Purchasing a home is among the most significant financial decisions a family can make. However, the majority of homebuyers lack critical information needed to get the best deal possible. This includes first-time homebuyers, which in 2017 made up over 34 percent of all home purchases nationwide.
First-time homebuyers often make mistakes when looking for a home to purchase. Most happen because of inexperience with how mortgages work, or eagerness to complete a transaction. However, avoiding these mistakes can help them save time, energy and thousands of dollars.
Looking for a home before applying for a mortgage
A significant number of first-time home buyers start looking for properties before talking to a mortgage lender. Doing so puts them at a disadvantage, as they may lose the chance to purchase their preferred home to other competitors.
In general, most real estate markets have some competition and only a few houses may go on sale every year. As a result, it is important that first-time home buyers be prepared to make an offer as soon as their chosen property becomes available. This can be done by asking for a pre-approval letter from a mortgage lender.
Most real estate brokers and home sellers give priority to buyers who have a letter of pre-approval. The reason is that such documents offer proof that a family has the financial background to get approved for a mortgage. Getting pre-approved also helps first-time home buyers narrow their search to include only properties they can afford.
Not shopping around for best rates
Another common mistake made by first-time home buyers is talking to only one mortgage lender. Although getting approved right away might look beneficial, doing so might close the door to better deals. To get the best interest rates and repayment terms, first-time home buyers should contact several mortgage lenders and compare their offers.
Most experienced loan officers recommend contacting at least three different mortgage lenders and make a comparison. They also recommend seeking advice from a mortgage broker experienced in the local real estate market. Homebuyers who do so can save thousands of dollars on interest rates, fees and closing costs.
Putting all of their savings towards down payment
Another common mistake made by first-time home buyers is putting all or most of their savings towards down payment and closing costs. As Ed Conarchy, a mortgage planner from Illinois explains, most first timers believe that putting as much money as possible for down payment is the best way to secure a mortgage loan. The reason why most try to reach 20 percent down payment is because it avoids mortgage insurance.
However, Mr. Conarchy explains that in most cases, it is better to pay mortgage insurance than being left with no savings. There are many unexpected expenses that may put a family in financial stress, including medical costs or car repairs. Draining their savings towards down payment will make it harder for them to meet monthly mortgage payments.
Choosing a cheaper home is one potential solution to avoid mortgage insurance without running out of cash. That way, homebuyers can save thousands of dollars otherwise spent in mortgage insurance and enjoy competitive interest rates and repayment terms.
Choosing a house they cannot afford to pay
First-time home buyers may feel tempted to go over budget and purchase a particular house they like. However, doing so can have significant negative effects if they go into financial hardship. The main risk of going over budget is foreclosure, but late payments can also impact credit scores.
Most mortgage brokers suggest looking at potential monthly payments to determine which house is affordable. In general, they recommend not going over fifty percent debt-to-income ratio when monthly mortgage payments are included. Debt-to-income ratio is a number that represents how much income goes into monthly debt payments. For example, a person who earns $3,000 each month will have a 33 percent debt-to-income ratio if their monthly debt payments total $1,000.
Focusing on monthly payments is a good way of avoiding excessive financial risk. First-time home buyers often pay attention instead to how much money they can borrow, which is not related to what they can afford.
Thinking 20 percent is the only down payment option
Most first-time home buyers assume they need 20 percent down payment to purchase a house. However, this is often not the case, as most mortgage lenders approve loans with much lower down payments in certain circumstances. If a family has good financial history, mortgage lenders will accept lower down payment amounts.
The main downside of not providing 20 percent down payment is being required to pay private mortgage insurance. This can increase monthly payments and add up to thousands of dollars in the long term. However, mortgage insurance gives families access to financing they would otherwise not have.
The amount of money paid as mortgage insurance is often determined by financial history. In general, homebuyers pay between 0.3 and 1.5 percent of the loan amount as mortgage insurance, regardless of down payment. As a result, families can put as little as 3.5 percent of the home’s value as down payment without increasing mortgage insurance costs significantly. Also, mortgage insurance must only be paid until the remaining balance falls below 80 percent of the loan amount.
First-time home buyers also have access to local or state housing programs offering financial assistance. Federal initiatives such as FHA, USDA and VA loans are also a good way to purchase a home with low or no down payment. These programs come with mandatory mortgage insurance but have more generous interest rates and repayment terms.
Overlooking government-backed mortgage loans
House prices and mortgage rates have been rising in the last few years. This situation may put some families in a position where they do not have enough money for down payment. Others may no longer qualify for traditional mortgage loans. In such cases, people still have access to funding through government-backed mortgage programs.
There are three main agencies offering government-backed mortgage programs. They are the Federal Housing Administration (FHA), U.S. Department of Agriculture (USDA) and Department of Veteran Affairs (VA). FHA loans are quite popular among first-time home buyers because of lower requirements. In general, families with credit scores above 500 are eligible for an FHA loan. Down payment can be as low as 3.5 percent. FHA loans also come with generous interest rates, often in the single digits, and mortgage insurance below one percent.
People who currently serve, or have previously served in any branch of the military, have access to special mortgage loans offered by the Department of Veteran Affairs. These loans have very generous interest rates, flexible requirements and no down payment. Instead, qualifying families must cover a funding fee that includes mortgage insurance. Surviving wives of deceased veterans also have access to these loans under special conditions.
Families living in rural areas can take advantage of home loans offered by the Department of Agriculture through its Rural Development program. These loans can be used to purchase homes located in select rural areas. Like VA loans, USDA mortgages have flexible requirements, which can include no down payment. for low and very-low income families.
Ignoring alternative methods to raise down payment
There are many different ways to come up with money to cover down payment. Most first-time home buyers believe that only their savings can be used for that purpose. However, mortgage lenders do not impose restrictions to where the money must come from.
First-time home buyers can use, for example, money gifted by family and friends to cover down payment. However, they will be required to provide extensive documentation, such as bank statements from benefactors. A written letter confirming that they money is a donation is also often necessary. First-time home buyers can also use money from a previous loan, as long as their final post-approval debt-to-income ratio is within lender requirements. In general, lenders approve loans to customers with debt-to-income ratios at or below 51 percent.
Crowdfunding is also an alternative to raise down payment money. Nowadays, people can set up a campaign in a crowdfunding platform such as HomeFundMe or FeatherTheNest.com and receive donations from hundreds of people around the country. This method has been available for only a few years, and has some limitations. However, it can be useful for young families expecting contributions from friends and family members living in other states or countries. HomeFundMe also offers up to $2,500 in matching contributions to help families raise money faster.
Another potential way of raising down payment is by requesting help from state and local governments. According to Rob Crane, CEO of DownPaymentResource.com, there are more than 2,500 programs designed to help first-time homebuyers raise down payment money. In Texas, for example, the local Department of Housing and Community Affairs offers 30-year fixed-rate mortgage assistance and down payment coverage of up to 5 percent of the loan amount.
The federal government also provides assistance through initiatives like the HOME Investment Partnership Program, which gives low-income families funding to purchase or renovate a property.