|
Preparing To Buy Your First Home |
 |
 |
 |
|
Written by Doug Beecher, MBA, CPA
|
 This is a great time to buy your first home, if you have prepared to do so. In many places, home prices are now 50% below what they were just two years ago. The federal government is offering $8,000 refundable tax credits (read “cash in your pocket”) for qualified first-time home buyers, and many states are offering additional incentives on top of that. It is tougher to qualify for a mortgage loan now, but those who can often buy a home for a lower monthly payment than rental on the same property. However, one of the reasons is it such a good time to buy is precisely because it is such a hard time to sell – so if you aren’t sure you will be staying in your home for a minimum of two years, and preferably at least five years, you probably aren’t ready to buy yet.
Here is an example of why it is so worthwhile to make the effort to properly prepare and then make a long-term commitment to buy a home. Suppose you can either rent or buy your home today for $1,000.00 per month, and that you will live there for the next 30 years. Assume also that your rent will increase an average of 3% per year over that time period. That is in year 2 you will pay $1,030.00 per month, in year 3 you will pay $1,060.90 per month . . . and in year 30 you will pay $2,356.57 per month to rent that home. (Frankly, I will be surprised if the average yearly rent increases stay that low for 30 years, which makes my point all the more). Over the 30 years total you will pay over $572,000 in rent, whereas if you have a 30 year fixed interest mortgage you will pay $360,000 in total principal and interest – a difference of more than $212,000!
Plus, if you buy you will have a paid off home but if you rent you have no equity in your home and can still be asked to move at any time by your landlord. Don’t think this will happen to you? I personally worked with people that lived in the same apartment for over 30 years, and then had to move when the owner sold the building and the new owner wanted to move his married child into the apartment. It happens.
How Much Can You Afford To Pay Monthly
A good place to start is to multiply your gross income (before taxes are deducted) by 25%. For example, if your monthly income is $4,000, then try to keep your mortgage payment as close to $1,000 as you can. You may be able to find loans as high as 40% of your income, which would qualify you for a $1,600 monthly payment on the same income. Try to find a home you are happy with at payments that are less than the maximum. Remember that you are going to have to pay for your own maintenance, something you have relied on a landlord to do in the past. Keep room in your monthly budget for emergencies and savings, if for no other reason than you probably will want to qualify for a bigger home in the future. This is very difficult to do if you overextend yourself.
Get A Copy Of Your Credit Report
Your credit rating is probably the biggest single factor that will determine whether you will qualify to buy a home, and how much you will have to pay. If you have a poor credit rating, even if you do qualify, you will have to pay a higher mortgage interest rate than if you had better credit. Good credit can save you many thousands of dollars over the life of your mortgage loan.
There are three national credit agencies that maintain records of the amount of credit you have and your payment history. These are Equifax, Experian, and Trans Union. All three have websites that will give you detailed information about your credit history for a fee. When you apply for a mortgage loan, you will probably be checked against all three. Because of this, if you do contact one of them for a report, choose an option that will give you a composite report giving information from all three.
If you have recently applied for credit and have been turned down, by federal law you have 60 days to request a free copy of your credit report.
Check Your Credit Report For Errors
Once you have a copy of your credit report, study it carefully. If you find errors, write a letter to the agency that provided you the report explaining in detail each item on the report you disagree with and why. Keep a copy of the letter in your records for follow-up later. The credit agency will contact the person or business who reported the item you are questioning. They have 30 days by law to respond with proof that their report is correct. If they cannot do this, then the item must be removed, which will benefit you.
If you find true information that is unfavorable to you, use it to develop a specific plan how to improve your credit report in the future. Do this by working on the various items noted in the next section about your FICO score.
Understand Your FICO Score
FICO scores have been developed by the credit industry to give a standard basis for comparing many different borrowers to predict who has the least risk of defaulting on repaying their loans. Lenders want to be repaid with interest. Some lenders will only work with those with a very low risk of default. Others are willing to work with a wider group of people, but charge a higher interest rate to everyone to offset the money they will lose on the portion of borrowers who later do not repay their loans.
One of the most important steps in preparing to buy your first home is to understand your FICO score and what you need to do to make it as high as possible.
FICO scores can range between a low of 350 and a high of 850. Scores between 700 and 850 are the best. Generally, you will qualify for the lowest interest rate if you can keep your score in this range. You do this by having a good mix of credit between revolving credit (such as credit cards) and fixed loans (such as car loans). Keeping your total amount of debt low compared to your income is important.
