First Time Home Buyer's Guide

Buying Your First Home

A recurring question I see when interacting with clients is “what can I do to prepare to buy my first home.” This is a great question to ask when one considers the potential benefits of homeownership. According to the Federal Reserve Board of Consumer Finance, the average homeowner in America has a net worth of $255,000 compared to $6,300 for those who rent. That’s a difference of 40x between the two groups and definitely a statistic worth paying attention to!

Home ownership can offer a variety of long term benefits. Yet with any type of long term investment, it has to be approached correctly and with proper due diligence. Knowing where to start can be a challenge and oftentimes individuals are in the dark regarding how to turn their dreams into reality. The good news is that following a simple plan can systematically move you closer to accomplishing your goal and get you into your first home.

A simple format that individuals can focus on when purchasing their first home is to break it down into the following four phases:

Phase 1: Build Your Financial Team

Phase 2: Maximize Your Credit Score

Phase 3: Secure Financing, Down Payment, And Closing Costs

Phase 4: Find Your Home And Negotiate a Winning Offer

Let’s take a look at each of these phases and how one can approach them.

Phase 1: Build Your Financial Team

Henry Ford is credited with saying “If Everyone Is Moving Forward Together, Then Success Takes Care Of Itself.” This couldn’t be more true when it comes to purchasing your first home. Surrounding yourself with the right team is critical to your success. For your home purchase, you will be best served by having three key strategic partners. Those partners are:

1. A Realtor
2. A Mortgage Lender
3. A Financial Advisor
   

Let’s review what each strategic partner does for you:

Realtor - Your realtor is the quarterback of your home buying experience. They will work with you, your financial advisor, and your lender to ensure everything is in good order for your purchase. They will provide detailed information on market conditions leading up to your purchase. They will organize your home search, set up home showings, advise on contract and offer negotiations, set up contractor appointments, and make sure your best interests are represented. Your realtor has a fiduciary obligation to represent your sole interests.

Mortgage Lender - Your mortgage lender ensures your financing is in good order so that you can purchase your home. A good lender will provide you with specific information to best position yourself for taking a loan. They will also educate you on the various lending options that are available to you.

Financial Advisor - your financial advisor will work with you to ensure your short term investments are properly allocated for your home buying time frame. They will provide tools to help you maximize your financial potential as well as provide broad education regarding positioning yourself in the best spot for your home purchase. They will also work with you to update areas in your financial plan impacted by your home purchase and, if needed, answer questions regarding utilizing retirement plan funds towards your purchase.

Now that we know the positions, let’s look at how you can fill your roster with the best players.

Finding Your Realtor

Finding the right realtor is the single most important decision you can make in your home buying process. A good realtor will walk you through each step of the process and ensure your best interests are represented. The best way to find the right Realtor is to start with referrals and carefully interview several agents. During the discussion, you’re trying to get them to describe to you how they go about assisting a buyer. You also want to get a feel for their background and experience level. Lastly, you want to ask them about their experience. You don’t have to go with the most seasoned professional, however if you’re going to pick a less-experienced agent, then it should be for a very specific reason.

As with any big purchase, your agent should be willing to spend time educating you on current market conditions. They should NEVER make you feel rushed or pressured to have to do something “right now.” Remember, a great agent isn’t there to tell you what to do but instead to hear you out, find your goals, then show you solutions to accomplish those goals.

The Real Estate Agent you select will perform 7 main tasks during your home search:

1. Educate you about the market
2. Analyze your wants and needs
3. Steer you to homes that fit your criteria
4. Coordinate the work of other needed professionals
5. Negotiate on your behalf
6. Review paperwork and deadlines
7. Solve any problems that may arise

During your agent search, here are some questions you could ask prospective agents to see if they can best help you find your home:

1. How many years have you been in the real estate business?

Ideally, you’re looking for someone who has multiple years of experience though different market cycles. A new agent isn’t bad, they just should be able to demonstrate a high level of training and support.

1. How many real estate transactions did you complete in each of the last two years?

Ideally, the answer should be more than single digits. You want someone who is consistently closing transactions as they’ll have a much better understanding of market conditions and what is and isn’t realistic regarding current market conditions.

