Buying a home as a first time homebuyer can be nerve-racking, challenging, and scary all at the same time. There is no home buying school unfortunately that we can attend where we learn all of the basics of the home buying process. We typically learn about buying a home from family, friends, and any sources of information that we find and trust to educate us on the topic. But with a little homework up front and a lot of preparation on the back end you too can stop paying rent and become a homeowner.
Who qualifies as a first time home buyer?
The Federal Housing Administration (FHA) defines a first time homebuyer as an individual who has had no ownership in a principal residence during the 3-year period ending on the date of purchase (closing date) of the property. In addition, FHA also includes any individual that has only owned a home with a former spouse while married. And finally, a first time homebuyer would also include an individual who has only owned a principal residence not permanently affixed to a permanent foundation, or a property that was not in compliance with State, local, or model building codes and cannot be brought in to compliance for less than the cost of constructing a permanent structure.
First Time Homebuyer Steps to Buying a Home
Since the homebuying process can seem so overwhelming and confusing to the first time home buyer, use these manageable steps to break down the buying process in to smaller chunks that are easier to navigate and will simplify the purchase process.
Check Your Credit
Credit, Income, and debt are the three most important factors that a lender considers when evaluating a potential homeowner. Borrowers must be able to show the “ability to repay” on their mortgage so a thorough evaluation of one’s credit, income and debt is always done at the beginning of the mortgage loan process.
To get an idea of where your credit stands, go to AnnualCreditReport.com to get a copy of your free credit report from each of the three credit bureaus. For an extra fee you can find out what your numerical score is, but just checking the reports should give you a good sense of what lenders will see. Review the reports for mistakes, unpaid accounts or collection accounts. If you see any credit errors or mistakes reported on your credit report, it may make sense to write to the credit bureaus to request that the items be removed. Once this credit improvement work is in process, I would also recommend to consult with your mortgage lender to have him or her review your credit report.
Be careful not to think that just because you pay everything on time every month means your credit is stellar. The amount of credit you’re using relative to your available credit limit, or your credit utilization ratio, can sink a credit score. So to can a lack of credit also affect your credit score if you only have one or two active tradelines.
Lets take a more in-depth look at credit utilization. Credit utilization is an important part of building or maintaining a solid credit score. Credit utilization is calculated by looking at one’s available credit and calculating how much of that available credit has been “utilized” in the form of a balance due. So if you have $10,000 available credit and you have $5,000 charged on the card, you have a 50 percent credit utilization rate which is higher than mortgage lenders and credit experts would advise, especially when buying a home.
The lower the utilization rate, the higher your credit score will normally be, assuming the rest of your report is clean. The credit bureaus acknowledge that their credit scoring models are optimized to provide the best credit scores to clients that have a credit utilization rate of 30% or below. While there are always many more factors that go in to a higher credit score, the credit utilization is one of the biggest factors that causes a wide swing in a credit score, whether the score goes up or down.
Repairing damaged credit takes time — and money if you owe enough on your credit cards that you need to lower the utilization so it is at 30% or less. Begin the process of evaluating your credit at least six months before shopping for a home, but preferably twelve months if you feel there is credit work to be done.
Know your Debt-to-Income Ratio
Mortgage guidelines determine the rules that all lenders need to follow and a borrowers debt-to-income ratio (DTI) is one of the main guidelines that borrowers need to meet to be approved for a mortgage. The ideal target debt-to-income ratio for most borrowers hoping to buy a home is 43% or less. If you don’t know your debt-to-income ratio then you can either try to calculate the DTI yourself, or you can work with your mortgage lender to assist you in calculating your DTI ratio.
The reason this number is so important for mortgage lending purposes is because lenders need to know how much of your monthly gross income is being devoted to debt payments. The debt-to-income ratio is a calculation that shows how much of your gross monthly income is going to pay your housing, credit cards, car payments, and student loans monthly payments. To learn more about how to calculate your debt-to-income ratio, you can learn more HERE
Determine your Down Payment
Coming up with that initial down payment can be a challenge for many first time homebuyers. There are low down payment mortgage programs ideally suited for first time homebuyers such as FHA mortgage loans which only require a 3.5% down payment. Conventional loans normally require a 5% down payment, but there is a conventional loan option that only requires a 3% down payment for first time homebuyers.
Those current and former Military members who have VA loan eligibility can get 100% financing with no down payment required as long as their VA loan eligibility checks out. VA loans are a great loan choice because there is no down payment required, there is no monthly mortgage insurance, and the VA interest rates are often some of the best rates available.
Saving for a down payment is one of the hardest things to do for families living in rental units with sky high rents. We understand how difficult saving money while raising a family can be. So when talking to your lender, make sure to inquire about down payment assistance programs for first time homebuyers and ask about the minimum qualifications of the different programs out there.
First time homebuyers will want to have some funds tucked away and ready to spend on their first home purchase. In addition to the down payment, keep in mind there will be closing costs involved with a home purchase so home buyers should also be prepared for this. Again, speak with your mortgage loan specialist Stephen Khan so he can prepare a home purchase plan tailored to your needs.
Organize, Organize, Organize your documents
“We see borrowers all of the time who want to buy a home but haven’t kept good records over the years and then struggle to gather the necessary financial documentation needed to apply for a loan” says Stephen Khan, a Phoenix, Arizona based mortgage loan officer. “We try to make it as painless as possible to give the borrower a simplified list of documents that they need to provide when applying for a mortgage” says Khan.
The best advice is to keep good financial records of income, debts, savings and investments so when the time comes to produce those documents they are in a file organized and ready to go. You’d be surprised at how hard it is to piece this information together if a home buyer hasn’t been keeping good records over the years.
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