You’ve been thinking about it for a while and have decided that you want to take the plunge — into buying a home, that is.
Whether you’re buying your first home or you’re ready to find your dream home, you’re about to take on a lot of financial responsibility, and falling in love with a property that’s a stretch — or totally out of reach — for your budget is no way to start. Here are some key things to understand about the homebuying process before you commit to your new home.
Premiums can range from $300 to $1,000 annually. For a rough estimate, divide the value of your home by $1,000 and multiply by $3.50.
Median property taxes range from 0.18 percent to 1.89 percent of the home’s assessed value and are determined at both your county and state level, so be sure to check your county and state’s tax rates.
Private Mortgage Insurance (PMI)
If you don’t have a 20 percent down payment, your lender will probably require you to get PMI to protect against default. PMI rates usually range from 0.3 percent to 1.2 percent of the loan.
Homeowners Association (HOA) Fees
These fees can range from $200 to $400 per month for most cities, although fees can vary or increase dramatically depending on variables like location and services offered.
Most lenders require a score of at least 620. If you’re unsure of your credit score, you can order
it through one of the three credit bureaus — Equifax , Experian or TransUnion — or see it for free
through sites like CreditKarma and Credit.com.
Your total monthly housing expenses should not exceed 28 percent of your pretax income and
should not exceed 36 percent when combined with all other monthly debt.
Buyers who have a small down payment are considered riskier to lend money
to than those with a larger one. If possible, aim to put down at least 20% to
help get a better interest rate and avoid PMI.
A track record of job stability lowers your risk profile with lenders.
How does all of this fit in with the “pre-approved” mortgage we hear so much about? It’s definitely helpful to have one, but understand what it really is — or rather, isn’t. A pre-approval is ultimately a letter from a lender that shows you’re qualified to borrow a specific amount of money, which can give you a competitive edge against other bidders.
Even though it’s not the mortgage, per se, it’s a tool that shows you’re serious and qualified to borrow. To that end, some sellers won’t even consider an offer unless it comes with lender pre-approval. Your lender’s inquiry will usually show up on your credit report, so ideally you only want to get it done once. Because pre-approval letters are typically valid for about 60 to 90 days, you want to be careful when you decide to seek out a pre-approval — it should be when you’re serious about the house hunt.
Some sellers won’t consider an offer unless it comes with lender pre-approval.
Mortgages are not one-size-fits-all. There are three main factors you should look at when choosing a loan: the term, interest rate and type of loan. All can have a different financial impact in the short and long run.
As a general rule of thumb, the longer the term (or life of the loan), the lower the monthly payment, but the more you’ll pay in total interest. For example, let’s say you have a $150,000 loan with a 3.5 percent interest rate. If you have a 15-year mortgage, your monthly mortgage payment (principal and interest only, excluding taxes, homeowners insurance and PMI) would be $1,072, and the total you’d pay in interest over the life of the loan would be $43,020. If you had a 30-year mortgage, your monthly payment would be $673 — but you’d pay $92,485 in total interest.
It is possible that your interest rate could change over the life of your loan. That’s because you can opt for either a fixed-rate or adjustable-rate mortgage. With a fixed-rate mortgage, you lock in your interest rate for the life of your loan, regardless of whether national interest rates change. This is great if interest rates rise. If they fall, you could refinance to try and take advantage of the lower rates, though there will be additional costs associated with refinancing.With an adjustable-rate mortgage (ARM), your interest rate remains constant for a set period of time, say three, five or seven years.
15-year vs 30-year loans
When that period is up, your interest rate would then adjust. If national rates rise, your mortgage rate can increase; if they fall, your payment could decrease.
Finally, there are three main types of mortgages you can apply for: Conventional loans, Federal Housing Administration (FHA) loans and those that fall under Special Loan Programs. The Consumer Financial Protection Bureau outlines these in detail as well as the pros and cons of each to help you make a more informed decision. But at a high level, here are easy ways to distinguish among them.
Types of Mortgages
These are the most common,
and they typically require a
20% down payment to avoid
having to pay PMI.
Backed by the government,
these allow for lower down
payments and credit scores
in exchange for possibly
Department of Veteran’s Affairs
(VA) loans, U.S. Department of
Agriculture loans, state and local
programs help make home
ownership more affordable.
Once you’ve made an offer on a home and it’s been accepted, the process of actually paying for the home will begin, and that happens in different phases.
When you make the offer, you’ll need to submit “earnest money” — about 1 to 2 percent of the purchase price of the home. If you back out of buying the home for any reason that isn’t stated in the contract, the earnest money goes to the seller. If the deal closes, it’s then applied to your down payment.The down payment is anywhere from 3.5 to 20 percent (or more) of the purchase price. Putting at least 20 percent down negates the need to purchase PMI, and also helps you get a better interest rate.
So if possible, aim to put down at least 20 percent.
Finally, there are closing costs to consider, and these typically run you between 2 and 5 percent of the purchase price. There are a number of fees involved that you’ll need to pay for, such as appraisals, inspections and taxes.
Once you’ve been handed the keys — congratulations! You’re officially a homeowner.
It’s now a good time to revisit your budget, as you’ll have to account for costs that often add up for new homeowners, such as furniture you may want to buy or appliances you may want to replace. It’s also time to look into the types of insurance policies you need to protect your new investment, as well as your ability to pay for it. Consider talking to a financial planner or professional in order to help you navigate your early years of homeownership.
No matter where you’re saving, our advisors are here to help create a personalized plan to make the most of your money today and in retirement.
This guide is not intended as legal or tax advice. Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.