Path to Home Ownership | Home Resource Center
Buying a home is exciting but also a long and sometimes challenge process.
The first step to home ownership is determining if you’re ready to take the leap from renter to home owner. Before starting the process of finding a home, take a deep internal look at the motivations compelling you to homeownership. Are there outside pressures from family and friends? Is the market or housing prices a big influence?
Owning a home is quite different than renting and many considerations such as property taxes, homeowners insurance, maintenance and home improvement will become your responsibility.
Ownership Versus Renting
Weighing the Advantages and Disadvantages of Home Ownership
Carefully weigh the advantages of home ownership against it’s disadvantages as renting may be a more financially better option.
• Gain a sense of control and community by owning property.
• Home ownership can build equity (the portion of the home that is free and clear). Equity is calculated by subtracting the amount owed (mortgage) to the home’s actual value.
• Deduct mortgage interest and property taxes on income tax returns. Consult your tax advisor to determine tax benefits.
Disadvantages of home ownership include the mortgage that can tie you up for 15 to 30 years. Additionally, for the next 2-3 years your money will be tied up improving the house, making repairs and turning the house into a home. Home owners are subjected to real estate market fluctuations, increase property taxes and changes to neighborhood dynamics.
Weighing the Advantages and Disadvantages of Renting
Renting may be ideal until you’ve saved enough money to build a sizable down payment or for those who don’t want a long term financial commitment. Most renters can afford better amenities including swimming pools or exercise rooms. Renters also have few financial responsibilities such as not being required to keep grounds maintained, fix appliances and make home. Although rent may increase after a lease expires the price typically cannot exceed a local ordinance’s guidelines.
As a renter, you don’t build up equity or receive tax advantages. Additionally, you’re limited in the changes you want to make to your home. Overall, paying rent is a transitional phase until you’re able to afford a home.
Understanding Your Finances
In order to be able to buy a home, you must either have money saved, or you must be able to borrow money to purchase your house. In order to do this, however, you must be “mortgage eligible,” which means that you qualify to borrow enough money to purchase a home. How you answer the following questions will help you determine whether or not you are mortgage eligible:
Do you have steady income?
Income does not include food stamps, unemployment benefits or undocumented cash labor.
Do you have stable employment?
How long you’ve worked at a job is important. Your profession is also taken to account if you’ve happened to change jobs frequently but remain within the same professional field.
Do you have good credit history?
Examine your credit history to make sure information is accurate and correct. Negative information such as bankruptcies, collections and late payments can have a serious impact on your ability to be approved for a mortgage.
Do you have enough saved for a down payment and for closing costs?
There is more to saving for home ownership than down payment as first time home buyers will attest the desire to make improvements and spend money to turn a house into a home. Consider the costs of ownership related from purchase to owning a house to turning it into a home.
Do you know how much debt you hold?
If your fixed income is tied up on existing debt consider paying off sooner to free up your cash flow. Payments for car loans, student loans and other installment loans can become more difficult once you add a bigger installment loan to the mix. Look at your variable debt as well such as credit card debt or lines of credit.
What are your current monthly expenses?
Not all expenses are debt although some debt is due to some expenses. For instance if you pay for your cell phone bill using a credit card, then you’ve turned an expense into debt if you decided to carry the balance from month to month.
Preparing for Homeownership
To start the home ownership process requires you to save money. You simply cannot apply for a mortgage, get approved and be ready for the financial impact it will have in your life without carefully planning a healthy savings strategy related to home purchase.
There are several things you may want to save for, including:
The down payment: Typically you will need to save 5 to 20 percent of the sale price in cash in order to qualify for a conventional loan. If you put down less than 20 percent, you will need private mortgage insurance. Saving for a down payment remains the No. 1 obstacle to homeownership. However, what many people don’t know is that there are more than 1,000 down payment assistance programs available across the U.S.
Closing costs: Closing costs are the fees required to obtain a mortgage and transfer ownership of the home, such as attorney costs, an appraisal, title insurance, a recording fee, points, and a loan origination fee. You may have to pay the fees yourself, although sometimes the seller will pay them or you can have them included in the mortgage.
Post purchase reserve funds: You may need to show the lender that you will have savings left over after you purchase the home. This provides assurance that the mortgage can be paid even if you are experiencing cash flow problems. At least three months’ worth of mortgage payments is a good amount to have in reserve.
From house to home: If you plan to buy a fixer-upper, appliances, or new furniture, include these costs in your savings plan.
In order to get a mortgage, especially one with a low interest rate, you usually need to have a good credit score. The most common scoring model is the FICO score with scores range from 300 – 850 and the higher, the better.
