A Guide for First-Time Homebuyers: 6 Steps to Prepare Your Finances

6 Steps For First-Time Homebuyers to Prepare Your Finances

Buying your first home is a major milestone and a life-long dream for many Americans.

However, buying a home also involves a huge commitment of time and resources, as well as lots of collaboration with your lender, the seller and any relevant third parties (such as a real estate agent and a home insurance provider).

For this reason, many first-time buyers struggle to know where to start.

In this article, we’ll explore the six key steps to prepare your finances for buying your first home, from figuring out how much house you can afford to preapproval strategies and tips on closing.

As you’re reading this article, keep in mind that everyone’s homebuying journey is different. Depending on your financial situation and the local housing market, you may need to adjust some of these steps or change course to ensure you can find the house of your dreams.

1. Review your accounts and budget to ensure your financial stability

More often than not, the decision of whether you can buy a home will depend on the specifics of your financial situation and whether you can find a lender offering a mortgage you can afford.

You should always start by asking yourself if buying a home is a smart financial decision for you right now.

For example, do you have an emergency fund to cover any unexpected expenses that might come up? Is your job stable enough to confidently say you’ll be making the same amount or even more five years down the road? Do you have any significant debt with a high interest rate that may be hurting your budget and draining your resources?

When planning to purchase your first home, start by asking yourself these questions to get an accurate view of your current and future financial situation.

Then, take steps to improve your finances to ensure you have a stable foundation as you begin shopping around for a loan provider:

• Ensure you have strong credit—Your credit will determine the rate you receive on your mortgage, significantly impacting the amount of money you’ll pay in interest over the life of the loan. If your credit is on the lower end of the spectrum, consider taking steps to improve your score before applying for a loan.
• Review your debt-to-income ratio—Lenders will generally offer mortgages to individuals with a debt-to-income ratio of around 36%, with no more than 28% of that debt going toward the house itself. Put another way, if you have debt equal to or greater than 10% of your gross annual income (excluding special types of debt such as student loans), you may want to consider paying off that debt first to improve your chances of receiving a favorable loan. Note, however, that if your application is strong in other areas, your lender may approve you with a debt-to-income into the 43% range.
• Save up for the down payment and other expenses—In most cases, you’ll want to save up a down payment of at least 3-5% of the total value of the home. Note that if you save for a down payment of at least 20% of the total value of the home, you may be able to avoid having to buy private mortgage insurance (PMI). Further, you should start saving up for other expense buckets as well, such as paying for moving expenses or ensuring you have enough money to cover closing costs and other related fees.

2. Understand the different types of mortgages

There’s no such thing as a one-size-fits-all mortgage, and certain kinds of mortgages could be better or worse for your finances depending on your individual situation, the house you’re planning to buy and numerous other factors.

In general, the biggest distinction to be aware of is the difference between fixed- and adjustable-rate mortgages:

• Fixed-rate mortgages—These mortgages charge a set interest rate over the entire life of the loan, allowing you to “lock in” a particular rate with the option of refinancing at a lower rate should one become available down the road. Fixed-rate mortgages are more stable and easier to manage than adjustable-rate mortgages but may be harder to qualify for if you have low credit or if interest rates are high.
• Adjustable-rate mortgages—These mortgages charge a variable rate that fluctuates over time to match changes in the broader market. While adjustable-rate mortgages offer the potential for lower rates when compared to fixed-rate mortgages (especially in the first few years of the loan), they also may swing in the other direction, leading you to pay additional interest should rates rise.

In addition to variations in the interest rates, you should make sure to review the different terms, benefits and other important information relevant to the different types of mortgage offerings:

• Conventional mortgages—Conventional mortgages are the “normal” type of mortgage you probably think about when you’re considering buying a home. Conventional mortgages can be either fixed-rate or adjustable, with some variation in how large of a mortgage you’re able to apply for (such as the differences that arise from “jumbo” loans, which generally apply to homes valued at more than $750,000 to $1,000,000).
• FHA loans—FHA loans are popular for first-time homebuyers with low to moderate incomes. Generally, they require lower down payments than most other loan options and offer flexible credit requirements to make it easier for first-time buyers to qualify. Lenders may also provide additional assistance to first-time homebuyers through related programs such as the Community Affordable Real Estate (CARE) program and HomeReady mortgages. Finally, most closing costs and fees can be included in the loan itself, significantly lowering the upfront cost of buying a home.
• VA loans—VA loans are flexible mortgage options offered to veterans as a way of helping them transition back into civilian life. Generally, you don’t have to make a down payment on a home purchased with a VA loan. Further, you won’t have to pay for mortgage insurance, and you will generally be able to bundle any closing costs and fees into the loan itself, much in the same way as an FHA loan.
• USDA rural housing loans—Rural housing loans are designed for borrowers in rural areas who have both income and credit history, but lack the down payment required for a conventional mortgage. If you choose this loan type, you won’t have to make a down payment on your home, and some of the closing costs may be included in the loan itself.

Due to the numerous mortgage options available, it’s recommended that you speak with a lender who has insight into your finances to better understand how each mortgage type can affect your interest rate, loan amount and mortgage term.

3. Choose a lender that’s right for you

Finding the right lender to take out a mortgage with can seem daunting, but in most cases it’s a pretty straightforward process.

