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So You Want To Buy Your First House…

By Brent Nyitray, CFA

Purchasing a home is daunting for everyone, especially for the first-time homebuyer. How much house can I afford? How much of a down payment do I need? How good must my credit be? What are closing costs? What are points? This article will attempt to address some of the biggest questions the first-time homebuyer typically has.

How much house can I afford?

Lenders use a formula called the debt-to-income ratio to determine how much you can afford to borrow. They will examine your current obligations (like student loan debt, any car loans, or credit card debts) with your prospective mortgage payment and divide that by your monthly income. As a rule of thumb, your mortgage payment should be no more than 28% of your monthly income and the total sum of your debt should be no more than 36%. That said, some mortgage programs do allow higher ratios, but that doesn’t guarantee the lender will go along. You can use a mortgage calculator like this one here that can help you conduct “what-if” scenarios.

Note for first-time homebuyers: These DTI requirements will be looked at again at the closing table. DO NOT take out a loan for new appliances, etc. until the loan is closed. Many inexperienced homebuyers had their purchase fall through at the last minute due to this mistake.

Remember the mortgage payment will include more than principal and interest. Your property taxes and your homeowner’s insurance will probably be included as well. Maintenance is another thing to keep in mind. The days of calling the superintendent when something goes wrong in the middle of the night and getting it fixed for free are over. Plumbers and electricians aren’t cheap.

How much of a down payment do I need?

It is conventional wisdom that you need 20% down to get a mortgage, however that is not necessarily the case. The government created the FHA program specifically to help first-time and lower-income borrowers qualify for a home loan. FHA currently allows borrowers to put as little as 3.5% down. If you are military or a veteran, you can borrow the entire amount via the VA loan program, subject to certain maximum loan limits. Note however, that the smaller your down payment, the higher your interest rate, and you may need to pay mortgage insurance. So, if you want to minimize your monthly payment, try to bring at least 20% to the table.

How good must my credit be?

40 years ago, a borrower needed pristine credit to get a home loan. Nowadays, the requirements have been relaxed. Generally speaking, lenders will start to balk if your credit score is below 640, however some will be willing to lend to lower credit scores. Lower credit scores will make your loan more expensive, so look into ways to improve your credit before getting your mortgage. Paying down old debts, settling outstanding disputes all help.

What are closing costs?

Closing costs are extra fees that are paid at the time of closing. This can include title, insurance, taxes, escrows, and other miscellaneous fees. Your lender will give you a loan estimate which will include a list of all the fees along with the specifics of your mortgage. This helps avoid surprises.

What are points?

Points refer to percentage points that are due from (or paid to) the borrower at the time of closing. Unlike a car loan or a credit card loan, a mortgage borrower has a choice of what interest rate to pay on the loan. Let’s say the lender quotes you 4.5% with no points. That isn’t the only rate choice on the menu. You could choose to pay a lower rate, say 4.375%, however you would have to pay points to get that rate. In other words, if you are willing to pay a fee (points) you can get the lower rate. Conversely, if you choose the higher rate, the lender will give you a lender credit, which is money at the closing table. You can use this to offset some of your closing costs.

Remember, you won’t be going through this alone. You will be going through the home purchase process with the aid of a loan officer who can answer all your questions about the loan and a lawyer who will be familiar with the laws of your individual state.  Between these two people there should be no bad surprises on your way to the closing table.

Brent Nyitray, CFA is the Director of Capital Markets for iServe Residential Lending. He is the author off the real estate blog The Daily Tearsheet.

For more information on iServe Residential Lending, visit https://iservelending.com/