Buying a home is one of the most significant financial milestones many Americans will achieve in life. But how do you know it’s time, or more specifically, whether you're even financially poised to look? Some folks may wait for a major life event, like getting married or having kids, before they decide it's time to look into buying while others may realize the amount they spend on rent exceeds that of a mortgage payment. However you land on right now being the time consider buying a home, though, you’ll want to first understand your financial profile to make sure you’re ready for the commitment.
There are a number of steps you should to take before you even kick off the home-buying process, and navigating them can be overwhelming if you don't know what to expect. As the GM of Credit Karma Home, I work to make the home-buying process easier, where possible—and education is a huge component of that. Between learning what your real budget is, who should be on your home-buying "team," the pre-approval process, and what to know about interest rates, below, I demystify common first-time home buyer questions.
Check out the top first-time home buyer questions I get asked, as a mortgage and home expert, answered.
Who should be on my home-buying "team?"
While there’s no rule specifying that you must work with a real estate agent, this person can function as an advocate to guide you through what can be a stressful and complicated process. An agent can (and should!) also negotiate on your behalf to make sure you’re getting the best deal that you can.
That said, many buyers—especially first-time home buyers—start their journey with a lender or broker. This person can help guide you through what you can really afford, find you a good loan to fit your needs, and compare interest rates across a wide variety of lenders.
How do I calculate what my budget really is, including what I need for a down payment and closing costs?
With the help of your home buying team, it's crucial to figure out what you can afford. You can leverage Credit Karma’s free home-buying power tool, which uses the same calculations a loan officer would, and helps give you an idea of how much home you can afford and what your monthly payments will be.
One of the top first-time home buyer questions I get is whether a 20 percent down payment is required to secure a good mortgage—and it's not at all.
And regarding that down payment, one of the top first-time home buyer questions I get is whether a 20 percent down payment is required to secure a good mortgage—and it's not at all. According to a January 2020 report released by the National Association of Realtors, 76 percent of non-cash first-time buyers put down less than 20 percent. While putting that amount (or more) may offer some advantages (namely terms of interest rates), many lenders and financial institutions offer mortgages with down payments as low as 3 to 5 percent.
Government-backed loans, including FHA, VA, and USDA loans, and some conventional loans (which are loans not backed by a government program) offer low down-payment loans for those who meet certain qualification criteria. Examples of low down-payment conventional loans include the following:
- Chase DreaMaker Mortgage: This product offers mortgages with down payments as low as 3 percent, which can be entirely from gift funds. This program also offers reduced mortgage insurance.
- HSBC Affordable and Regional Mortgages: HSBC offers a variety of mortgage options for (but not limited to) first-time homebuyers and veterans.
- CommunityWorks: This low down payment mortgage program may be combined with eligible grants to help pay for costs associated with obtaining a mortgage.
- HomeReady: This affordable low down payment mortgage option requires minimal out-of-pocket funds and considers income from a non-occupant, co-borrower or a renter for qualification.
- HomePossible: This product offers the stability of a fixed-rate mortgage, requires minimal out-of-pocket funds, and allows flexible sources of funds. It also offers mortgages with down payments as low as 3 percent.
It’s worth noting that there are a few tradeoffs to keep in mind if you’re going to secure a low down-payment loan:
- You’ll start off with less of an ownership stake (aka equity) in your home, and it may take longer to pay off your mortgage. It’s also likely to take you longer to build up your equity to the point where you can borrow against it with a home equity line of credit or loan.
- Depending on the loan, you may be on the hook to pay for private mortgage insurance (PMI).
- Your monthly mortgage payment will likely be higher, since you’re borrowing more money from the lender.
- You’ll end up paying more interest over the life of the loan, unless you’re able to pay it off early.
And lastly, make sure to budget for closing costs, which are fees outside of the down payment you are responsible for upon closing on your mortgage. Common closing costs include title insurance, homeowners insurance, home inspection fees, and appraisal fees.
What should I know about qualifying for a loan?
When determining whether you qualify for a mortgage loan, lenders will examine your income that goes toward paying debts—aka your debt-to-income ratio (DTI). A lower DTI shows a lender that you won’t be using all of your remaining cash on making your house payment. There are two key ways to lower your DTI ratio: reducing your monthly debt or increasing your income.
Increasing your credit score is one of the best ways to improve your chances of being approved for a loan with better terms.
Your credit score is another important financial factor that is taken into consideration by lenders. Increasing your credit score is one of the best ways to improve your chances of being approved for a loan with better terms. Aspiring homeowners should monitor their credit reports regularly and consider a few tips to boost their scores:
- Pay your bills on time. What lenders care about most is the likelihood that you’ll pay back your debts. Consistently making payments on time shows you are reliable and should increase your credit health. Late or missed payments can significantly harm your credit score, so if your issue is keeping track of bills, consider setting up automatic payments or payment reminders.
