Buying a home is a complex process, and there are many factors to consider when you’re starting out. You’ll need to consider the area you want to be in, what homes cost in that area, and how your commute will be. You may consider school districts if you have or are considering children, or maybe proximity to parks if you’re a dog lover. You should consider how long you want to stay in your new home- is a starter home, or a forever home? Most importantly, though, you should consider your finances. A home is an investment, and if you make a good investment, it could help you get ahead financially. To ensure that you make the best investment that you can, you should take a good hard look at how you’re managing your money and where you stand as far as income, credit and debts.
Know Your Debts and Assets
The most important part of searching for a home is understanding what you can afford. The easiest way to do this is to create a budget. A good budget will be detailed and include money put toward efforts to pay off debts and add money to a savings account. Once you determine your monthly expenses, you can then begin to get a good idea of how much you can afford to increase your living expenses.
According to Forbes.com, a lender- that is, the bank that will be financing your loan- cannot legally approve a loan where the mortgage will exceed 35% of your monthly income. That is still considered high, however. Most lenders and advisors recommend following the 28% rule, which states that your monthly mortgage payment will be equal to or less than 28% of your monthly income. You can determine what amount that is for you by multiplying your monthly income by .28. If you find that 28% of your income $1200 and you are currently paying $800, for example, then you know that you could pay up to $400 more a month for a home.
Consider Your Credit
Your credit score is a huge factor in qualifying for a home loan, as well as determining what you’ll pay, and at what interest rate. The first and most notable factor that your credit affects is whether you can qualify for a loan at all. The lowest credit score you can have to still qualify for a FHA- or Federal Housing Administration- loan is a 580. Many creditors won’t lend to those with a credit score under 620. So knowing where you stand with your credit can really be the deciding factor in whether you can purchase a home at all.
With that being said, getting approved for a loan isn’t the only part of the process that your credit affects. Your credit score will determine how much your lender approves you for, and at what interest rate. Your credit score is comprised of numerous factors that tell lenders the level of risk involved in loaning you money. These actors include:
• Credit Age: The length of time that you have held lines of credit is known as your Credit Age. Having a longer credit age will reflect more favorably on your ability to borrow money responsibly.
• Hard Inquires: When you apply for a new line of credit- such as a credit card, auto loan, or home loan- the lender will check your credit. These credit checks are known as Hard Inquires. Having just a few Hard Inquires is ideal, as it shows that you are not frivolously applying for lines of credit.
• Total Accounts: This is the number of total credit lines you have open, including any collections accounts you may have. It is favorable to have multiple lines of credit, and multiple types. A mixture of loans and revolving credit- such as credit cards- is best.
• Derogatory Marks: If you have an account go to collections, file bankruptcy, or have your wages garnished, this will factor into your credit score and is known as a derogatory mark. It is best to have no derogatory marks on your credit report.
• Credit Utilization: The amount of your total available credit that you are using is known as your credit utilization. Lenders recommend using 30% or less of your available credit.
If you find that your credit score is stopping you from receiving a loan, or from getting an interest rate that you’re comfortable with, there are credit repair answers so that you can apply again with a better result.
Know the Implied Costs
There are certain costs that are “implied” when it comes to buying a home. These can be one-time costs, as well as monthly. Some of the implied costs of purchasing a home include:
• Inspection Fees: Prior to purchasing a home, you will need to have the property inspected for safety. While this may add to the cost, it typically works out in the buyer’s favor. This is because any safety issues must be fixed at the cost of the seller. If the seller does not do the repairs, that amount can be deducted from the selling price of the home. The price of a home inspection varies based on square footage and can be between $200-$400 dollars.
• Appraisal Fees: During an appraisal, the value of the property will be inspected to determine its market value. This is a very important step in your home buying process, because the seller may be overestimating the value of the home. If the appraisal comes in lower than the listing price for the home, you may have negotiating power. Appraisals can cost $300 and up, depending on the size of the home.
• Title/Deed Transfer Fees: When a property is sold from one person to another, there are plenty of legal documents that accompany that process. The title or deed of your home will need to be transferred into your name, processed, and filed with the county records office. This is unavoidable and can cost an additional $250 plus filing fees.
• HOA fees: The HOA- or Home Owners Association- is an association that helps real estate agents sell and market homes. If the property you’re buying has an HOA, then it will come with an HOA fee. This fee can range from $200-300 a month.
• Home Owners Insurance, Mortgage Insurance, and Property Tax: Homeowners insurance is much like any other type of insurance- its there to protect you if something happens to your home. You must carry homeowner’s insurance by law and can expect to pay an estimated $35 per $100,000 value of your house. Mortgage insurance is required by anyone who puts less than 20% down payment on a home and is there to protect the lender if you fall behind on payments. The cost of Mortgage Insurance is about .5%-1% of your total loan. Property Tax is a tax you pay based on the value of your home. Property tax typically cost about .75%-1.5% of your homes total value.
While it may feel overwhelming, it pays to do your homework when it comes to buying a home. It is an expensive process and a serious investment, and the last thing you want is to agree to a bad deal because you didn’t know better. Making a list of questions for your real estate agent and lender is a great start, and don’t hesitate to ask for clarification if something comes up that you don’t understand. You’ll want to feel secure in your finances so that you can start making memories in your new home.