Your score is calculated using data from your credit report, which is compiled by three bureaus: Equifax, Experian, and TransUnion. A lender may check your score from all three bureaus or only one. Many lenders require a score of at least 680 to get a mortgage, and those with a score in the mid-700s and above usually get the best interest rates. If your score is lower than 680, you may only qualify for sub-prime loans, which usually have a high interest rate, or find it difficult to get any loan.
Get your free copy of your credit report through AnnualCreditRepot.com and review your credit information. It’s good practice to regularly review your credit report and especially way before you decide to apply for a mortgage. Learn ways to improve your credit situation a full year before you fill up the first application.
Payments, Interest, Taxes and Insurance
If you are like the vast majority of people, you will need to take out a mortgage to purchase a home. Paying it back will likely be your largest monthly expense. But what exactly is that money used for?
Most of it goes towards repaying the mortgage loan. Loan payments can be divided into principal and interest. For the majority of mortgages, early payments consist primarily of interest. As you continue to make payments, a higher percentage goes toward principal. This is called amortization.
Part of your mortgage payment may consist of money the lender collects on your behalf for property taxes, homeowners insurance, and, in some cases, private mortgage insurance (PMI). PMI protects the lender against loss if the borrower defaults on the loan and may be required for people with less than a 20% down payment. Every month, the lender puts aside the money for these expenses in an escrow account and pays them when they are due. This allows them to ensure that these important bills are not neglected. Together, the principal, interest, tax, and insurance payments are referred to as PITI.
If you purchase a condominium, townhouse, or other type of unit with a homeowners association (HOA), you will likely also have to pay HOA dues. This money goes toward property management, upkeep of the common area, and in some communities, certain utilities. You may pay the dues directly to the HOA or through your lender.
Fixed-rate mortgage: Fixed-rate mortgages come with an interest rate that remains constant over the life of the loan. The interest rate is usually initially higher than for other types of mortgages. However, because the interest rate and monthly payment are fixed, they provide a stability that is appealing to many buyers.
Adjustable-rate mortgage (ARM): ARMs have a period of fixed interest, after which the interest rate and payment adjust at specific intervals. In general, the interest rate and monthly payment for an ARM start off lower than for a fixed-rate mortgage of the same amount. However, they often become higher once a few adjustments occur. An ARM may be a good option for people who plan to sell in a few years or expect their income to increase significantly, but it can be risky. If you cannot afford the payment increase, you may lose your home.
Interest-only mortgage: With an interest-only mortgage, you pay just interest for a specific period of time, usually 3-10 years. Once that period is over, the payment rises to include both principal and interest. The initial payment is lower than for a fixed-rate mortgage since you are not paying any principal. However, once the interest-only period is over, the monthly payment becomes higher because you are paying down the principal in a shorter period of time. Like with an ARM, there is a risk you will not be able to afford the mortgage once the payments increase.
Mortgage terms: The term refers to the length of the loan. The traditional mortgage term is 30 years, but it can range from 10 to 50 years. In general, the shorter the term, the lower the interest rate. You get a lower payment with a longer term, but you wind up paying more in interest over the life of the loan (not just because of the higher interest rate but also because you are borrowing for a longer period of time).
Loans offered through federal government programs can come with more attractive features than conventional loans. The two most popular ones are:
VA loans: VA loans are insured by the Department of Veterans Affairs and are only available to eligible veterans. No down payment is required. Visit Benefits.VA.gov
FHA loans: FHA loans are insured by the Federal Housing Administration, a division of HUD (the Department of Housing and Urban Development). A down payment of at least 3.5% is required. Visit HUD.gov
Many states and cities have programs specifically for first-time homebuyers. They make it easier to buy a home by offering such things as down payment assistance, below-market-rate units, and/or low-interest loans. Contact your local housing authority for information about programs in your area.
When to Apply for a Mortgage
Don’t wait till you found a home and make an offer to apply for a mortgage. In some instances, a real estate agent will not work with you unless they see a mortgage pre-approval letter. This helps manage everyone’s time from yours (buyer) to sellers and real estate agent.
With a pre-approval, a buyer will know how serious you are in purchasing a home and a real estate agent may prioritize his or her time to find the right houses to see for you. Additionally, you narrow down your search based on the financing amount and don’t have to feel rushed securing a mortgage when you find your dream home.
Lenders have the ability to pre-qualify or pre-approve you for a mortgage. A pre-qualification gives you an estimate on what a lender believes you can afford however it’s not a guarantee. With a pre-approval a lender has committed to provide a mortgage for you up to a specific amount barring any major financial changes or problems with the house.
If you’re serious about buying a house, you can get a pre-qualification letter to start the hunt with a real estate agent however you may want to get your pre-approval as well as it can take up to 90 days.