Credit cards can be useful financial tools, especially if you travel for business or other purposes. Strive to pay your balance in full every month. If you occasionally cannot pay in full, at least try to keep your credit card balances below 30% of your credit limit to keep your FICO credit score high.
For both credit cards and fixed loans, pay on time every time, and try to pay more than the minimum required on a consistent basis each month.
If you are good at paying on time, but keep your credit balances higher than 30% of your credit limit, you probably will have a FICO score in the 600s. A score between 650 and 700 will cost you a little more mortgage interest than a score above 700, but you will still qualify for many programs. Between 600 and 650, you will often pay 1 to 2 percentage points more, have a higher down payment requirement, and have less loans to choose from. On a $100,000 loan for a home you own 5 years, this interest difference alone will cost you $5,000 to $10,000!
If you have late payments, and have occasions you are over your credit limits, you will probably have a FICO score in the 500s. I have seen cases where with concerted effort people with scores in the 500s have raised their score 100 full points in one year. If you have a score in this range and do not own a home yet, you probably will want to focus on improving your score before trying to purchase your first home. If you decide to go ahead anyway, you may pay anywhere from 2 to 6 percentage points more in interest, plus extra upfront points, so be very careful. In today’s lending conditions, you will probably also have to make a larger than normal down payment in order to get the loan if your credit score is this loan. It can make a bad situation worse to buy a home before you are ready, get overextended, and then lose the home because you cannot make the payments.
People with the lowest scores (below 500) will probably not be able to find mortgage financing at all. These are usually people with recent bankruptcy, foreclosure, or judgment records on their credit report. All of these poor credit reports can be improved with time, good planning, and discipline. If this is you, definitely focus on improving your credit before attempting a home purchase.
Choose a Loan Officer
Interview at least three loan officers before settling on one you are comfortable with. Your bank or credit union is one place to consider, as are many of the licensed mortgage loan brokers. Try to find someone with good references and a wide variety of loan programs to choose from.
Comparing Mortgages
Mortgage loan advertising can be confusing. Try to find a loan that matches your needs. If you will live in a home for less than seven years, you probably want an adjustable rate loan, or one that is fixed for 5 to 7 years and then adjusts. These will often save you at least one percentage point compared with a 15 or 30 year fixed loan, and you will sell your house before the longer term loan is paid off anyway.
If this is likely a lifetime home, you may want to pay a little more for the 15 or 30 year fixed loan in exchange for its guarantee that the interest rate will not change. This is because interest rates are currently at historic lows, and are more likely to go up in the future than down. If you do choose an adjustable rate loan, make sure you understand how often and how high interest rate adjustments can go. Modest rate adjustments might be OK, while a loan with the possibility of payments doubling over a five-year period should be avoided.
If you have special circumstances, such as a business you are financing in addition to a home, you may want to get professional advice particular to those circumstances. A home equity line of credit charging only interest monthly at a low rate may be the best (or only) way to finance your business. Keeping your home secure is vitally important too. Weigh both carefully in your decision making.
Choose a Realtor
Once you know what you can afford to pay monthly, understand your credit, and know what mortgage you want, a good realtor can show you what homes are available that are consistent with your needs. Follow the same procedure as you did with the loan officer, interview at least three. Make sure you are comfortable with their personality, their professionalism, and their specific knowledge of real estate in your area.
A good realtor can also help you with all options. Buying your first home can be a daunting task. Sometimes the best option can vary between a condo, a fixer (if you have the time and skills), or a duplex (You rent out the other half of the home. It may be small, and you may have to deal with repairs and collecting rent, but it can be a good way to get started if you have the skills)
The best realtor will want to work with you over a lifetime. If your first purchase requires a year of patience, your realtor will be there for you, because he or she wants your referrals and your future business when you move to a bigger home later.
Get Your Tax or Financial Questions Answered In A Future Article
I choose topics for my articles based on the questions I receive most frequently from you. I appreciate your input! I originally wrote this particular article on the steps you should take to prepare to buy your first home for my local newspaper in 2005, and have updated it in 2009 to reflect the opportunities currently available.
Important Note!
The information in this article is intended to inform you of some of the financial opportunities provided in the tax laws or elsewhere. It is not intended to give you specific advice for your personal situation, since each case is different. If you need such advice, please contact a qualified professional!
© 2005, 2009, Doug Beecher, MBA, CPA, all rights reserved. This article, either as a whole or in part, may not be reproduced or transmitted in any form without the prior written permission of the copyright holder. When such permission is granted, the user must state that the material was used by permission of the copyright holder. |
|
|
News | Blog