- Pay down your debt. Your credit utilization ratio compares the amount of debt you owe to the amount of credit you have. Lenders want to ensure you’re not borrowing more than you can pay back. Work to keep your credit utilization below 30 percent by paying off your credit card balances in full each month or making consistent payments throughout the month. Card companies will gladly accept payment anytime!
- Don’t open multiple credit cards at once. Every time you apply for a credit card or loan, it generates a hard inquiry on your credit report, which usually stays there for about two years. Too many hard inquiries in a short period of time may turn lenders off because they may think you’re looking for cash or on the cusp of racking up a lot of debt.
- Don’t close old credit cards. It can be tempting to get rid of old cards you don’t use, but the length of your credit history is a significant factor in most credit scores, and you risk shortening that length by closing your oldest credit cards. Unless the annual fees outweigh the benefits, consider putting a couple charges a month on that card to keep your credit history longer.
What's the difference between getting pre-approval and being pre-qualified?
Both pre-approval and pre-qualification can give you an estimate of how much you may ultimately be approved to borrow. The difference between a pre-approval and a pre-qualification comes down to the level of scrutiny under which your information is examined. A pre-qualification can be issued without verification of income, employment history, or assets. Essentially, it assumes the information you provided is accurate. Pre-approval, on the other hand, is only issued after the lender verifies the information you provide. That said, the specific definitions of pre-approval and pre-qualification often vary from lender to lender, so it’s important to understand each lender’s process.
While a pre-approval doesn’t guarantee you a loan, the vetting process and any accompanying letter that comes with it function like the mortgage equivalent of getting a golden ticket to Willy Wonka's chocolate factory.
The difference here matters because in a competitive market, you want the seller and their agent to take you seriously—you want them to know that you can move fast if your offer is accepted, and that a loan officer has already vetted your finances to avoid costly missteps down the road. While a pre-approval doesn’t guarantee you a loan, the vetting process and any accompanying letter that comes with it function like the mortgage equivalent of getting a golden ticket to Willy Wonka's chocolate factory.
Why do interest rates matter, and how are they factored into the cost of a home?
Your mortgage isn't free and comes with interest attached. The higher the interest rate, the more you’ll pay over the life of the loan. There are two basic types of mortgage interest rates: fixed and adjustable. Adjustable-rate mortgages (ARM) generally come with higher risk: They’re low initially and will typically remain the same for five to 10 years, and then fluctuate annually afterward. ARMs are popular for refinancing, particularly for borrowers who plan to sell their home or fully pay off their loan in the near future. Alternatively, fixed rates will stay the same, and the mortgage payments won’t change over the life of the loan.
To figure out which loan type is right for you, think about your overall financial goals, budget, and assets. A fixed-rate mortgage locks in your interest rate for the entire loan term, which typically ranges from 10 to 30 years. It’s common for first-time homebuyers to choose a 30-year fixed-rate loan because of the long-term predictability. Interest rates are typically lower on shorter loan terms, but the payments are higher because of the shorter repayment period.
When shopping for a mortgage, a common term you’ll notice is annual percentage rate (APR). While a mortgage interest rate is a small percentage that’s applied to your loan balance to determine how much interest you pay each month, an APR encompasses all the costs of financing a loan, so it will typically be higher than the mortgage interest rate.
What should I expect when actually making an offer?
Once you’ve zeroed in on a home, your real estate agent can show you comparable sales, or “comps.” These are nearby home sales that are close matches for the home you’re considering. Looking at other homes in the neighborhood that were sold within the past few months and that are in about the same condition, with comparable square footage and amenities can help you determine how much the home you’re interested in might ultimately sell.
If the comps suggest that you’re dealing with a “seller’s market,” where multiple buyers are bidding up the price of homes, the property might receive several offers well above the asking price. Think about the highest amount you’d be willing to pay if you end up bidding against someone else.
Next, decide on the financial details of your offer. Choose an offer amount that’s within your budget and in line with your agent’s estimate of the market value, based on comps. If your offer is accepted, you’ll go into contract. During this time, you’ll work with your agent to set up a home inspection to rule out structural flaws or environmental hazards, as well as hire an appraiser to determine whether your offer you’re making is in line with the home’s worth. These fees are usually paid by the buyer, and usually run $500 to $1,000 each.
An offer acceptance also usually comes with a commitment known as “earnest money.” This is a deposit that a buyer makes as a commitment to the seller, and is given to a title or escrow company to keep in escrow—an account that isn’t controlled by either the buyer or the seller. If you end up purchasing the home, the earnest money goes to the seller as part of your payment. If the seller accepts your offer but then you change your mind, the seller may keep the earnest money, depending on the terms of your contract.
Once you get the mortgage itself and the lender clears you to close, your down payment and earnest money are swept into escrow, the seller gets paid by the lender, and you are a homeowner, complete with a set of keys and a brand new mortgage.
Andy Taylor is the GM of Credit Karma Home, where he works to improve the often frustrating mortgage experience to help Credit Karma’s 100 million members.
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