Mortgage Application Guide for the First-Time Home Buyer
Sep 22, 2022
We know that the housing market is chaotic and understanding all the moving pieces can seem daunting. If you are a first-time homebuyer who is in the market for a new home, don’t stress! We live in a time where guides such as this exist to help you deal with life as it happens.
This guide will tackle key information you need to know to buy your first home. From clarifying what a debt-to-income ratio (DTI) is and the qualification process, to closing on your mortgage.
Having a better grip on the ins and outs of the home-buying process will give you the confidence you need, to take the first step toward buying a new home.
- The Federal Housing Administration (FHA) established a 43% DTI as a benchmark for approving mortgages. A DTI measures your ability as a borrower to manage monthly payments. In other words, all your regular debt payments, topped with your housing-related expenses should not equal more than 43% of your monthly gross income.
- Lenders will also evaluate your front-end DTI, which calculates how much of your gross income is going toward housing costs. A back-end DTI calculates the percentage of gross income that is going toward other debt types, such as credit cards and car loans. Lenders will usually set a standard ratio of 28%.
- You must make sure to get pre-approved for a home loan. Sellers will not even consider your offer if it did not come with a mortgage pre-approval from a lender.
- Lenders will recommend that you put down 20% on your loan to bypass private mortgage insurance (PMI). A PMI will be added to your mortgage payments and would usually cost between 0.5% and 1% of the entire mortgage amount.
- Purchasing a mortgage means considerable upfront costs. A good rule of thumb is to ensure you have a savings account with at least 6 months' worth of deposit, including emergency funds. This is a prerequisite demanded by lenders.
- Take advantage of all the methods that are available to you when searching for a home. Go through online listings, drive around neighborhoods you are interested in, search for sale signs, and include your friends and family.
- There is a wide range of loan programs that are specifically tailored for the first-time homebuyer. Many programs offer minimum down payments that go as low as 3% to 5%, and there are a few programs that require no down payments at all.
- Your real estate agent should help you make an offer (from deciding on how much you can afford, to closing on the home). You are advised to review your budget factoring in all your expenses before making an offer. Once the offer is accepted, you will make a good-faith deposit to escrow until the house is taken off the market and receives inspection.
- When the inspection checks out, you will be ready to move forward toward closing on your mortgage. Next will be the signing of documents and settling any fees you have outstanding (e.g. application and origination fees, title fees, appraisal fees, taxes, insurance, etc.)
- Once the keys are in hand you will need to start preparing for the unexpected. This means keeping an emergency fund for your home, performing regular maintenance,
Getting Ready to Buy
Before you jump into the housing market to search for the house of your dreams, take a moment to think of all the things you need to consider.
Are you financially prepared to buy a house? How much would you qualify for? How much house will you be able to afford?
Other factors that play a huge role in getting qualified for a mortgage is your debt-to-income ratio and mortgage rates. It is necessary that you understand these concepts well before moving forward.
Your Debt-to-Income Ratio
Buying a house requires a hefty financial investment, it is unlikely that you would make an upfront cash payment to the seller and move into a new home. So, your first logical step will be to apply for a mortgage of some kind to help you afford the house.
The first step lenders will take when they are qualifying you for a mortgage is your debt-to-income ratio.
The Federal Housing Administration (FHA) established a 43% DTI as a benchmark for approving mortgages. A DTI measures your ability as a borrower to manage monthly payments. It is calculated by adding up all your monthly debt payments, divided by your gross monthly income. So, by evaluating your DTI, lenders will get a better idea of whether or not you can meet their monthly payments.
Keep in mind, some lenders might be more stringent about the DTI, depending on the current state of the real estate market and the economy,
What the Lenders are Looking for?
You should also know that there are some variations to the DTI. Lenders will also check your front-end DTI, which calculates how much of your gross income is going toward housing costs. Your Front-end DTI is categorized as a housing expense (i.e. mortgage payments, insurance, etc.)
A back-end DTI calculates the percentage of gross income that is going toward other debt types, such as credit cards and car loans. Lenders will usually set a standard ratio of 28%.
You might be wondering why lenders put up all these strict benchmarks on your DTI. Mainly to ensure that borrowers aren't committing to a financial obligation that they can't maintain.
If more than 43% of your gross income is tied to paying off other debts, you will have no room to take on additional expenses that you may not see coming.
Keep in mind that mortgages require a long-term commitment, you will be making monthly payments for the next 30 years. It is highly recommended that you evaluate your income and expenses and forecast how much you expect your expenses to increase over time.
How much do you qualify for?
Once you have prepared your finances to meet lender requirements, you need to see what you qualify for. Lenders will evaluate your application based on factors such as your monthly income, the size of your existing debts, and the state of your employment (e.g. how much have you been working in your current job).
You must make sure to get pre-approved for a home loan. Sellers will not even consider your offer if it did not come with a mortgage pre-approval from a lender.
Rates and fees cam vary between different lending companies, so be sure to shop around a bit for the one that will work for you and your current financial situation.