2. What was the dollar volume of your transactions in each of the last two years? What would you say is the average price of homes you helped clients buy and sell?

This will help you get a pulse on if they are representing buyers similar to you. If you’re looking at houses far above their average, you may be talking with an agent that is not as familiar with the particular market you’re interested in.

3. How will you notify me about homes that may fit my criteria?

Most agents will at a minimum set you up on a market report designed to notify you as potential fits hit the MLS. However, a good agent will also mention something about reviewing new properties daily and calling or texting you directly if something meets your needs.

4. Do you work as an individual or on a team?

This will give you an idea of how this agent deals with the limitations of being in multiple places at once. Real estate can move fast so you’ll want to verify that the agent has help to support you in the event things are moving rapidly. Solo agents who are extremely talented do exist however the most successful agents are typically part of a supporting team. Either way can work however I would place a lot of value on an agent who has a dedicated team working towards your success.

5. Do you work as a Realtor full time or do you have another job?

Personally, I would have a hard time hiring an agent who is still working another job unless they were part of a leading team in your community. If the agent has another job, they can not put 100% of their focus on you or real estate as they have other obligations to meet. However, if the agent is not part of a successful, well established team, you may want to continue your search. Not always, yet often there will be a noticeable experience lag with this type of agent and, in my opinion, you want a seasoned professional representing you in your search and negotiations.

6. What is your written business plan for how you will help me find my home?

The agent you hire should be able to clearly show you in a written business plan how they will help you find your home. There should be processes in place that lead to your success. I would want an agent to be able to clearly demonstrate their step-by-step process before selecting them as my agent.

7. What is your process for helping me negotiate and submit winning offers?

This is another area that I would want to see agents have a solid process they’re following. Once you find your home, you will have to submit an offer. You want an agent who is aggressively representing your best interests. More so than finding your home, a strong negotiator is KEY to completing successful transactions. Someone unfamiliar with current market conditions or in a spot where they “need” to make the sale won’t be as likely to tell you to walk away from something or when it’s time to hold your ground.

8. How will you help me coordinate the work of other needed professionals?

Making a home purchase involves multiple steps and oftentimes requires other professionals to get involved. You want to find an agent who can help you coordinate these professionals and has a deep pool of seasoned professionals to pull from. An ideal agent should be able to immediately answer questions like “who do you use for your home inspections?” or “Do you have a roofing contractor you work with?” or “which mortgage professionals do you work with and why?” Remember, your real estate agent is the “quarterback” of your transaction so they need to be able to make things happen and keep things moving forward for you. You most likely don’t want to be represented by an agent who doesn’t have a list of preapproved, successful professionals they can utilize as situations dictate.

If you’d like additional questions you should ask, a good informational book is “100 Questions Every First-Time Home Buyer Should Ask” by Ilyce Glinn. This book covers the first time home buying process from a lot of different angles and can be a solid resource as you start this process.

Finding Your Lender

An essential ingredient to a successful purchase is finding a lender you can trust to walk you through the process. To select a mortgage company, you should pick them based on experience, customer service and referral recommendations. The one thing you SHOULDN’T do is to make the decision based solely on which lender is offering the lowest rates. There are numerous types of loans and financing options available so finding a lender who is willing to take time to educate you is key. My suggestion on this is to talk with your Realtor and ask who they recommend. If you did a good job in selecting a solid Real Estate Agent, they will know great lenders in your community. More than likely, they will provide you with 2-3 great options to start with. You can also get referrals from friends and family who are homeowners. Lastly, you can speak with someone at your local bank or credit union. Using these various sources, you should be able to come up with a handful of referrals to begin interviewing.

Once you receive these referrals, take the time to call at least 3 of them and let them know you’re interviewing lenders for a first time home purchase. These lenders will be more than happy to schedule a time to meet with you and answer any questions you may have. Ask them for any information they have specific to first time home buyers. Oftentimes, these lenders have materials dedicated specifically to individuals making their first time purchase. Let’s cover what a mortgage actually is before we go any further.

A Mortgage Is A Pledge Of Your Property As Security For Payment Of Your Home Loan.

