The homeownership rate has edged up 1 percentage point in the last five years, to 64.8 percent. And there are many renters eager to join the club, especially since interest rates are holding near historic lows.
For first-time buyers, the process of becoming a homeowner can be intimidating. It’s a big purchase that comes with a host of responsibilities and costs. But, it’s also a long-term investment in your future.
For some, it might take longer (especially if you have existing debt, live in an expensive area or are just starting your career), whereas others are just a couple steps away. Regardless of how much you earn or what you have in the bank, it’s never too late (or early) to get ready to buy a home.
Here we break down what you need to do to achieve homeownership in 2020 or beyond.
How to budget for homeownership
- How much can you afford?
- Create a need vs. want list
- Where can you afford a house?
Every major purchase should begin with a balance sheet, which should include your debt, income and assets. You’ll also want to include estimated costs associated with homeownership, such as a comfortable amount to put toward a mortgage and estimates for property insurance, taxes and homeowners association fees (if applicable).
This will give you a clearer picture of what you can afford and how much you have available for a down payment. Our online calculator can walk you through how to determine how much house you can afford.
Would-be buyers who live in expensive metros might need to think creatively when it comes to buying a home.
“One option might be to find a seller that is willing to do a ‘rent to own.’ In this situation, you start off by renting, and at some point, exercise an option to buy,” says Chuck Czajka, founder at Macro Money Concepts. “You might also be able to find a seller that would be willing to give a private mortgage. Looking for an affordable home might mean a smaller home or even a condominium.”
Getting your credit in shape
- Get your credit in order, as this has a direct effect on your interest rate
Whether you have no credit, average credit or bad credit, getting your FICO score in the best shape possible is a crucial step in buying a home. First, to qualify for a conventional mortgage you have to have a minimum 620 FICO score. There are other loans, such as FHA and VA loans, with looser to no credit-score requirements, so you can still buy with a lower score.
However, the second reason for improving your credit score is that you’ll qualify for a better interest rate. The lower your interest rate, the less you’ll pay each month and over the life of your loan.
If you need help managing your money or figuring out how to improve your credit, meet with a financial adviser.
“Find someone that not only has a good reputation, but also someone you feel connected with,” says Peter Boomer, executive vice president at PNC Bank. “Someone who is willing to build a relationship with you, not only help you with figuring out how much you can afford but one that will help you figure out how much you want to afford.”
Saving for a down payment
- Save for your down payment
- Figure out how much you can put down
- Should you cash in stocks/bonds? Ask parents for help?
The down payment for a home is one of the major barriers to homeownership for most first-time buyers. As home prices continue to rise, so does the cost of a down payment — especially if you want to avoid PMI, private mortgage insurance. PMI is a yearly cost — about .03 to 1.5 percent of your mortgage, that homeowners with less than 20 percent down must pay if they have a conventional or FHA loan (VA loans don’t have this requirement).
This means if you have less than 20 percent saved for a down payment, you should add PMI to the list of housing costs when you’re figuring out your budget.
Some folks might have to dip into savings or even cash in stocks or bonds to have enough for a down payment. Family members can also chip in for your down payment, which requires a gift letter. A real estate agent can help you write up this document, just be sure to include all of the necessary information such as the amount of money that’s being given to you, a statement that the money is a gift and not a loan and where the money’s coming from (checking account, etc.).
Once you know how much you can put down, you might decide to postpone homeownership until you have more saved. For people with less than 20 percent down but who want to lock in a low interest rate, another option is to pay down the balance faster to get rid of PMI sooner. If your home appreciates in value quickly, you can get a new appraisal to show that the balance has dropped below 80 percent of the home’s value, which can also eliminate the PMI requirement.
If you plan to buy in the next year or two, the safest place for your down payment money is a high-yield savings account.
Identify the best mortgage type for you
Next, it’s important to determine the kind of mortgage you want as well as what you might qualify for. A real estate agent can help you identify loans and lenders that fit with your goals and existing financial situation. So, this is a good time to get recommendations from friends and colleagues.
If you have a sub-620 FICO score, you might not be able to get a conventional mortgage. Other options, such as FHA and USDA loans, are on the table for folks with lower credit scores. However, these loans come with certain restrictions conventional mortgages don’t have.
For instance, it’s harder to get a fixer-upper with an FHA loan. Here’s where you have to go back to your balance sheet and compare what you have with what you need and want. Different loans offer their own set of advantages and drawbacks, so it’s important to research them carefully.
Those who want to pay off their loans early and get a lower interest rate can opt for a 15-year mortgage rather than the traditional 30-year mortgage. A shorter term means higher monthly payments, but an overall lower loan cost.
Homebuyers on a fixed budget might be better off with a longer loan, as they can still make extra payments toward their principal (at their discretion) without the obligation of larger monthly payments. So, should someone lose their job or an emergency arises, they can stop making extra payments (until they can afford to later).
“I advocate for taking a 30-year mortgage as opposed to a 15-year mortgage, simply because the monthly payments will be lower,” Czajka says. “This way, buyers can grow into their home. Should they decide to pay the home off early, they can pay a little more to the principal as they get used to the new budget.”
Get preapproved for a mortgage
Before you start shopping for a house, find out how much you qualify for. The best way to do this is through a preapproval.
To get preapproved for a mortgage, you’ll provide lenders with detailed information about your work history, income, debt, assets and credit profile. The lender will verify the information you provide, including running a hard credit check.
If you’re preapproved, you’ll receive a loan estimate with how much you can borrow. This preapproval letter is a great asset when you’re shopping for a home, as it lets sellers know you’re a serious and qualified buyer.
Before you sign a home purchase contract
Now that you have your preapproval letter in hand, it’s time to start shopping. This is the exciting part of buying a house. You might imagine the parties you’ll host by the pool or the long baths you’ll take in the oversized master bathroom.
But, avoid barreling toward something that you might regret down the road, Boomer warns. It’s important to take time and research everything from the neighborhood to the schools, particularly if you have a family or plan on starting one — even if it’s down the road. As more homeowners are staying in their houses longer, it’s wise to think of what you might want a few years from now.
“Don’t be in such a rush to make a buying decision. Start by investigating the area that you want to live in. If starting a family is in the cards, check out the schools in the area. Look at other nearby homes to see if the neighborhood is growing and if prices will be increasing,” Boomer says. “The last thing you want to do is purchase the biggest and best home in the neighborhood. Starting out with a house that needs a little attention can pay dividends later when it’s time to upgrade. Purchase a house for a lower price, fix it up and sell it at a higher price later.”