Can you Afford the Down Payment?
Lenders will recommend that you put down 20% on your loan to bypass private mortgage insurance (PMI). A PMI will be added to your mortgage payments and would usually cost between 0.5% and 1% of the entire mortgage amount.
A common misconception about down payments is that you must put down 20%. This is not true. You can buy a home with a 3.5% down payment through a government-backed loan program with FHA. A higher down payment would earn you bonuses such as:
- Lower monthly mortgage payments
- Wider choice variety of lenders – as some lenders would only provide a mortgage if you put 5% or 10% down
Keep Your Lifestyle Needs in Mind
Besides money, there are other factors that you should also keep in mind. You need to think about the purpose of why you are moving, are you looking for a bigger house because you need more space? Are you relocating because your children are changing schools? Is the move worth it? How much time are you planning on living in your new house?
Give yourself some room. First, consider your essential expenses, hobbies, and interests, and then, account for the monthly mortgage payments. Next, as part of your calculation, factor in the monthly cost of your expensive but non-essential hobbies. If you find that the balance is not enough, you may need to sacrifice some of your expendable hobbies, or compromise by looking for a more affordable home.
Your First-Time Buying a Home
Key Questions to Keep in Mind
If you are planning to buy a home, the first thing that you should do is consider what your goals are. Are you seeking to take advantage of the long-term cost-cutting benefits of owning a home? Are you looking for a good long-term investment? We have created a set of questions that will help point you in the right direction
What is your financial situation?
Are you financially prepared to take on a long-term loan? Keep in mind that you must be comfortable enough to handle the purchase and the ongoing expenses of owning a home. This exercise should help to let you know if you can move forward with buying a home or if you need to re-evaluate your decisions.
- Evaluate your savings. Purchasing a mortgage means considerable upfront costs. A good rule of thumb is to ensure you have a savings account with at least 6 months' worth of deposit, including emergency funds. This is a prerequisite demanded by most lenders. Remember that lenders that do not require you to have enough savings in your bank account, will perceive you as a higher-risk borrower, and accordingly raise their interest rates which would translate to higher monthly payments (hence, a higher long-term cost). One of the challenges when it comes to maintaining a savings account is determining a safe and accessible channel that would give you a return so that you keep up with inflation. If you have 1 to 3 years to achieve your goal, a Certificate of Deposit (CD) could help you keep the money you save. If you need something more short-term, you can apply the same concept with a short-term bond or a fixed-income portfolio. These strategies will grow your savings while protecting you from turbulent stock market dynamics. If your need is more immediate (6 months to a year) your best option is to save your money in a high-yield savings account, preferably with an FDIC-insured bank. Under such short periods, keeping your money liquid is your best bet.
- Keep track of your expenses. Closely understand how much you are spending every month. This will enable you to know exactly how much money you can allocate toward your monthly mortgage payments. Make sure you account for everything – including utilities, food, car maintenance and payments, student debt, clothing, kids’ activities, entertainment, retirement savings, regular savings, and any miscellaneous items.
- Examine your credit health. To qualify for a mortgage, you will typically need a good credit score, which entails a history of paying your bills and debts on time, and a maximum DTI of 43%. These days, lenders prefer to limit housing expenses to 30% of the borrower's monthly gross income. (Note that this figure might vary depending on the local real estate market dynamics). Get a copy of your annual credit report and review it periodically to make sure that you stay in check.
What type of home do you need?
There are several different types of residential properties. You can choose between a traditional single-family home, a duplex, a townhouse, a condo, a co-operative, or a multi-family building. There is an upside and downside for each option you choose. Alternatively, you can buy a fixer-upper at a cheaper price.
Keep in mind, however, that the amount of time, equity, and money required to upgrade a fixer-upper into your dream home, could end up costing you more than what you have bargained for.
What are the ideal and necessary features you need in your home?
When planning to make the biggest purchase of your life, it is very important that you have a list of your non-negotiables. The necessary features that need to be a part of the home you own. This list should cover general things, such as home size, neighborhood, all the way to room layout, and kitchen appliances.
How much home can you afford?
Not all loan offers will fit your financial situation. Just because you qualified for a loan of $300,000, does not mean you have to take that much. This is a common mistake amongst first-time homebuyers who often end up trapped, unable to cover essential living costs.
Realtors are your partners in the home purchase process
Once you get pre-qualified for a loan, a real estate agent can help you choose homes that meet your needs and your price range. They will meet with you when you are going out to view those homes. Once you have picked the home you wish to buy, they will support you during the entire purchase process. From making an offer, getting a loan, and completing paperwork. Good real estate agents are useful in helping you avoid any obstacles you may come across during the buying process.
The Buying Process
If you believe that you are ready for the journey, follow the guide below to get a better idea about what to expect from the home-buying process.
Finding a Home
Always take advantage of all the methods that are available to you when searching for a home. Go through online listings, drive around neighborhoods you are interested in and search for sale signs. Tell your friends and family that you are in the market for a new home. They may refer you to a home that they came across when they were searching for their own.
