
Homeowners insurance, or home insurance, is a type of insurance policy that protects you from incidents involving your home such as damage, theft, or accidents within the home.
Most coverage requirements will be for the fair market value of your property or the purchase price of the home. Depending on the claim, coverage could include the value of personal belongings, lodging in the event that your home becomes unlivable, and occasionally legal expenses among other things.
There are three main levels of homeowners insurance coverage – actual cash value, replacement cost, and extended replacement cost/value (also known as guaranteed replacement cost).
These different levels can be chosen based on the level of coverage needed by the homeowner.
Actual Cash Value
Coverage for the cost of your home and value of your personal belongings based on the current worth (accounting for depreciation of value)
Coverage for the cost of your home and value of your personal belongings based on the original purchase price of items (does not deduct to account for depreciation of value)
Extended Replacement Cost
Coverage for the cost to repair or replace your home and personal belongings, even if it exceeds the value that would be covered in actual cash value or replacement cost coverage. There is still a limit to the replacement cost that will be set by your insurance carrier, but this level of coverage can help account for inflating prices that will drive up the amount needed to repair or replace your home and possessions.
Homeowners insurance rates are based on risk, which can be defined as the likelihood that a claim is filed by the policyholder. There are many factors that can influence the cost of homeowners coverage, including: home value, location, coverage, credit score and claims history.
The average cost of homeowners insurance in the United States is $1,445 annually or around $120 per month.