5 things to consider before buying your first house
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Buying a house is a lot to think about, especially if you've never done it before. After you pick a neighborhood and find the home you like—you might be left wondering if you can actually afford it.
Rather than trying to pay in cash, most people end up taking out a mortgage to afford the home of their dreams. But this doesn't mean you're off the hook financially. There are still quite a few things to consider before buying your first home. We'll dive into those here.
Have the minimum credit score
In order to qualify for the best rates on any loan—you'll want to be sure your credit score is in good standing. According to Experian, most conventional mortgages require a minimum credit score of 620, although some may require one as high as 660.
If your credit score isn't looking that great, take the time to improve it. Good credit scores open doors (that should be on a t-shirt). But really, the better your credit score—the better your mortgage offers will be. And having lower interest rates will save you a lot of money in the long term. Building your credit score is just one part of personal finance management and planning to achieve your financial goals.
Save up for a down payment & closing costs
Even if you plan on applying for a mortgage, you'll still need some cash to seal the deal on your new home. Most lenders require a down payment that's equal to at least 5% of the cost of the home, but some may require more according to the Consumer Financial Protection Bureau. You can start saving up for your home's down payment in advance, once you determine your target price range.
If you're able to save more than the minimum, that's even better—since the more you pay up front the less interest you'll owe over the life of the mortgage. Having a larger down payment will also look better to your lenders, and you'll save even more money if you're able to put down 10% or 20%. You may be required to buy private mortgage insurance (PMI) if your down payment is less than 20%. Keep in mind that closing costs average around 2-5% of the home price, and you'll be expected to pay this expense at the time of purchase as well.
Know your monthly payment
Figuring out how much your monthly mortgage payment will be goes beyond just the price of your home. In many cases, lenders may require you to pay a portion of key expenses, such as real estate taxes or homeowners insurance, each month as part of your mortgage payment. These amounts would be held by your lender in escrow until payment was due. It's important to understand what these costs are and how they could affect your monthly payment.
Know your debt to income ratio
Whenever getting ready to take on new debt, it's always a good idea to review the debt you already owe. For many of us, college loans are something we continue to pay for years after graduation. Then there's also car loans, credit cards, and other monthly expenses to consider. Having too much debt isn't a good thing— especially in the eyes of lenders. And you likely won't be approved for a mortgage if your debt-to-income ratio exceeds 43%.
This might sound complicated, but debt-to-income ratio is just how much you owe in monthly debt payments divided by your gross monthly income. Banks like to make sure you can actually afford to take on new debt before approving you for a loan. But it's also something you should consider yourself. Since banks only have a partial picture of your monthly expenses, it's always a good idea to run the numbers yourself. This way you can be sure the new mortgage is something you're comfortable paying on a monthly basis.
Shop around for the best interest rate
Once you've familiarized yourself with the ins and outs of what you can afford, it's time to start shopping around. Banks are businesses, and they will (and should) compete to become your lender. Don't just settle on the first mortgage package that comes along. Shop around with several lenders before making any decisions. If you don't like the rates being offered, spend some time improving your credit score and paying down some of your debts. This might involve doing something like debt consolidation, which might mean considering taking out a personal loan to pay off credit card debt. Or maybe even setting a tighter monthly budget while you pay down some bills. Keep in mind that mortgages are something you'll be stuck with for a long time— usually 15 or 30 years. If you can find one that you're comfortable paying, you'll be one step closer to becoming a happy homeowner. Calculating interest rate can be complicated and confusing, make sure you understand the basics of interest rates and how to calculate them.
Bottom line
Buying a house is one of the biggest decisions you'll make in a lifetime. Planning ahead will save you from the majority of common pitfalls. Small differences in key elements like your credit score and interest rate can make a big difference over the life of the time you own your home. Spend the time before buying a house to make sure you're set up to enjoy your purchase for years to come.