The thought of buying a home can seem overwhelming. It’s a big financial decision with many steps, tasks and requirements. But buying a home can also be exciting! After all, becoming a homeowner is part of the American dream and offers many financial benefits.
It can help you reduce federal taxes in some cases and build equity that will pay off when you sell it later. This can help you build wealth over time.
If this is your dream, here are a few tips to help you decide if you are ready to become a homeowner and if so, guide you through the homebuying process.
1. Review Your Financial Health. When preparing to buy a home, you first need to be in a good position financially. Start by checking your credit. To qualify for a home loan, you’ll generally need good credit. Your credit will also influence your interest rate. If your credit needs some work, the most effective way to improve it is by paying all your bills on time and paying down your debt.
2. Save. Save. Save. There are three major costs to consider before buying a home. Your down payment, closing costs, and moving expenses. Here’s a look at each:
a. Down Payment: Your down payment is what you pay upfront. It’s important because it represents your contribution toward the purchase of your home while the lender provides the remaining amount. Your down payment will depend on a few different factors including the price of your home, the type of mortgage you elect and your lender. A 20 percent down payment is a great goal, but many times you can put down less.
b. Closing Costs: Closing costs are fees you pay to finalize your mortgage and complete the purchase of your home. You can ask the seller to pay a portion of your closing costs which range between 3-6 percent of the amount of your loan.
c. Moving & Unforeseen Expenses: You’ll want money set aside to help get situated in your new home. Plus, you never know when a hot water heater or air conditioning unit may need replacing. Be prepared for the unexpected.
SAVINGS TIP: Set up an automatic transfer to move money from your checking to savings account on a monthly, weekly or even daily basis. Choose the amount you feel comfortable transferring and increase that amount over time.
3. Do Your Research. Your credit is looking good and your savings account is growing. Now what? It’s time to start researching mortgage loans.
a. Conventional – A conventional loan is a type of loan that is not insured by the government. Instead, the loan is backed by private lenders, like a bank or credit union. Conventional loans require private mortgage insurance, also called PMI. PMI is a payment that you make to protect the lender in the event you stop making mortgage payments. PMI is usually paid monthly. However, if you can afford a down payment of 20 percent, you will not have to pay mortgage insurance with a conventional loan.
b. FHA – FHA loans allow for lower credit scores than conventional mortgages do and are easier to qualify for. FHA loans are insured by the Federal Housing Administration. With an FHA loan, you’ll pay mortgage insurance regardless of the amount of your down payment.
c. USDA - USDA loans are low-interest mortgages with zero down payments designed for low-income Americans who don't have good enough credit to qualify for traditional mortgages. With a USDA loan, you’ll pay mortgage insurance regardless of the amount of your down payment are provided…
d. VA – VA Home Loans are designed for veterans and provided by private lenders. The VA guarantees a portion of the loan, enabling the lender to provide you with more favorable terms. VA loans do not require mortgage insurance, instead, they have a VA funding fee that can be paid upfront or rolled into your loan amount.
Did You Know? Mortgage insurance is not forever. Your lender must automatically terminate PMI when your mortgage balance reaches 78 percent of the original purchase price, provided you are in good standing and haven't missed any scheduled mortgage payments.
4. Choose A Lender. You’ve done your research and are ready to choose a lender. How do you know which one to choose?
a. Compare mortgage loans. A mortgage loan can be obtained from a bank, credit union, mortgage broker or online service. Be sure to compare offers from a few different lenders.
b. Mortgage points. Mortgage points are fees you pay your lender to reduce the interest rate on your mortgage. Paying for points is sometimes called “buying down the rate.” These points are optional and may make sense if you’re buying a home you plan to live in for many years to help you save on interest over time. However, it’s solely your decision, not your lenders.
c. Avoid adjustable-rate mortgage. Interest rates are currently low, so to take advantage, you’ll want to go with a fixed-rate mortgage. A fixed-rate mortgage charges a set rate of interest that does not change throughout the life of the loan. So, if you’re locked in a 3 percent interest rate, that figure will never change. An adjustable-rate mortgage (ARM) can be set below the market rate but then can rise as time goes on. This can be dangerous to your financial situation if your income remains the same, but your mortgage payment goes up.
5. Get Pre-Approved. Preapproval is the process of determining how much you can borrow to buy a home. Your lender will look at your income, assets and credit score to determine what loans you could be approved for, how much you can borrow and what your interest rate might be. Once you find your home, you’ll need full approval which is a lengthier and more detailed process. In some cases, a lender will lock in a low interest rate for you for a certain period of time while you are house shopping.
6. Stick to Your Budget. Your pre-approval is simply the amount the bank has decided to lend you. It does not mean you should borrow the full amount. Remember, as a homeowner, you are not only responsible for your monthly mortgage payment, but also property taxes, and homeowners’ insurance, not to mention any unexpected costs that arise. So, stick to your budget and to what YOU can afford.
7. Stay Vigilant During the Closing. After you have found the home you want, your mortgage lender will now start the approval process. Stay involved. Watch the figures in the closing contract to make sure everything is correct.
8. Maximize the Benefits of Home Ownership. Congratulations, Homeowner! You did it. You found your dream home. Now, it’s time to reap the rewards of homeownership. Here are some tips to maximize those benefits:
a. Tax Deductions. Make sure to itemize your expenses including your mortgage interest and property taxes when you file your taxes. If all of your expenses add up to more than your standard deduction, you may get a tax deduction. However, be advised, that this is much more difficult with today’s tax code than it has been in the past. Be sure to consult with a professional tax advisor or CPA to get the most up-to-date information before making any tax-related decisions.
b. Home Equity. Equity is the difference between what you owe on your mortgage and what your home is currently worth. The amount of equity in your home increases as you pay down your mortgage. Your equity will also increase if the value of your home jumps.
After you sell your home in the future, you can use it as a down payment to move into a larger, more expensive one. You can also use it to pay for home improvements, pay down other debt or plan for retirement.
To build the most equity, plan to stay in your home for 5-7 years and make extra payments towards your principle as you will be paying mostly interest in the first few years.
If you would like further advice on home mortgages or home equity loans, contact us at (210) 223-6561.