Want to buy your first home? You’ve probably got some cash saved for a down payment and maybe even recommendations for real-estate agents from savvy friends. But have you cleared your credit report, hired a tax adviser or weighed FHA financing compared with a conventional mortgage?
Kasara Williams, 31, has taken all three steps in a yearlong quest to buy her first home. “This whole experience has taught me that it’s important to have your financial act in order,” said Williams, a commercial-property manager in Arlington, Va.
Not every first-time buyer will need a tax adviser, as Williams did to fill out forms needed to withdraw part of her IRA without being penalized. But everyone should prepare early with orderly finances, information and plenty of patience for the long, complicated process ahead.
Since the housing market’s collapse in 2008, mortgage lenders and home sellers have become more demanding in the documentation they require for a home sale. And with the market heating up, you should think through contingencies and prepare your balance sheet to compete with other home seekers, many of them with a track record of ownership.
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Here’s a primer on what first-time buyers need:
STEP 1: CREDIT AND SAVINGS
Start by requesting a free copy of your credit report from the three major credit bureaus via www.annualcreditreport.com. Use only this link to avoid the credit-reporting scams out there.
If you see accounts you don’t recognize or negative marks on your credit report, clear them up now.
“You’d be surprised. Your parents might be on there, your cousins,” said Mary Malgoire, founder of the Family Firm, a financial-advisory firm in Bethesda, Md. “It’s really important to clean it up before you start this whole process.”
Williams learned that her father was still a joint holder on her checking account, so she asked him to write a letter certifying that all the funds were hers. She also noticed a negative item about an old dispute with Verizon over a landline that never functioned, for which she refused to pay the bill.
“I had to call them multiple times until I could talk to someone who was sympathetic and would get it removed,” she said.
If you see old credit cards you no longer use, consider closing some strategically, starting with the newest, low-limit cards that are unused. Lenders prefer a low ratio of debt to credit limit, so it’s good to have more credit available than you use monthly. They also like to see long-standing lending relationships, so don’t close your oldest credit card.
Finally, if you close too many credit cards in a short period, that raises a red flag as well.
“If you close down a lot of credit cards that you’re not using, it could trip a switch. If you have too many lines of credit open, it could affect your score negatively,” said Christopher Brown, a certified financial planner in Rockville, Md. “There’s a happy medium.”
STEP 2: STICK TO YOUR BUDGET
Create or revise your monthly budget so you’re setting aside the money you would pay as a homeowner that you don’t pay as a renter. This includes the home mortgage, mortgage insurance, property taxes, condo or homeowner-association fees, home furnishings, maintenance, cleaning and any utilities or fees your landlord pays.
Living with this budget will teach you what you truly can afford, as well as help you pay off credit-card debt or add to the savings you should already have amassed for a down payment. You’ll return to this budget when you make an offer, so consider this a draft version.
The bank and credit-card statements that you use to create your budget will probably be requested later by mortgage lenders. Start keeping your financial statements and pay stubs in a file, where you’ll put new documents as they arrive so everything remains current.
This is an opportunity for a reality check, said Kate Fries, a certified financial planner with the Family Firm. Will you stay in the area where you want to buy for at least five years, and do you have enough saved beyond the down payment for moving costs, maintenance and repairs?
“A lot of people jump into homeownership before they should. They get excited — their friends are doing it, the rates are really low and the idea that you should own a home. That’s not always a good starting point for making good financial decisions,” Fries said.
Review your personal and professional plans to see whether there’s a chance you might move to another city for work or add to your household through marriage or childbirth, both of which have implications for your income, location and the size of your home, said Carter Ferrington, an associate broker and agent for Vogel Realty.
STEP 3: FIND A GOOD AGENT
Your real-estate agent can advise you on neighborhoods and new listings of interest and be your advocate in a competitive market. Ask friends, family and colleagues for recommendations of an agent with expertise in your target market.