Your mortgage is paid in monthly increments, and your payment will consist of four parts, commonly referred to as PITI.

P - Principal - The amount left on your loan apart from the interest

I - Interest - The interest paid in monthly increments for the life of your loan

T - Taxes - Your monthly property tax payment. This is approximately 1/12th of the total property tax for the year

I - Insurance - Referred to as hazard insurance or homeowner’s insurance, this coverage protects your home and certain possessions and can help protect your home from liability claims or lawsuits for accidents on your property.

Additional expenses may be included depending on what mortgage product you select. The components of PITI will typically make up your main home expenses each month. However, when estimating your monthly budget, you might also need to factor in these monthly costs:

Private Mortgage Insurance (PMI):

Private Mortgage Insurance is a form of insurance typically required for homebuyers who take out a conventional mortgage loan for more than 80% of the total value of the home. This added insurance protects the lender against loss if the borrower defaults on the loan. As a first time home buyer, PMI may allow you to buy a home with a down payment as low as 5%.

Monthly Mortgage Insurance:

Homeowners with a Federal Housing Administration (FHA) insured loan, which only calls for a 3.5% minimum payment, are required to pay monthly mortgage insurance (MI), even if the make a larger down payment.

Homeowner’s Association (HOA) Fees:

A HOA is an organization that enforces covenants and rules for the community and maintains shared property, such as open spaces, parks, and community pools. If you buy a home in a community with a HOA, you’ll be responsible for any HOA fees. Investigate the cost of membership before selecting a property to make sure the added expense is within your budget

Additional Taxes:

If the home you want to buy is located in a special district, sometimes called a Community Facilities District, you’ll pay additional taxes to fund improvements such as schools, parks, and roads.

Maintenance Costs:

One of the main differences between renting and buying is that you become responsible for any maintenance costs on your home. Set aside an amount each month in a home maintenance account so you’ll have funds on hand when a need arises.

Similar to interviewing your Realtor, you’ll want to take time to speak with each lender to get a feel for their process. Here are some questions you can ask when speaking with potential lenders:

1. How Many Years Have You Been In The Lending Business?
2. Which Type Of Mortgages Do You Offer?
3. Which Types Of Mortgage Terms Do You Offer?
4. Which Type Of Mortgage Is Best For Me?
5. What’s The Down Payment Needed To Buy A House?
6. What Credit Qualifications Do You Require?
7. Do You Offer Any Tools To Help Me Maximize My Credit?
8. What Is The Application Process?
9. What Will My Monthly Payment Be?
10. What Is The Interest Rate And Apr?
11. What Will My Fees And Payments Be?
12. What Will Closing Costs Be?

Remember, you’re not obligated to work with anyone. If you don’t have a good connection with the lender don’t feel pressured to move forward with them. Seek out a lender you feel comfortable with to help you through the process and be willing to walk away if things seem like they’re not a good fit.

What You Should Be Doing With Your Financial Advisor

Your financial advisor should be there to help you get prepared for the process. When I meet with clients, I play the role of an educator. Your Realtor and Mortgage Lender will be able to go more in depth on each of their respective fields, however an advisor’s role is to make sure you walk into each section of the process as an informed consumer.

Your advisor should work with you to utilize tools to:

1. Lower Your Debt-To-Income Ratio
2. Understand And Increase Your Credit Score,
3. Build Up And Properly Allocate Your Down Payment
4. Help You Navigate Using IRAs Or 401(K)S Towards The Purchase Of Your Home
5. Establish An Easy To Manage Budget
   

Lastly, your advisor will  help you update other areas of your financial plan that are affected by the purchase of your home. These include subjects such as:

1. Reviewing Your Life Insurance Coverages
2. Reviewing Your Estate Planning Documents
3. Updating Your Investment Allocations
4. Establishing An Emergency Fund For Home Repairs
   

Phase 2: Maximize Your Credit Score

“A high credit score is an integral part of financial planning.”

