Mar 31, 20226 min read

Steps to Buying Your First Home

Updated: Jul 9, 2024

By: Tinuke | March 15, 2022

Are you thinking about purchasing your first home? Are you overwhelmed and don’t know where to begin? The home buying process can be an overwhelming process. There are six things you need to know to prepare yourself for your first home purchase.

1. Know what you can afford

2. Save for a down payment, closing costs, and cash reserves

3. Review your credit report

4. Know your debt-to-income ratio

5. Proof of income or employment history

6. Get pre-approved

Know what you can afford.

First, know what you can afford and create a monthly budget. Your monthly budget should include a list of your income and expenses. Review your monthly spending and estimate what you can afford to pay for a mortgage (principal, interest, property taxes and insurance), utilities, and maintenance.

Save for a down payment, closing costs, and cash reserves.

Second, save for a down payment and build up your cash reserves.

Saving for a down payment can feel daunting and challenging, but it is very important to begin saving. A down payment is the amount of funding you contribute toward the purchase of the house. Also, it is your initial financial stake in the home and the lender provides the remaining funds to purchase the property. As a result, both you and the bank now own a percentage of the house. So, remember if you do not pay, your house will be taken away!

The typical down payment range between 3% - 20% and depends on the type of loan. The higher the down payment, the lower the borrowers’ monthly mortgage payments and the lower the overall interest over the life of the loan. There are various loan types designed for different circumstances, such as conventional, Federal Housing Administration (FHA), United States Department of Agriculture (USDA), and Department of Veterans Affairs (VA). To get additional information on the various loan types and who is eligible, check the Consumer Financial Protection Bureau’s website.

In addition to saving for a down payment, you will need to save for closing costs. Closing costs are processing fees you pay to the lender to create your loan. Fees associated with closing costs can be home appraisal, home inspection, loan origination fee, just to name a few. The actual closing costs you will pay depends on where you live and the type of loan you receive. You can request the seller to pay closing costs, but it is a good idea to save for these costs. In addition to saving for a down payment and closing costs, you need to save for cash reserves, which is also called mortgage reserves.

Cash reserves are extra funds the borrower will have in the bank to cover mortgage payments. You might say to yourself, what is the purpose of saving for cash reserves? Cash reserves cover the monthly mortgage payments when there is a disruption to the borrowers’ finances. When the buyer has cash reserves, this shows the lender that the borrower is less likely to miss mortgage payments. Further, some lenders may require borrowers to have at least three months cash reserves, while other lenders might require six months. The cash reserve requirement depends on the borrower’s qualifications (i.e., debt-to-income ratio (DTI) and credit score) and the number of units in the property.

Review your credit report.

Third, I have two questions. Do you know your credit score? Have you reviewed your credit report lately? If your answer is no to both questions, understand it is important to know your credit score and to review your reports during the home buying process. Your credit score and credit report help lenders determine if you qualify for a mortgage loan and determine the interest rate lenders will offer.

Steps to receive and review your credit report

1. Request your credit report.

You can request your credit report from each of the three major credit bureaus (Equifax, Experian, and Transunion), but you may have to pay a fee. Or you can request a free copy of your credit report from www.annualcreditreport.com. Your credit score will not be impacted when you check your credit report.

2. Review your credit report.

Once you receive your credit reports, read each report. Review your reports for incorrect information or fraudulent activity. There are several reasons your credit reports may have incorrect information, so it is important to review your report. Some of the incorrect information include people who have commons names, birth dates, or when data is being entered or updated on your reports. If you see incorrect information on your credit reports, please dispute the information. According to AnnualCreditReport.com, “Federal law allows you to dispute inaccurate information on your credit report. Important to note, there is no fee for filing a dispute.” Check the Consumer Financial Bureau on how to dispute an error on your credit report.

Know your debt-to-income ratio.

Fourth, an important step to help you prepare during the home buying process is knowing your debt-to-income ratio or DTI. There are two types of DTIs the lenders evaluate and consider: the front-end ratio and the back-end ratio. Lenders will review your DTI and take this into consideration during the process. They evaluate whether you are able to pay off the loan you are applying for based on your DTI.

• Front-end ratio is also called the housing ratio or mortgage-to-income ratio. This ratio shows the percentage of an individual’s monthly gross income which would be allocated to mortgage expenses. Lenders prefer a front-end ratio of no more than 28% depending on the type of loan.

To calculate front-end ratio:

1. Divide your expected monthly mortgage payment ($2,500) by your monthly gross income ($7,500).

2. Multiply the final result by 100. The total percentage 33% is your front-end DTI ratio.

• Back-end ratio shows the portion of an individual’s monthly income which is allocated to monthly debts, such as personal loans, car loan payments, credit card debt, or student loan payments. Monthly gross income is determined by your salary before any taxes or deductions are taken out of your paycheck.

To calculate your back-end ratio:

1. Add all of your monthly debt payments $1,500 (personal loans, car loan payments, credit cards, or student loans).

2. Divide your total monthly debt payments by your monthly gross income ($5,000).

3. Multiply your final result by 100. The result 30% is your back-end DTI ratio.

Most lenders look for a ratio of 36% or lower. A low DTI can help you get a lower mortgage interest rate and ensure that you’re able to live comfortably while paying your debts and household expenses.

Proof of income or employment history

Whether you are self-employed or are employed with a company, you will need to show proof of income or employment history depending on your situation. Make sure you have all of your necessary documents available. Documents may include pay stubs, tax returns, W-2 forms, and bank statements.

Getting pre-approved

Do you know how much you can borrow from the lender?

Getting pre-approved is an important part of the home buying process, even though it is not required. A pre-approval letter shows how much you can borrow and helps the realtor search for listings that are in your price range.

Jennifer McCluskey, a Realtor with ReMAX First Choice in Essex, MD, stated “I typically don’t move forward with individuals interested in viewing houses if they don’t have a pre-approval letter. I let them know that it is important to receive a pre-approval letter to know what they can afford to pay monthly.” Jennifer also mentioned individuals should keep in mind that the lenders’ numbers don’t factor in household expenses, such as groceries, gas, medical costs, childcare, etc.

When speaking with potential clients regarding the importance of receiving a pre-approval letter, Jennifer stated, “Some people are reluctant or afraid to provide their personal information to someone online or over the phone.”

Borrowers may have to work with lenders who are not located in their states. In those cases, borrowers will have to work with lenders online and over the phone. For example, for over 10 years, I’ve searched and worked with lenders both online and in person (if there was a branch of the lender in my area). I say this because when you are searching and contacting lenders, the lender that may have better rates may not have a branch in your area, so you will have to provide your information to them online. There are precautions you should take to protect your financial and personal information. According to an article written by First Bank Mortgage titled, “How to Protect Your Personal Data When Applying for a Mortgage Online”, they suggest these four strategies, 1) Get a Loan from a Reputable Lender, 2) Ask About the Bank’s Security Policy, 3) Submit Your Application Over a Secured Network, and 4) Be Cautious When Responding to Emails.

Hopefully, you found this information useful and you are ready to begin the home buying process!