If you are on a tight budget, look for homes that still have the potential to increase in value. Make compromises on small things that you can live with for a short while, such as replacing an old bathroom wallpaper. Do not let physical imperfections turn you away unless they put your safety at risk.
Your Financing Options
There is a wide range of loan programs that are specifically tailored for the first-time homebuyer. Many programs offer minimum down payments that go as low as 3% to 5% (compared to 20% for conventional loans). You will also find that there are a few programs that require no down payments at all. Make sure to do your research, here are a few programs for you to consider:
- HUD’s resource list: The Housing and Urban Development (HUD) does not provide individuals with grants. It does, however, grant funds for financing the first-time homebuyer to organizations that hold an IRS tax-exempt status.
- Your IRA: As a first-time homebuyer you are eligible to withdraw $10,000 from your individual IRA without paying the 10% penalty for early withdrawal. If you and your spouse are looking to purchase a home, you can both withdraw a total of $20,000 from your IRA without incurring any penalties. Keep in mind, however, that this amount will need to be repaid within 120 days. Otherwise, you will be liable for the 10% fine (in addition to income taxes charged to the withdrawals.)
- State programs: Many states provide financial assistance programs to first-time homebuyers. The programs often cover assistance with down payments, closing costs, and expenses towards property improvement. Eligibility criteria are based on income and the size of the property’s purchase price.
Keep in mind that mortgage fees considerably vary, based on where you choose to apply for it. Take an FHA loan, for instance, the rates that a credit union would charge in comparison to a mortgage broker would not be the same. For this reason, keep your options open and take your time when shopping for a lender – Do not limit your options.
Once you have chosen a lender, they will go through your financial information (credit scores, employment information, DTIs, etc.). Accordingly, the lender would then pre-approve you for a mortgage. Note that, getting a pre-approval from a lender does not mean you are in the clear. Your loan could still fall through, especially if you made decisions that affected your credit score, for example, if you recently financed a new car or other large purchase.
Making an Offer
Your real estate agent will help you draw up an offer. They will help you decide how much money to put into the house in addition to the unique conditions you want to ask for. Your agent will then present the offer to the seller, who will accept, reject, or issue a counteroffer against. You can continue negotiations with the seller, accept their offer, or drop the lead altogether.
Before submitting your offer, review your budget again. This time, include the estimated closing costs, commuting costs, and any immediate repairs you will need once you have moved in. Try thinking ahead to avoid any unexpected costs. For example, you can ask for the energy bills from the past 12 months to get a better idea of your average monthly costs.
Upon reaching an agreement, you will make a good-faith deposit and transition the amount into escrow. During these 30 days, the seller takes the house off the market with the contractual expectation that you will buy it. This is followed by an appraisal or an inspection.
Inspecting the Home
There is no way to skip this step. Even if you are purchasing a brand newly built home, hiring a professional to inspect the property is mandatory. The appraiser will inspect the quality, safety, and overall condition of your potential new home. If serious, undisclosed defects were discovered with the property, you will be able to withdraw your offer and get your deposit back. Alternatively, you can negotiate for the seller to make the repairs or discount the selling price.
Closing on your Home
If everything with the inspection checks out, you should then be ready to close on your loan. Closing, in short, entails the revision and signing of all documents. Fingers crossed that nothing falls short at the last second of course!
Some things which are dealt with during the closing phase include, having your home appraised (or inspected). Doing a title search to make sure no one other than the seller has a claim on the property. Purchasing private mortgage insurance (PMI) if you made a down payment of less than 20% on your mortgage. Ensuring all mortgage paperwork is complete and signed. The closing portion of your loan might include some expenses such as origination fees, application fees, title insurance, surveys, taxes, and credit report charges.
Congratulations! You have received the keys to your new home! You are settling in and the new place is finally coming together! The journey has come to an end and the day you have longed for is finally here. Except that this is not true, and your journey as a homeowner is only just getting started. Below are some tips that will hopefully make your life as a homeowner a little bit easier.
Make an Emergency Home Fund. Unexpected charges and expenses are almost unavoidable as a homeowner. Why it is prudent to set some emergency money aside, specifically for home emergencies.
Regularly Maintain your New Home. If you want to try and avoid losing value on your home, and reduce the risk of unexpected charges, you will need to put an effort into making sure that your home stays in excellent condition.
Do not worry about the housing market. The value of your home does not matter up until the moment you are trying to sell it. Having the choice in deciding when to sell your home, in contrast to being forced to sell it, is the key factor that determines how much profit you get to make out of selling your home.
This overview of the home-buying process should help set you on your way toward buying your first home. The more you educate yourself about the process beforehand, the less stressful it will be. The goal is to get the house you want for a price that you can afford.
About the Author
Qais Hudhud is a copywriter and technology specialist at Premier Lending. For two years, Qais wrote articles that touched on banking and microfinance institutions. Later graduated in mortgages, where he worked alongside industry experts with over 11 years of experience in helping homeowners from the west coast to the east coast, achieve their dreams.