-LexingtonLaw.com

Maximizing your credit score is about making yourself easy for financial institutions to want to lend to. It’s important to begin with a basic understanding of what your credit score is. Your Credit score is a three-digit number found at three different credit bureaus (TransUnion, Experian, and Equifax) that institutions use to determine how likely you are to repay your debts. To access a copy of your credit report you can visit https://www.annualcreditreport.com/index.action.  This site will allow you to receive 3 free credit reports annually - one from each bureau. It’s important to note, your reports WILL NOT show your actual score. Instead, they will just show you what is reported regarding your credit. If you’re getting ready to purchase a home, it is a  good idea to pull all 3 reports to see what each bureau is reporting. To understand what you’re looking for when reviewing your reports, you can follow the header on annualcreditreport.com titled “what to look for” (found HERE) which will walk you through what to look for when reviewing your credit as well as what actions to take if you find any errors. If you’d like to see your actual credit score, most banks or credit card companies offer this information for free on their websites if you spend a few minutes searching it out.

Concerning your home purchase, your credit score will affect:

1. The Loans You Qualify For
2. The Interest Rate You Qualify For (And Your Payments As A Result)
3. Your Homeowner’s Insurance Rate

Credit scores are based on 5 factors (listed below) and they represent the RISK a financial institution takes in doing business with specific individuals. The more RISK that they (the lending institution) take THE HIGHER REWARD (i.e. interest payment) they expect to receive. We want lending institutions to look at you as a “low risk” investment. Anyone, regardless of their income, can have an AMAZING CREDIT SCORE if they simply manage their finances well and understand what contributes to a good score.

It’s important to remember that a credit score will never factor in personal information like your race, gender, religion, marital status or national origin.

Payment History - 35% of Your Credit Score

Your Payment History Is The MOST Important Factor concerning your credit score. Negative payment history will stay on your credit report for 7-10 years. Some key facts regarding your payment history to keep in mind are:

1. Payment history makes up 35% of your credit score. Making consistent on time payments will raise your score over time.
   
2. When you pay your balances late, you are often assessed a fine for doing so however they typically are not reported to the credit bureaus for at least 30 days.
   
3. If a payment is more than 30 Days late then that item is reported to the different credit bureaus and begins to negatively affect your score
   
4. Once you are over 90 Days late, the damage done to your score is much heavier than 30-60 days late
   
5. If you’re more than 90-120 days late the following records can also hurt your score - collections - Charge-offs - Repossessions or Foreclosures

Amounts Owed - 30% Of Your Score

Amounts owed is the 2nd largest impacting cause to a high or low credit score. From a lending standpoint, if you have a high amount of debt, you are more likely to be stretched thin financially so lending you additional funds could lead to you defaulting on your loans and the institution not getting their money back. Thus we want to focus on keeping your Debt To Income Ratio and your Credit Utilization Ratio LOW.

Your debt to income ratio works like this - Let’s say you make $5,000 per month (pre-tax) and your total debt payments are $1,500 per month then your debt to income ratio would be 30% ($1,500 divided by $5,000 = .30). We want to pay off as much debt as possible prior to buying a home as it will free up funds for the purchase of your home while also boosting your credit score by making you a “lower risk investment” from the financial institution’s perspective.

Credit utilization refers to how much of your available credit you use at any given time. For example, if you have a credit card with a $10,000 available credit and you have a $4,500 balance, then you would be utilizing 45% of your “available credit” and 45% is your “credit utilization.”

To increase your credit score, you want to keep your credit utilization below 30% each month on each card you have. Having higher than a 30% credit utilization signals to the credit bureaus that you either need the cards to supplement your current lifestyle or you may be irresponsibly spending money that you don’t have - either way causes them to view you as more risky to lend to.

A common misconception is that you need to keep a balance on your cards for it to positively impact your score. This is NOT true. Simply having a card open, even with a zero balance will help improve your score. The only reason to use cards is if you’re paying them off every month and you’re

One way to systematically reduce your amounts owed is to establish a debt elimination strategy. To do this, we recommend you use the “budget tool” on your eMoney portal to figure out where your money is going each month. Once you identify your top 5 expenses (excluding rent) you’ll want to set clear budget goals for each category so as to free up additional funds to use towards paying down your current debt and building up your savings for your down payment.