Essentially, you just need to compare different lenders in a few key areas to find options that work for you, and then make your final choice from the resulting shortlist:

• Interest rate—Interest rates can go up and down depending on various market forces and the state of the broader economy. When looking for a mortgage lender, look for rates that are on the lower end of the spectrum to minimize how much you’ll pay in interest.
• Loan term flexibility—Mortgages usually have terms (“lengths”) of between 15 and 30 years, though some lenders are beginning to offer terms of up to 40 years. Your mortgage term will be the largest determining factor in your total monthly payment and how much interest you’ll pay over the life of the loan, so you’ll want to make sure your lender has different options to best match your unique financial situation.
• Fees and associated costs—Depending on the type of loan you’re applying for, your lender may waive various fees and other costs as a result of your first-time homebuyer status. Others may bundle these fees into the loan itself, minimizing the upfront cost of buying a new home.
• Down payment requirements—Some lenders require a down payment of a certain size as a necessary qualification for getting a mortgage. Depending on the size of the nest egg you’ve saved, you may be able to get various perks or even more favorable terms by putting down a larger payment.
• Mortgage insurance—Most private lenders require that homebuyers with a down payment of less than 20% of the home’s cost purchase private mortgage insurance (PMI). This insurance protects the lender in the event you default on your payments or experience an unexpected emergency that affects your ability to make payments on your mortgage. Many lenders also have programs specifically designed for first-time homebuyers, ask for details.

After reviewing all these factors in relation to each of the offerings, it’s wise to take a step back and consider your options from a human perspective.

Specifically, while interest rates and loan terms are fairly standard across the industry, whether or not your chosen mortgage lender is the right fit for you is a whole other question.

Look for a lender that puts your needs first and offers superior customer service and communication. After all, mortgages are decades-long relationships, so it’s smart to choose a local, people-focused option that can help you achieve your long-term financial goals.

4. Get preapproved before you start shopping

Preapproval is a process in which your bank calculates how large of a loan you might receive after you go through the formal mortgage qualification process.

The major benefit of preapproval is that you will know the loan amount you could qualify for, giving you a fair representation of how much house you can afford. It will also identify any problem areas that may be holding you back, such as having low credit or a high debt-to-income ratio.

Specifically, your ability to qualify for a mortgage will depend on several factors, including, but not limited to: your credit score, your debt-to-income ratio, your employment history and earning potential, and the amount of money you’re willing to put forward as a down payment.

When pre-approving you for a loan, your lender will look at each factor to give you a ballpark number to aim for as you start looking at houses.

You should note that this preapproval amount may be the absolute maximum that the bank will offer you for a mortgage. In most cases, it’s wise to look for houses well below this maximum amount to ensure you aren’t buying more house than you can reasonably handle without straining your finances.

For example, if the bank pre-approves you for a 30-year mortgage for $400,000 (with a 20% down payment and a 5% interest rate), your total monthly payment would likely sit at around $2,075. Meanwhile, if you’re pre-approved for $400,000 but only spend $300,000 buying a house, your monthly payment will go down to $1,650.

This $400+ difference each month could play a huge role in your family’s budget and quality of life, regardless of whether you can theoretically afford the higher payment each month.

Additionally, remember that government-backed loans are often much easier to qualify for, even if you score lower than you might want in any of the areas listed above.

This means that you should discuss any potential qualification you may have (such as being a veteran or qualifying as a first-time homebuyer) with your mortgage loan officer so they can help you find the mortgage type that’s right for you.

5. Find the home that’s right for you

Once you have a general budget in mind and are pre-approved for a set loan amount, you can start looking for homes that are the right fit for you.

Start by writing down the price range you’d be comfortable paying alongside several “must-haves,” such as the home having a large backyard. Don’t forget to factor in any additional costs for closing or moving that may affect your chosen budget.

These initial criteria can help you narrow your options to a short list of potential houses that meet your family’s specific needs.

Then, if several houses make this initial list, take the time to consider any wants or wishes you may have for your new home.

For example, how many bathrooms should the house have? Do you want a minimum square footage? Does it need to be within walking or biking distance of a grocery store? Do you refuse to settle for anything without a large driveway?

After arming yourself with a detailed list of essential criteria (price, square footage, location), must-have features (bathrooms, renovated kitchen), and house-hunting “wishes” (hardwood floors, marble countertops), you’ll be able to more accurately find something that matches your unique needs, flair and style.

6. Make an offer and close the deal

Once you find a house that matches all (or most) of your needs, you’ll have to put in an offer to the seller and state your intention to buy the home.

Given the state of the housing market recently, you may have to put in an offer either at or higher than the asking price to ensure you’re at the top of the list once the seller makes their decision.

For this reason, it’s generally recommended that you work with a real estate agent who has experience in your market to ensure you have the best possible chance of having your offer accepted.

At this stage in the process, you’ll want to work closely with your mortgage lender to ensure everything’s accounted for and the process can go as smoothly as possible.

Specifically, this is the point in the process where you’ll work to convert your pre-approval offer into an actual mortgage, meaning you’ll have to work closely with your mortgage loan officer to fill out all the necessary paperwork, settle any closing costs or other fees and negotiate the final terms of your loan offer.

Work with a local lender to realize your homebuying dreams

Buying your first home doesn’t have to be difficult, especially if you partner with a local lender and other experienced professionals who can help you navigate the process.

In most cases, the hardest part is ensuring that all your financial ducks are in a row so you can lock in a favorable interest rate and loan term without breaking your budget.

From ensuring you have strong credit to lowering your debt-to-income ratio, there are several strategies you can employ to make sure you’re financially ready to purchase the home of your dreams.

The key to this process, however, lies in understanding the differences between different mortgage types and the various pros and cons of working with a specific lender or mortgage provider.

For this reason, your first, and most important, step should always be to sit down with a local banker who can help walk you through the process.

At Associated Bank, our mortgage loan officers have the expertise you need to make informed decisions about your upcoming home purchase.

To learn more about the different ways we can put your money to work for you, please schedule an appointment with us online or reach out to one of our local branches to find a loan officer in your area who can put you on the right path to home purchasing success.