Buyers Guide

First Time Home Buyer Facts

Fix Your Credit

The first step toward buying a home takes place months before walking into your lender’s office. It’s crucial to check your credit score at least three to six months ahead of your mortgage application, says Rod Griffin, director of Public Education at Experian. You can request a free copy of the report from each of the three credit bureaus (Experian, TransUnion and Equifax) at annualcreditreport.com.

Even if you don’t have sterling credit (generally a FICO score of 720 or above), the most important thing to do is to take stock of what the figure means. “Every score is educational,” says Griffin. “It’s more about why the number is than what the number is.”

This is especially true since there are different proprietary scales used to gauge credit: the Vantage score, for instance, ranges from 501 to 990, while the FICO score runs from 300 to 850. Make sure to read the accompanying credit report to understand what your score actually means. It’s also important to check for errors in the report, which can have a negative effect on your credit, and ultimately, your mortgage rate. One in four reports has an error serious enough to prevent homebuyers from getting credit, according to the U.S. Public Interest Research Groups. So get your reports well in advance of the house hunt.

Prepare for Down Payment and Closing Costs

It used to be the norm to put 20 percent down, but with the market in its current state of flux, many first-time homebuyers are finding ways to pay just 3 to 5 percent of the total cost upfront. Federal Housing Act (FHA) loans increasingly have become a popular option for first-time buyers, says Greg Herb, regional vice president of the National Association of Realtors. These competitively low-interest loans are ideal for buyers with less than perfect credit, and because the Department of Housing and Urban Development (HUD) minimizes the risk of default for lenders on these loans, borrowers are only required to put down 3.5 percent of the cost–a far cry from the traditional 20 percent down payment.

Still, there are advantages to paying more at the start. A larger down payment ultimately means smaller monthly bills down the line. Also, if you purchase a conventional loan (i.e.: one that is not backed by a federal agency), paying 20 percent or more upfront will eliminate the need to pay Private Mortgage Insurance (PMI) charges. PMI is insurance for your lender that can be paid upfront or in monthly installments, and is designed to offset your lender’s risk in the case that you’ve paid less than 20 percent on your home. It can cost around $55 a month per $100,000 financed. While it’s important to note that FHA loans also carry mortgage insurance with a down payment of under 20 percent, their low barriers to own still make them a good choice for first-time buyers.

Figure How Much House You Can Afford

Your debt-to-income ratio (DTI) is the percentage of your gross monthly income set aside for paying debts. While some loans may qualify you for up to 50 percent of your monthly gross income, it’s advisable that you use no more than 30 percent, says Joe Adamaitis, a mortgage banker in Sarasota, Fla. Be realistic about how much you can pay, because an unexpected event could tear a hole in a tight budget.

If, for example, you have a $5,000 gross monthly income, Adamaitis gives this scenario: After taxes, you might actually clear around $3,600. If you expect to owe 30 percent of your gross monthly income, that’s $1500 a month, leaving you a grand total of $2,100 to live on. At this rate, your 30 percent debt is actually cutting into 42 percent of your monthly income, after taxes. So when calculating your budget, be completely honest about your spending habits, even if lenders say you qualify for more.

Choose a Mortgage

For the reasons already stated, a first-time homebuyer’s best mortgage bet is usually to go with an FHA loan. They’re easier to qualify for, require a much smaller down payment compared to conventional loans, and have competitively low rates. But there are reasons to pursue other avenues.

“With loans, it’s not one size fits all,” says Herb. For first-time buyers who know that they won’t live in their first house forever, adjustable rate mortgages (ARMs) are a strategic option. A “7/1” mortgage, for instance, starts with a low interest rate for the first seven years before adjusting to an index your lender is using. While that’s probably not favorable over the long haul, if you can time your move in line with the next rate adjustment, you may end up saving a lot of money, Herb says.

Hunt for a House

Finding the perfect home can have a lot to do with finding a compatible real estate agent. Herb can’t stress enough the importance of meeting with an agent and getting pre-approved for a loan before starting the search. “The person you choose will quarterback the whole process for you,” he explains. It’s crucial to be in contact with an agent before starting the home search, “because you might be looking at x when all you can afford is y.” First-time homebuyers should make it clear what features they’re looking for and how much they’re willing to spend.

There are, however, certain questions that Fair Housing laws prohibit agents from answering, such as where to find religious centers in the area, the quality of the school systems, and crime rates. Be proactive in speaking with members of the community and inquire about the issues that matter most to you. For parents, search public sex offender registries, which can be found online, to see if there are high-risk areas in the neighborhood. In most states, agents must disclose whether violent crimes occurred on a property within a set number of years, but not so with suicides — find your comfort level and do your research.

Make an Offer

Sellers can price a property however they see fit, but that doesn’t mean homebuyers should pay a ridiculous cost. “Get your agent to pull all the comparable sold properties that occurred in the last six months,” says Adamaitis. “How many were short-sales? How many were foreclosures? Then gauge by square foot the comparable cost.”

Get Your Money’s Worth

At signing, the buyer should demand that the contract be contingent on an objective appraisal of the house, Adamaitis says. Look into the history of the home and make sure there aren’t any liens against the property. You should be able to negotiate with the seller to make any necessary repairs to the house before closing on the deal.