Finding a lender
Applying where you already have a pre-existing financial relationship such as a bank or credit union. Many lenders let you apply for a mortgage on-line, but if you have questions, you may want to apply in person with a loan officer.
Be careful with whom you choose. Most lenders are honest and legitimate, but there are some who are not. Avoid lenders who ask you to falsify information, sign blank documents, ignore your questions and concerns, or put excessive pressure on you.
Lenders consider many factors when deciding whether or not to approve a loan and how much to approve you for. They typically include:
What Lenders Look For
Your credit score: As discussed previously, many lenders require a score of at least 680 for approval and mid 700s for the best interest rate.
The down payment amount and your other assets: Most lenders require you to pay for a certain percentage of the home purchase with cash from your pocket. For example, if your lender requires a 10% down payment and you have $20,000, the most you could borrow would be $180,000 ($200,000 maximum purchase price – $20,000 down payment). The reason for this requirement is that if you have some money invested in the home, you are less likely to walk away. Lenders also like to see that you will have savings post-purchase that you can use to pay the mortgage in case you experience a cash-flow problem.
Your employment history: In order to know that you are capable of handling a mortgage, lenders usually want to see a stable employment history (at least two years of consistent employment in the same field).
Your income: Traditionally, lenders have required that the mortgage payments, including taxes and insurance, not exceed 28-33% of your gross income. This is called the housing expense or front ratio. However, in recent years, many lenders have raised that ratio. You will likely have to provide two years worth of Form W-2s and/or paystubs to document your employment and income. If you are self-employed, you usually need to provide two years worth of tax returns and balance sheets.
Your existing debt: Many lenders require that your existing debt payments plus your mortgage payment not exceed 36-38% of your gross income, although some allow a higher percentage. This is called the total debt or back ratio.
After collecting the necessary information, the lender will approve or deny the loan. Many lenders use an automatic, computerized system and can tell you right away if your loan is approved. With other lenders, a person makes the decision, and you may have to wait a few days or weeks before hearing back.
If the loan is denied, the lender is required to tell you the reason why. You will probably be disappointed, but use the feedback provided to make changes. If the loan is approved, the lender will tell you the amount you can borrow.
Truth in Lending Statement
Within three business days of receiving your loan application, the lender must give you a Truth in Lending Statement, which shows the amount financed (borrowed), annual percentage rate (yearly cost of the loan expressed as a percentage), finance charge (total cost of the loan expressed as a dollar amount), total amount that will be paid back over the life of the loan, number of payments, payment amount, late payment policy, and if there is a prepayment penalty. Be sure to read the statement carefully, and ask for clarification from the lender if you have any questions.
Examining your Budget
If the lender approves you for a $350,000 mortgage, that means you can afford a $350,000 mortgage, right? Not necessarily. Lenders typically only look at a few factors, namely your income, debt, and down payment. However, you have more expenses than your debt. If you have to pay $1,000 a month in daycare, that reduces the money you have available for your mortgage.
Finding a Real Estate Agent
People often wonder whether they should search by themselves or use a real estate agent. Using a real estate agent makes the buying process much easier. Your agent can find available homes for you, arrange showings, and help you write an offer. Best of all, in most cases, the seller pays your agent, not you.
There are several steps you can take to find a real estate agent you will be happy with:
• Ask for referrals: Many of your friends and relatives have probably bought and sold their homes through real estate agents. Make some phone calls, and get the names of the agents they liked.
• Comparison shop: Talk to several prospective real estate agents and ask questions about the areas and types of homes you are interested in. Do they seem knowledgeable? Is their personal style a good fit with your own?
• Avoid using the seller’s real estate agent: Many people choose the real estate agent selling the house they want to put an offer on. This is usually not a good idea because the real estate agent is working for you and the seller and may not be able to advocate for you.
Your housing search will be more efficient and focused if you think beforehand about what you want. Features to consider include:
• Number of bedrooms and bathrooms
• Square footage
• Type of home (such as single family or condo)
• School district
Most buyers’ budgets are limited, so you may not be able to get everything you want. Think about what is most important.
The Home Search
Use your real estate agent to help you find the home of your dreams and also do some research online using websites like Zillow and Trulia. A real estate agent may have information on homes you can’t see online so it’s always good to send them some of your findings and discuss what you like or don’t like.
When you find a home you like go for a walk-through, talk to the homeowners and the neighbors. Before making an offer, you may want to visit the house a few times in different parts of the week and at different times. Consider driving by the home at a Wednesday night or early Sunday morning.
Really dig into school district if that is important to you and what’s around the neighborhood and recently reported crime.
Making an Offer
Once you find the house you want to purchase, your real estate agent will prepare an offer. Offers typically have at least three components:
• the purchase price,
• the closing date,
• and how long the offer is good for.