“The one thing I have that you won’t have if you’re a buyer is objectivity,” broker Donna Evers said. “You’ll fall in love with some charming front porch. I’m going to be the little angel at your elbow saying, ‘Can you borrow that much?’ ”
Your agent can help craft a strategy for being a competitive bidder. For instance, sellers prefer a buyer with no inspection or appraisal contingency, but you’ll need to think through your comfort level with paying for an inspection ahead of your offer being accepted and with buying a home that appraises for less than the sale price.
“These are the two things you might have to drop if you’re going to be competitive,” Evers said. “Those are going to be the two hairy things for first-time homebuyer.”
After Reese Goldsmith and Larry Mosley had two purchase offers rejected, they began to question the wisdom of their agent’s strategy. Even when the couple bid $5,000 higher than the next offer, they lost to buyers with conventional mortgages. Sellers knew their FHA financing would take longer to close and had a higher likelihood of bumps along the way.
“We were getting pretty frustrated,” said Goldsmith, 25, a government-affairs manager. “We needed someone who could rethink our search for us and be a bit more proactive.”
They changed agents, began looking in more affordable neighborhoods and switched to conventional financing. Even though a conventional mortgage requires a higher down payment, the lower overall cost of the house made the arrangement workable. Moreover, they avoided paying private mortgage insurance, which would have run $500 to $800 a month.
A few weeks ago, they bought a recently renovated colonial row house overlooking a park near an elementary school. “We were able to stay on budget and also avoid a lot of the pitfalls of FHA financing,” she said.
STEP 4: FIND A GOOD LENDER
Your agent is a terrific source for the other important professional for homebuyer: a mortgage lender. Whether you work with a specific lender or a mortgage broker who can connect you with many lenders, interview several before choosing. But don’t let anyone run your credit until you’ve decided, as several inquiries could raise a red flag and lower your credit score.
“Make sure that person is reputable and can perform,” Evers said, recommending that buyers check references. “Have someone who has a lot of access and control of the situation.”
You don’t want to let a quarter-point-lower rate tempt you into an Internet-based lender, then be unable to reach the underwriter when you’re in a fast-moving bidding war. “Get preapproved,” Evers said. “This is going to be so necessary this year because we are looking at an extremely competitive situation coming down the pike.”
Your lender can walk you through financing options and give you a realistic view of how much you can borrow based on your income and credit. Ask the lender to run a hypothetical scenario so you have a written estimate of the monthly principal and interest payments, closing costs, insurance fees and property taxes.
The first lender whom Goldsmith and Mosley spoke with failed to mention the caps on certain types of financing or to explain the higher down payment needed above that cap. “Really understanding our financing was definitely an issue for us,” Goldsmith said.
Your lender can also walk through your credit report with you, give advice on improving your score and estimate how long it might take for your actions to be reflected in the credit bureaus’ records. Make sure you understand in what circumstances you’ll be required to buy the home — or will forfeit your earnest money — even if your loan application is denied.
STEP 5: STAY ALERT AND READY
All that remains is to look at properties and be ready to make an offer quickly. That means keeping your finances spiffy for the final check before the sale. “Please don’t go out and buy a big car between now and settlement, or incur any new debt,” Evers said.
When you find a property you want, call utility providers for usage history and check on condo or homeowner-association fees and property taxes, then build all those costs into your monthly budget. Don’t let the beautiful home sway you if the expenses will push you over the limit of what you can afford.
“You always run into this thing where someone’s trying to push your budget, either the lender or your Realtor telling you that you can afford more,” Goldsmith said. “You need to have the money to take care of the home as well.”
Don’t drain all your liquid resources to pay for the down payment and closing costs, Brown said. It’s better to have slightly higher debt and enough cash on hand to afford emergency repairs or unexpected expenses.
“It’s a lot of responsibility, but it’s a rewarding responsibility. It’s like getting your first car times 10,” Goldsmith said.
“I imagine building our lives there. That’s why real estate is such an emotional thing, because it’s going to be a part of our lives now — the third member of our family.”