Length Of Credit History - 15%

The third factor impacting your credit score is the length of time you’ve had credit. Unfortunately, there’s not much you can do on this front other than establish a source of credit (i.e. have a credit card or some type of loan that reports to the credit bureaus) and pay it on time. If you have no credit history, applying for a credit card can begin to help you establish it. The key here is that you don’t have to (and shouldn’t) apply for multiple credit cards at once. Having one or two that you use from time to time and keep paid off will help you start building a positive credit history.

Credit Mix - 10%
Credit mix refers to the different types of credit you have and how you have used them. For example, having a credit card, auto loan, or home loan would all be seen as different types of credit. From the credit bureau’s standpoint, demonstrating that you can responsibly use various types of credit will boost your credit score. This however doesn’t mean you should go apply for all these different types of credit at once.  For most people, adding a credit card that you keep paid off will help build your credit score the most. Ultimately, at some point in time, many people will also end up with an auto loan in their lives. If you can responsibly handle these two types of credit you should be just fine when it comes to having an adequate credit mix.

New Credit Inquiries -10%
The last factor affecting your credit score is New Credit Inquiries. When you apply for credit there are two types of credit pulls - Hard Pulls and Soft Pulls. Soft inquiries do not affect your credit as they are used for pre-approvals or when you personally are trying to get information on your credit without actually applying for additional credit. Hard inquiries occur when you are applying for a loan. The reason applying for a loan lowers your credit score is because it creates a new, unaccounted for factor in your finances from the credit bureau’s perspective. Essentially, it is an “unknown” as to why you are applying for the funds and, as a result, it causes the credit bureau to view you with slightly more risk than they would beforehand.

Think of it this way - if you applied for a new credit card, from the credit bureau’s perspective, they don’t know why you are applying for it. Is it because you know you’re going to be losing your job in a few weeks? Is it because you know of some upcoming, unforeseen financial event that you’re going to need additional funding for? Or is it something as simple as you received an Amazon gift card for applying for the card and you wanted to save money on a purchase you were making and everything else is fine in your life? All these things are “unknowns” in their calculations and can lead to your score being lowered.

The opposite of this is also true though. If you have not applied for any new credit for an extended period of time then this will help you be viewed as more stable and, ultimately a lower risk investment to financial institutions.

Errors On Your Credit Report
The Federal Trade Commission estimates that over 20 million Americans have errors reporting on their credit reports. These reports can range from having a negligible effect on your credit to a massive one. If while reviewing your credit report you find errors, follow the steps listed under the “what to look for tab” on their website to report the error to the appropriate credit bureau.

Phase 3: Secure Financing, Down Payment, and Closing Costs

As alluded to earlier, securing financing is critical step to your success in buying a home. Unless you plan on paying cash for the house, you’re going to need some type of loan to cover the purchase.  While you’re working towards building up your credit score, or if you already have great credit, at some point in time you’re going to need to get pre-approved for a home loan.

The difference between pre-approved vs pre-qualified:
The main difference between being pre-qualified versus being pre-approved is that a pre-approval is a commitment in writing from the lending institution to provide funds for your home purchase whereas a pre-qualification is more of a “best-guess” as to what the lender will approve you for once all needed documents are submitted. A pre-qualification will require you to submit a variety of documents that your lender will request to ensure that you qualify for the loan and to determine at what terms the loan will be offered to you.

When working with your lender, they will provide you with the exact documents needed to get you pre-qualified for your loan. Lenders will have you complete an application as well as submit financial documents to prove you are able to afford the loan. When they run this process, it will be considered as a “hard pull” on your credit. Remember, too many hard pulls will lower your credit score. However, depending on the credit scoring model used, inquiries within a 14-45 day process for the same type of loan are typically viewed as one hard hit towards your credit score. An easy rule to follow is to have all your applications for any lenders you’re shopping be processed within two weeks of each other.

While your lender will cover everything needed for the application, a few items you can have ready to expedite the process are:

1. Copies of all bank statements for the last 3 months
2. Copies of all investment account statements
3. Most recent pay stub for you and your spouse or partner
4. W2 form for the past two years
5. If you’re self-employed, the past two years of tax returns
   

Once you have these documents together and you’re ready to move forward, ask the lender for their application, complete it, and see what you’re approved for.

