What Can I Do Now to Prepare to Buy a House?
If you’re looking into buying your first home, even if you’re not ready to pull the trigger yet, first things first, reach out to a lender or a Realtor! It’s NEVER too soon to start a relationship with a Realtor and a lender. These professionals can help coach you to a successful purchase.
From a financing perspective, though, we want to help you start on strong, solid footing. There are a lot of myths swirling around out there about what it takes to buy a home and how the process works, and we want to help set you on the path to homeownership with the CORRECT information.
So if you are wondering what you can do now to prepare to buy a home, we have the answers! Let’s dive into some common questions and myths.
Myth – I need at least 20% to put down.
No, you don’t. This is one myth we often hear, but it’s simply not true! There are several loan programs out there where you need little to no money down, including VA, Rural Development, FHA, and even Conventional Loans. Your lender can guide you on the one that fits you best!
This myth has been perpetuated by people who either don’t know about all the wonderful loan programs available or think PMI (private mortgage insurance) is a bad thing when it’s not! PMI is only applicable on a Conventional Loan when there is less than 20% put down, but it will be less expensive with good credit AND can often help you keep interest rates lower, so don’t let it scare you off!
Also, there can be state and local incentives for first-time home buyers that can help with down payment assistance and/or pay for closing costs and prepaid expenses! Your lender should know the ins and outs of those programs for you and what it takes to qualify. If you haven’t owned your primary residence for the most recent three years, you are considered a first-time home buyer!
How much money do I need to have?
Aside from the down payment, there are also costs involved that cover things like getting an appraisal done on the house, recording the deed and mortgage after closing, making sure you have a clear title to the home, etc. Those are called closing costs. There are also prepaid expenses, like paying for your first year of homeowners insurance at closing and setting up your escrow account so that the taxes and insurance can always be paid. Those vary based on the area you are buying in, but in Iowa, the total for both closing costs and prepaid expenses can be around $4,000.
Plus, we strongly encourage but do not require a home inspection. Those are typically around $500 and paid at the time of the inspection.
You will also need to be able to pay earnest money when you have an accepted offer on a home. That money is NOT additional funds but goes towards everything (down payment, closing costs, prepaid expenses) at closing, and is a deposit you pay up-front, so plan to have enough to cover earnest money when you put an offer in.
Your Realtor will guide you on how much is appropriate for your area and the purchase price range to put as earnest money. In general, having at least $1,000 in the bank, after earnest money, is a rough minimum. Gifts from family members are acceptable sources of funds, as well, but must be documented—your lender can talk through your options with you, so be sure to discuss with them.
What about credit scores? What do I need my score to be to qualify?
The credit score needed for qualification can vary from lender to lender and loan program to loan program. In general, though, the higher the credit score you have, the more options you have for loan programs and/or grants.
To give you an idea of a number, most grant programs have a 640 minimum qualifying score, but some loan programs can allow you to go a bit lower.
If you are monitoring your credit score on any of the free apps or your credit card site, know that those scores are normally directionally accurate but not point-for-point accurate. The higher the score, the more accurate it seems to be. If you are in the lower range, it seems to be off by 20 points or more. So a 660 on a free site might be closer to a 640 on a hard pull. That isn’t something you can control, but you should be aware of it when tracking it.
A change from a 720 score to a 740 score may seem like a small amount, but it can really reduce your interest rate, so as you get close to buying a home, any credit card balances you can pay down to bring that score up helps.
How do I know what monthly payment/purchase price I can afford?
Your lender will help you with this calculation, but this is where your debt-to-income ratio comes into play.
A lender will look at your gross monthly income (the amount you make before taxes are taken out) and can help you spend roughly 30% on your ‘front end’ or ‘housing’ ratio for the projected new house payment.
The total debt-to-income ratio that lenders can help you spend is roughly 41% to 54% of your gross monthly income. That is between the debts you already have on your credit report for car payments, student loan payments, credit card minimums, etc., and the projected monthly housing payment.
This is how we back into what you can afford for the purchase price.
So should I pay off all my debt before I can think about purchasing a home?
Having a lot of monthly debts already can typically decrease your purchasing power for a new home. So, paying off your debt before purchasing a home can be a smart move.
However, individual loan programs can vary on what the debt to income ratio can be, so if you want to know now what you need to plan to pay off so you can buy a house at a later date, reach out to a lender and talk through the equation, they can give you an idea of what might be necessary.
What types of income count?
Several factors also influence the income part of the equation. Yes, you make what you make, but lenders might not be able to count all of your income toward your ability to repay. Lenders typically like to see steady employment over two years with consistent income. That means if you’re in a job where you earn a commission and you haven’t had that form of income for very long (less than two years), it likely cannot be counted. Same for bonuses and overtime pay.
HOWEVER, each situation is unique, and your lender can help explain which rules apply to your specific circumstance. The main thing to note about potentially using another form of qualifying income is being able to correctly document it, so if you’re a couple of years out of buying a home, contact a lender and explain your situation to see what is needed and start documenting it now!
What if I’m about to graduate and start my career? Will that mean I have to wait two years to buy a home?
No, not usually! Don’t let the 2-year “rule” scare you off. Once you have a job offer, your lender can use that information to calculate what your ability to repay income will be and how much house you can afford.
But what if I’m changing jobs, and that’s why I am now comfortable thinking about buying? Do I have to wait to buy?
Again, not usually! That job offer information is still valuable to you and your lender for calculating how that change affects you and what you can afford. A lot of people buy homes as they are making job changes and/or relocating to a new area, and your lender can help you understand how that works.
In general, you don’t have to be an expert to buy a home, but you need to be comfortable with the decision to buy—and have a lender and Realtor that will help you and answer your questions throughout the process. That’s why starting those relationships early to help coach you to the most successful position is so important. You probably don’t want to be either a lender or a Realtor, so let the professionals that love doing those jobs (like us) help you!