One of the questions I’m often asked is about buying a home. There are so many different ways to purchase a home and so many different components that go into that it can be daunting. So I want to help alleviate some of the mystery and confusion around buying a home – especially if you’re a first time home buyer. Now, I’ll forewarn you that this post is going to be information-heavy as I want to make sure that I cover as much information for you as possible.
The Different Types of Mortgages
Before we can really dig deep in the whole buying a house thing, we need to talk first about the various mortgage options out there. Please do not allow a Mortgage Broker to sell you on a mortgage that does not make sense for your family! Do you’re own research and run the math to figure out which one makes sense BEFORE you even walk in the Broker’s office.
ARMs or Adjustable-Rate Mortgages
Basically with an ARM the starting interest rate is lower. The thought process (and how this mortgage is typically marketed) is that you start with the lower interest while you’re just starting out in your career. Then the idea is that by the time the higher interest rates kick in you will have a better paying career and therefore can afford more. The concept of the ARM is to transfer the risk of potential higher interests to the borrower.
Here’s the deal – if you’re offered one of these mortgages please run the opposite way. These are notoriously bad mortgages and cause the mortgage payments to rise so substantially that it can and does financially cripple folks.
Honestly, I don’t even know why these exist because you’re only paying the interest. You’re not going to be making any headway on your principle balance. I mean, isn’t that the point to one day own your home outright? If so, avoid this loan.
These are the most well-known type of loans because they’ve been around the longest and they are one of the best options. With a Conventional loan they are not backed by the government like a FHA or VA loan is. They are usually through Fannie Mae and are privately insured against default. You will need to put down at less 10% of the home sale price for this loan but to avoid PMI (explained below) you’ll need to put down at least 20%. You can finance for 15 or 30 years.
Federal Housing Administration (FHA) loans are insured by HUD – the federal government and are typically marketed to first time home buyers. This is actually the type of mortgage we had on our home. With an FHA loan, you can put down as little as 3.5% versus the higher down payments of the Conventional Loans. These loans are typically just offered at 30 years but I have heard that some brokers will do 15 years.
VA loans are insured by the U.S. Department of Veteran Affairs and are only offered to service members. Some VA loans will allow you to purchase a home with no money down or a very small down payment. The biggest downside to these loans is the Funding Fee. The Funding Fee is based on how much money you’re putting down, how long you were in service for, and if this is your first, second, or third VA loan.
Okay, PMI is not a mortgage loan but it is something that you will come across if you put down less than 20% of the price of the home. PMI stands for Private Mortgage Insurance and trust me when I tell you it’s a huge pain in the next to get rid of. However, it’s not impossible but you do need to be aware that you will be required to pay this along with your regular mortgage payment every month until you have paid down the principal value of your mortgage to at least 80% of the value of your home.
This is another “not a mortgage loan but” thing. Earnest money is money that you use to confirm interest in a home. This is not the same thing as your down payment. This is like “good faith money” and allows the seller more time to get things together. There are pros and cons to putting down earnest money. The money is typically housed in an escrow account (below) until the final contract is signed. The money is then typically applied to the closing costs.
Escrow is an account that will house money to pay for your home insurance premiums and property taxes every year (it can house other expenses but these are the two most common). Escrow will be included in your monthly mortgage payment but it does not get applied to interest or the principal balance. Escrow is like a savings account and the money you pay towards escrow from your mortgage payment every month goes into that account to pay for the above-mentioned expenses.
Now That That’s Out of The Way…
Okay, so now that all that boring stuff is out of the way, let’s talk about some other things you’ll need to consider when buying a home. The first thing you need to do is research, research, research, and research some more. Don’t just rely on your realtor or mortgage broker to tell you what you can afford. You need to do the math yourself and determine what options best suit your family.
Things you’ll need to consider:
- Location of the house.
- The “bones” of the house.
- The floorplan of the house (no weird floorplans, weird additions, or things that don’t make sense.)
- The current state of the roof and when was the last time it was replaced.
- The current state of the home and how much it’ll cost to repair/remodel.
- Septic or Sewer? If septic, when was the last time it was pumped and inspected as well as where is the tank and field lines located.
- The school district (even if you plan to homeschool or private school your kids you need to know the rating of the schools in the home’s area).
- Meet some of the neighbors and talk with them. Trust me, you can make an ugly house beautiful but you can’t make a rude neighbor nice.
- Depending on the type of property you’re looking at, you may want to consider the surrounding area and what it’s zoned for. Especially if you’re looking at a property not in a subdivision or on the main highway.
Let’s talk about some of these in a little more detail. (I also have this post in video format if you’d rather listen than read. Click here to watch on YouTube.)
Location of the house.
