Your first home is far different from any previous purchase. It’s more exciting, emotional and, of course, much more expensive. While getting your finances in check is not the most glamorous part of the house hunt, it is arguably the most important. Below are our tips on how you can best finance your first home.
- Decide how much you can afford to spend.
Most experts say that you can afford a mortgage around two and a half times your yearly salary and that you shouldn’t spend more than 30 percent of your gross monthly income on mortgage payments. These are general rules of thumb, and you will need to consider other payments, such as auto loans and credit card debt, when figuring out your own magic number. Use online mortgage calculators to help you with the process.
- Research down payments.
The tried and true rule for down payments is that you should pay 20 percent of the total cost of the home upfront. However, many loan programs allow you to put down as low as 3 percent. While this is an appealing option, your monthly payments will be higher, and you will spend much more on interest and private mortgage insurance. Saving up for a down payment can be daunting, and it is understandable that 20 percent is not doable for everybody. Before you opt for a lower down payment,be sure you understand exactly what it means. Down payment calculators can help take the guesswork out of it.
- Set aside money for closing costs.
Closing costs are an often overlooked financial aspect of purchasing a home. Most homebuyers can expect to pay between 2 and 5 percent of the price of the home in closing costs. These costs can include an application fee, a homeowners’ insurance payment and the cost of a home inspection. The cost will vary based on the type of loan you choose, so take these closing costs into consideration when comparing lenders.
- Evaluate your credit score.
The higher your credit score, the lower your interest rates will be. Be sure to know exactly where your credit score stands and if there is anything you can do to increase it quickly. Also be aware that some activities can hurt your credit score in an instant. Any time you open a new line of credit, even a new credit card, the lender runs a hard inquiry, which can temporarily lower your credit score. Do not open new credit accounts or make any large purchases if you are planning on applying for a mortgage soon.
- Keep your numbers conservative.
When calculating what you can afford to spend, use your current income, not how much you think you will make in years to come. Additionally, once you get approved for a loan, try to stay under the amount given to you. That is the absolute maximum you can spend, and it doesn’t leave room for repairs or new furniture. When figuring out numbers, lowball what you can pay and overestimate what things will cost to ensure you don’t become “house poor.” New homes require home owner responsibilities that should be factored in such as lawncare, home repairs and maintenance. Be sure to budget for these hidden costs. Bonus tip: If you take out a less expensive mortgage, you may be able to make additional mortgage payments throughout each year. This will help you pay off your home quicker, which can save you thousands in interest payments.
Buying your first home is a huge milestone and we hope you enjoy the process. Be sure to check out our tips on how to house hunt effectively. In the comments below, feel free to share your best tips for financing a home.