For first time buyers, buying a home can be both an exciting and stressful adventure. Let’s face it, acquiring the keys to your new home is likely one of the biggest financial decisions you will ever make. If you are considering becoming a homeowner, chances are you are wondering where to begin. To help answer some of your questions, I’ve created a step by step blog series to guide you through the home buying process.
Step 1) Become pre-approved / determine your budget
Before you start shopping for your dream home, it is essential to know what you can realistically afford. Have you ever seen an episode on an HGTV show where they are shown their dream house and fall in love with it, only to find out that it is actually WAY over their budget? That is often the reality for first-home buyers who start home shopping before they know what they can afford. This can be extremely frustrating for a first-time buyer, but it is completely avoidable with proper pre-planning.
Unless you are one of the lucky few that can pay for your home entirely with cash, chances are, you are going to need a loan. Becoming pre-approved for a loan provides insight to how much you can borrow, as well as how much you will need of your own money for a down payment. Pre-approval comes from a lender, and is typically valid for 90 days. Thus, if you become pre-approved and your home search extends beyond 90 days, you will need to get another pre-approval.
When shopping for a lender, there are various lending institutions available to choose from, including common sources like banks and credit unions. When you apply for pre-approval, the lender will gather various information from you, such as debt to income ratio (in simple terms: how much money you have coming in per month versus how much money you have going out per month… such as bills and expenses à a lender will look to see where the new expense of the monthly mortgage payment comfortably fits into this equation) and credit history, to learn more about your financial situation. After processing your information, the lender will provide you with a pre-approval letter and subsequently an idea of what your housing budget should be.
A quality lender will not only show you what types of loans you qualify for, but will also help you to determine the best fit for your budget. Not all lenders are the same, which is why I encourage my clients to shop around and explore various loan options from various lending institutions
For example, just because you qualify for a loan of $250,000, does not necessarily mean you should purchase a home for $250,000. Beyond the total purchase price, a homebuyer must consider other financial obligations, such as:
- the monthly payment amount that goes toward the cost of the home
- the monthly interest amount on the loan
- monthly taxes on the home
- as well as monthly * insurance costs
This is also known as PITI: principal, interest, taxes, and insurance. Knowing this amount, as well as your monthly income and liabilities, will help you to determine how close to the top of your budget you should spend on your new home. Additional costs include your down payment, closing costs, home warranty, homeowner’s insurance, and more.
*Insurance:
PMI (Private Mortgage Insurance) = Conventional Loan
MIP (Mortgage Insurance Premium) = FHA Loan
This type of mortgage insurance is different than homeowner’s insurance, which protects a homeowner from loss from incidents such as a fire. This insurance protects a lender from a borrow defaulting on his or her loan.
–For a conventional loan (a non-government loan), if a borrower has a down payment less than 20% (example: sales price of $250,000: 20% down = $50,000), the borrow will have to pay PMI until they reach 20% equity in their home.
–For an FHA loan (government loan), the borrower pays MIP typically for the life of the loan. Alternatively, there are other types of government loans, such as a VA Loans (Veterans Affairs), that regardless of the down payment, do not require monthly mortgage insurance. Because there are a variety of loans available for home buyers, it is essential to talk with a lender about your options.
In essence, the added expense of mortgage insurance, which will be broken down in further detail by your lender, must be considered when selecting a housing budget.
Want to know more about becoming a pre-approved buyer? Contact me today for a virtual meeting and buyer’s consultation. Although we are currently living in a time of social distancing, you can still get pre-approval by lenders virtually and from the comfort of your home.