Selecting an Offer Price: to determine an appropriate offering price, your agent will probably look at “comps” – similar houses that have sold in the neighborhood. Other considerations are how long the house has been on the market and whether there are other buyers making a competing offer.
Concessions, Inclusions and Contigencies
Many offers have additional components, such as seller concessions, inclusions, and contingencies.
• Seller concessions: are costs that the seller pays for the buyer, which reduce the amount of money the seller receives. Typical concessions include closing costs and cash back for repairs or renovations.
• Inclusions: refer to what stays in the house. If you want the appliances, blinds, chandeliers, or anything else, make sure to put it in the offer.
• Contingencies: are conditions that must be met in order for the sale to go through. A home inspection, financing, and an appraisal are common contingencies.
Once the offer is written, your agent will present it to the seller.
Along with the offer, it is customary to give the seller earnest money, also called a good faith deposit. Usually the amount is between 1-3% of the offered purchase price, but customs vary from place to place. This money is part of the down payment and shows the seller you are serious about purchasing the house. The money should go in an escrow account (an account where funds are held for, but not owned by, a party), not given to the seller.
Acceptance, Rejection or Counter Offer
The seller will accept, counter, or reject the offer.
If the seller accepts the offer, the house is taken off the market, and you are under contract. The only way to legally cancel the contract is if a contingency is not met. Otherwise, if you walk away from the house, you lose your earnest money deposit. When sellers counter, usually it is with a higher purchase price, but they can also counter on the closing date, concessions, inclusions, and contingencies. You can accept the counter or respond with your own counter. If you do not get the first house you put an offer on, try not to get discouraged. There are likely many houses out there that meet your needs.
Once your offer is accepted, you can arrange for the home inspection, which should be done by an independent, qualified professional, and either apply for a mortgage if you have not already done so or let your lender know you found a home if you were pre-approved.
The lender will start to prepare for closing and may need additional documentation from you, such as proof of homeowners insurance. During this period, it is a good idea to periodically check in with the lender and make sure that they have everything they need. Otherwise, your closing may be delayed.
Potential Closing Issues
Occasionally, buyers who were pre-approved later get their loan denied. For example, you may be unable to purchase a particular house if the appraisal comes in too low. Also, your lender will likely check your credit report right before closing, and your loan may be denied if there have been major changes since you first applied, like additional debt or recent late payments. However, if there are no problems, your loan will get final approval, and the lender will be ready to pay out the mortgage funds.
About a day or so before closing, ideally after the seller has moved out, consider doing a final walkthrough of the property. In the walkthrough, you should make sure that the seller left everything he or she agreed to leave and that the property is in the same condition it was in before. This is the best time to bring up any problems, such as a stain on the carpet, since the seller has not yet gotten paid. Once closing passes, your options for getting the seller to do something are limited.
Closing is the day that the mortgage is finalized and the title of the house is transferred to you. In many states, closing is handled by the title company. If not, it may be handled by a closing company or attorney. You will need to bring photo identification and a cashier’s check for the amount you are paying for closing costs and the down payment.
There will be a lot of paperwork to sign, but do not feel rushed. You have a right to review the documents at least 24 hours before closing. Make sure that you understand them. You may want to hire a real estate lawyer to accompany you to closing and explain what everything means.
The documents you will be signing include the:
• Mortgage note: The mortgage note is your promise to pay the lender according to the specified terms.
• Mortgage or deed of trust: This gives the lender the right to the title of the home if you do not pay the mortgage.
• HUD-1 Settlement Statement and Truth in Lending Statement: The HUD-1 Settlement Statement shows your closing costs, and the Truth in Lending Statement shows the amount you are financing, APR, and other loan terms. If you see any unexpected fees or the mortgage terms are vastly different from what you discussed, don’t just sign the documents – ask the lender to explain them.
After you get through the mountain of the paperwork, you will receive the keys to your new home. You are now a homeowner!
Tax Benefits of Homeownership
Your mortgage payment will probably be higher than your rent, but owning a home can provide a nice tax break. If you itemize your deductions on your income tax return, you can deduct some home-related costs, the most common ones being mortgage interest and property taxes. Since deductions lower your taxable income, your tax liability decreases.
With a lower tax liability, you may be able to reduce the amount of taxes being withheld from your paychecks. (You can adjust your withholdings by filling out a new Form W-4, available on the IRS’s website.) If you keep your withholdings the same, you may get a big refund.
You may want to consult with a tax professional or use the withholding calculator available on the IRS’s website to help you determine how many exemptions you can claim on your W-4 form.
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+ VA Home Loans – Learn more about active military and veteran home loan programs.
+ FHA Home Loans – Learn about first time home buyer programs and HUD loans.
+ IRS – Learn about potential tax incentives and advantages of home ownership.