Down Payment

As part of the homebuying process, you should expect to have a minimum of 5% down payment for your home purchase. Your lender can educate you on various options available to you however a minimum to plan for is 5% of the purchase price. You also should plan to have around 1% set aside for closing costs, which are fees paid by the homebuyer to finalize the home purchase. It is possible to negotiate these costs into the mortgage if need be and this is a question you can ask your Realtor and lender about. Once you know approximately how much homes you’re interested in are selling for, we can work out a periodic savings plan to begin saving the funds you’ll need for your down payment and closing costs.

A common question asked is “Where should I hold my down payment while I build it up?” The answer on this typically has to do with your purchasing time frame. The simplest way to view this is that the longer away you are from buying your home, the more growth minded you can be with the funds. However, if you have a short term horizon, funds are typically kept in a low risk spot so as not to be subject to any excess market risk. Each situation is different so it’s important to discuss your options before making a decision.

Phase 4: Find Your Home & Negotiate A Winning Offer

The final step in your home buying process is to actually find your home. This is where your Realtor will be your greatest resource. Your agent should set you up on a home search based on your buying criteria. This search will be linked to the Multiple Listing Service (MLS) which is the database of available homes for sale in your state. Your agent will set parameters for your home search that will automatically notify you when a home that meets your criteria becomes available.

When working with your agent, you’ll want to set up your search to provide you with these details in a way that best suits your needs. Some people prefer to get these alerts in real time, others prefer a summary email every few days. Less motivated buyers may be fine with a weekly or monthly report. Your agent will be able to help you determine what is best depending on your current situation.

Once you find a home you’re interested in, your agent will set up a time for you two to go and visit the property. During this time, you and your agent will view the home and see if it’s a fit for you. Your agent will also have access to any important information regarding the home so that they can provide you with all necessary facts pertinent to the home. If the home is something you’re interested in purchasing, your agent will then work with you to submit an offer. During this process, your agent will provide you with their best recommendations regarding pricing based on current market conditions. They will then help you put together an offer representing your best interests. An important fact to remember is that you are 100% in control of what you offer. The agent is there simply to provide guidance and their best recommendations based on industry data. However, if an agent says a solid offer is $450k but you only want to offer $380k, that is 100% your right. Remember though, an experienced agent knows the market and what things are selling for. They will also be providing you with supporting data regarding why they are making the recommendations they are making. The offer stage of the game is not the time to start doubting your agent’s expertise. Hear them out and use their recommendations to make the best decision for you. Once your offer is submitted, the seller will have a set amount of time to respond to your offer and either deny it, accept it, or make a counter offer. This process continues until the offer is accepted or denied by either party.

If your offer is accepted, you’ll go under “mutual acceptance contract” meaning that both parties agree to move forward solely with each other and that other offers will not be entertained as long as the process is moving towards closing. At this point of time, your agent and lender will work with you to perform your due diligence to make sure the house is indeed in good standing. As part of this process your agent and/or lender will:

1. Set up a home inspection - a home inspection is where an independent 3rd party inspector comes to view the home and identify any areas of concern or issues in major disarray. This report is something you as the buyer pays for and typically costs around $500. The inspection allows you to verify the home is in a condition that you feel comfortable buying as. If, after the inspection, you no longer wish to purchase the home due to information gained, you have the option to terminate the contract and walk away from the purchase.
2. Order an appraisal - your lender will have an independent appraiser come out and value the home to ensure the amount being lent to you is not greater than the home is actually worth.
3. Order Title Services - this step verifies that no other individuals or entities have a claim to the property you are purchasing. This protects you from buying a house from someone only to find out later they were not the only owner on the property.
   

The time from putting in your offer to closing on the property is typically around 60 days. Assuming all goes well and the offer moves forward, you will eventually meet with a title company to sign your documents and close on your house. After these documents are signed, you will have a date where you can begin occupying the property. Congratulations….you can now begin moving into your new home!

If you're looking to get an advisor's perspective on your first time home purchase, you can ask your questions by emailing Questions@LetsWinWithMoney.com