I’m not just talking about the physical location of the house in the neighborhood, I’m talking about the location of the house on the actual property as well. The last thing you want is to buy a house where one side of your house backs up to your neighbor’s junk pile. Along with the location of the house, you want to look into the proximity of the house to the interstates (or other main highways). As well as, what is all located around the house – what types of stores, businesses, and other neighborhoods. Also, you’ll want to consider your travel time for work, school, and other outings.
The “bones” of the house.
I’m married to a contractor who professionally remodels homes for a living so talking about the “bones” of a house is something that I’m quite used to. The “bones” of a house are the structure and layout. Just like I mentioned having a good floor plan that makes sense, you need to have a good structure in place. Drywall and flooring can be replaced but replacing a foundation is beyond costly. Same with termite damage or severe water or fire damage. Those are the types of things that would make the “bones” of a home not good. So long as the bones are good you can remodel and repair anything you like!
The current state of the home and how much it’ll cost to repair/remodel.
You’re going to want to take into consideration how much money you have saved for repairs and remodeling before you sign on the dotted line. Many folks don’t realize how expensive a professional remodeling job can cost. And so you want to make sure you have a realistic idea of how much it’ll cost before you purchase. If you’re really interested in the home, I would encourage you to seek out a professional contractor and ask them for an estimate. This will give you an idea of how much it will cost to make the home what you want.
Now, don’t allow a big number to scare you away from the home. There are many things that can be done super cheap that totally transform a home-like painting and replacing flooring. Also, compare how much the house is with how much the estimate is to a new home’s costs. This will help you determine a more accurate “total cost” of the home.
The school district.
Regardless if you plan to homeschool or private school your kids or if you’re even planning to have kids, you need to be aware of the school district your possible new home is in. Here’s why: a bad school district will drive down the resale value of your home but a good school district will drive up the value. So do your research on the schools in that district and look at their past performance along with their current performance. This will help you establish the longevity of the good school rating.
Depending on the type of property you’re looking at, you may want to consider the surrounding area and what it’s zoned for.
It’s important to know if they’re planning to develop around the property you’re looking at. You don’t want to buy a house only to find out a few months later that the vacant lot behind your house had been zoned for a Walmart. No one wants a view of Walmart through their kitchen window. So make sure you do a plot survey and have due diligence done on the site before you buy. That will give you a heads up on exactly where your possible property begins and ends as well as any issues with the property and what the surrounding properties are zoned for.
Other Things to Consider
Okay so now turning back to money you need to determine a few different things before you go off house shopping.
- How much money do you already have saved?
- How much debt do you currently have?
- What is your current credit score?
- What is on your credit reports?
- What is your income that you bring in every month?
1. How much money do you already have saved?
If you don’t already have money tucked away for a down payment then that needs to be a priority before you start house shopping. Typically you have to have your down payment money and earnest money in your account for at least 60 days BEFORE you start the mortgage loan process. Like I mentioned above, you’ll be subject to PMI if you put less than 20% down on the home but you can put down as low as 3.5% with an FHA loan. However, you need to have that money saved up before you start this whole process.
2. How much debt do you currently have?
This is an important one folks. If you’re debt-to-income ratio isn’t right you won’t get approved for a mortgage – meaning if you have more debt than income, then they will say “no” to your application. So depending on how much debt you have, you need to consider paying off all or at least half of it before starting this process. Oh and this includes deferred debt – so if you’re still in college and you took on student loans but you aren’t yet required to pay them, the mortgage company will still take into account those student loans. So pay off as much debt as you possibly can before starting this process.
3. What is your current credit score?
It’s good to know this before filling out a mortgage application. If you have a low credit score you will get a higher interest rate on your mortgage. So know your score so you can take action on improving it before house hunting. Below is a snapshot from myfico.com on current scores to interest rates available.
4. What is on your credit reports?
As I mentioned in my YouTube video about increasing your credit score, it is vital to your financial well-being to know what is on your credit reports. I highly recommend you pull your report from all three bureaus for free at annualcreditreport.com and then go through the reports with a fine-toothed comb. You want to identify any errors on the reports and anything that may be in collections that either shouldn’t be or needs to be paid. Then work on fixing those errors before applying for a mortgage. Here’s the thing, the mortgage company is going to go DEEP into your credit history so you want to make sure that you are aware of anything that may be a red flag before you start this whole process. This will make sure that when you do start the process that your reports are accurate.
5. What is your income that you bring home every month?
Just like I mentioned above they will look into your debt-to-income ratio so you better know how much money you (and your spouse if you’re married) bring home every month. Which of course you already know because you’re actively budgeting and managing your money – right? 🙂
Goodness, this post has become massively long but I hope that it’s been helpful to you if you’re trying to navigate all the ends and outs of buying a home. I did want to leave you with this though – it’s not a sin to rent. If you’re not financially ready to buy a home don’t feel pressured into buying a home. Renting isn’t throwing your money away. It’s not. Save your money, pay off your debts, build up your credit score, and then when you find the right home you can buy.
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