It’s daunting to tackle any big goal, particularly if it’s something that you’ve never done before, and for many young people, financial circumstances and anxiety put the idea of buying a home out of mind. But as younger generations have aged and become more financially stable and as more have started families, home buying is on the rise for the under-40 set. With interest rates at an all-time low in 2020 and millennials now representing the largest portion of home buyers at 37%, many people are going about the process for the first time.
No first-time home buyer can know exactly what they’re getting into; markets are different in each location, every home they see is unique, and their needs and wants vary based upon income and the size of the family. But, it does help to start with a basic knowledge of the home buying and finance process. There are fundamental terms that every prospective buyer should keep in mind before setting off down the path towards finding that first ideal home.
Very few people have the cash on hand to pay for a home in full, so prospective home buyers have to seek a mortgage loan from a bank or company to pay for the purchase. As with other loans, borrowers have a set period to pay back the mortgage (with interest) in monthly installments. Importantly, until the loan is repaid in full, you don’t truly own your home, and unlike other loans, your mortgage is secured with the home itself, meaning that failure to make payments can result in the mortgage company or bank repossessing the home.
How much you can borrow, and how much interest is on the loan, depends on your own credit rating and eligibility as well as prevailing market rates. The higher the risk, the higher the interest rate, so if you’re considering buying a home, you should work towards paying off debt; improving your credit score; and raising the ratio of your monthly income to monthly debt payments (known as an income-to-debt ratio) as much as possible.
Your home loan will also require a down payment that is some percentage of the loan amount; that amount depends upon what the lender requires, and how much (or how little) you want your monthly payment to be. Special mortgage programs, like VA loans, FHA loans, and state-run first-time homebuyer programs, offer loans for little or no money down plus assistance to borrowers with weaker credit scores.
If you’re thinking about starting the home-buying process, you can start talking with lenders to get either pre-qualified or pre-approved for a home loan. What’s the difference? A pre-qualification is simply an estimate from a lender on how much they could potentially loan you, based upon what you’ve told them of your finances without an approval process. To get pre-approved, you have to submit an application with the requisite documents, often including proof of employment or savings, for review. If approved, you’ll have an offer for a loan for a specific amount, under set terms and within a specific time period.
A pre-approval isn’t the same as actually having a loan, but it is useful in the process of looking at homes. A pre-approval letter is something you can show to sellers to demonstrate your seriousness about buying and your willingness to move forward on a particular home. Importantly it can show that you can afford the home in question. To get started with the process, collect your income and financial account information and reach out to more than one lender to see where you can find the right loan for your needs.
As you might expect, mortgage companies will want to verify your income before they offer you a loan to determine what you can afford and what interest rate to offer. To verify your income, you will have to submit your last two years’ W-2s, your last two tax returns and your two most recent pay stubs. The mortgage company will then contact your employer to verify the information you’ve provided. You may also have to provide information about your other financial accounts and credit card statements.
To ensure that the property you’re buying belongs to the person offering it for sale and to verify other legal issues, you’ll need to work with a title company to do a title search for any other claims of ownership or outstanding liens or property taxes due, or any credit taken out against the home. The title company will then issue an abstract of title detaining what they found in their search as well as a title opinion letter attesting to the validity of the title if no other claims were found. The title search is usually only done after there is an accepted offer on a specific home.
While a title company will do a thorough search of public records, mistakes are possible, which is why both buyer and mortgage companies can avail themselves of title insurance. Typically a borrower will pay for lender’s title insurance to protect the mortgage company during the closing, which ensures they will be paid for their equity in the home should any claims on the property emerge.
A home equity line of credit (HELOC) is money taken out against the equity you have in your home, which is to say the home’s value today less the amount you still owe on the mortgage. A HELOC typically has a lower interest rate than credit cards, so it makes sense to use it for larger purchases. However, like your mortgage, a HELOC is secured against your home and contingent upon factors like your income and credit.
The actual work of buying a home may be long and tedious, and while there’s little to do to change that, having the basics is a good start. Once you’ve got everything and everyone in place, all that’s left is the small matter of finding the right house and working through the purchase process, avoiding pitfalls along the way. But the first step is often the hardest one, and doing your homework can allow you to feel more confident about the home buying experience.
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