Contingencies vary by state, but you should certainly inspect the home for possible lead paint, radon, and structural issues. Depending on which contingencies your state recognizes, these flaws can provide grounds to cancel the contract without penalty, and get back the earnest money deposit you put down at the start of negotiations.

Stay on Course

Beginning to end, you can expect the entire process to last around four to five months, says Herb. Of course, with as much great inventory on the market as there is, it’s not unusual for homebuyers to find something within two to four weeks.

On a brighter note, Mike jumped back into the house hunt a little wiser this year and closed on a three-bedroom townhouse for him and his family in about four month’s time. The real journey starts at the end of the month, though — when his first bill arrives in the mail.

 

Understanding Closing Costs

Many home buyers mistakenly arrive at closing unprepared for a laundry list of closing costs: major and minor fees that are a routine part of any home purchase. This can be because the lender increased fees on lender-controlled aspects of a transaction, or because a buyer chose a third party (appraiser, inspector, attorney, title company) that might charge higher prices than those estimated by the lender.

Fortunately, new rules and regulations provide more clarity on the closing costs that borrowers can expect to pay. As a rule of thumb, homebuyers can expect to pay closing costs equivalent to 3 percent to 5 percent of their loan amount. This is money that the homebuyers will spend in addition to their down payment, and those stretching to buy should know that they’ll need to cover these closing costs in addition to the savings reserves that some lenders require. (In other words, raiding your savings on closing day to pay unforeseen closing costs may not work out!)

So how can you avoid surprises with closing costs? There are several steps you can take:
Ask the seller to pay the closing costs
Before you make an offer on a home, discuss with your agent whether you can negotiate with the seller to pay some or all of your closing costs. Many buyers who are stretching to finance a down payment make an offer that’s slightly higher and ask that, in exchange, the seller pay some or all of the closing costs. (Essentially, this amounts to financing closing costs within the mortgage loan.) Sellers eager to complete a transaction may offer to pay some closing costs in order to expedite a deal, or price their home slightly high on the assumption that they’ll be helping a buyer with closing. If a seller commits to pay some or all of the closing costs, its recommended that getting it in writing and appending the seller’s commitment to HUD loan documents so that the seller is held to their promise.

 

Understand the Good Faith Estimate
Make sure you get — and carefully review — the Good Faith Estimate that your lender must provide within three days of your loan application. This paperwork will describe to you the closing costs associated with your loan, ranging from lender-related fees (such as loan origination fees) to outsiders’ fees required to complete your transaction (inspection, appraisal, etc.). A good faith estimate is just that — an “estimate” — and some closing costs cited in that estimate can change. But as of January 2010, the government made it illegal for some of those costs to rise and capped other cost increases at no higher than 10 percent.

Closing costs that cannot increase include points (once an interest rate is locked), loan origination fees and transfer taxes. The costs that can increase, but by no more than 10 percent, include any services required by a lender, title-related services, and government recording charges. Other closing costs that can change include services that the buyer selects, such as extra home inspections, title services not required by the lender, homeowner’s insurance, and escrow deposits.

Get more than one Good Faith Estimate
Because lenders all use the same form to provide customers with the closing cost numbers, it’s possible to compare the estimates of various lenders, and to negotiate with them on some fees.

Read your HUD-1 Settlement Statement closely
Ask that your lender to provide the HUD-1 Settlement Statement well before closing, so you can comparing the closing costs listed in the statement with your Good Faith Estimate. You should feel free to ask your lender about any discrepancies or price adjustments you notice, so that you’re prepared and well-equipped to close with confidence.

“You do have recourse after the loan closes if you find out you’ve been overcharged.

DOCUMENTS AND FEES YOU SHOULD EXPECT AT CLOSING
Documents

  • Bank note: If you’re closing on a house or condo it’s called a mortgage. If it’s for a co-op it’s called a security agreement. The security agreement or mortgage “puts teeth into the note.” A note is a piece of paper that says I borrowed the money and I will promise to pay it back. The security agreement or mortgage says what the bank will do if you don’t pay it back.
  • Transfer documents: For a co-op, those are co-op documents, which are a proprietary lease. For a condo, the unit condo power of attorney gives the condominium limited power of attorney to conduct the business of the condo. A house does not have a transfer document
  • Hud-1: Discloses fees and costs
  • Aztech: For a co-op, it’s a recognition agreement. The bank has a security interest in the shares but the coop also has a security interest in the shares. The recognition agreement is signed by the bank, co-op, and the borrower/buyer, recognizing each others’ mutual security interest in the shares.
  • Lead paint disclosure: The seller, buyer and usually the agent all sign. Most people waive their right to do a lead paint inspection.

Fees

  • Attorney’s fees: Fees attendant to the loan, including the bank attorney’s fees.
  • Transfer agent fee: If the co-op has a transfer agent, the transfer agent gets a fee to review the recognition agreement; condos also sometimes have have transfer fees.
  • Co-op charges: Charges can include a move-in fee and a transfer fee; co-ops come up with all kinds of fees.
  • Title charges: (for a condo or house) pays for the title report ordered by the lawyer. It’s a onetime insurance premium you’re paying for the title. It’s a research of the property to find any and all encumbrances. The seller has to secure all the claims against a property to close. The title company is ensuring that the buyer has a good, clean, marketable title to that home or condo.