At last! Homeownership is right around the corner. You’ve put in so much hard work to save up a down payment and build a solid employment history. You don’t want to make a costly mistake at the last minute. Here’s what you need to keep in mind to make your first home purchase go off without a hitch.
- What you can afford
Before you get serious about buying a home, figure out what you can afford. This will depend on how much you’ve set aside for a down payment (more on that below) and what kind of monthly payment will fit your budget.
The Consumer Financial Protection Bureau’s toolkit for buyers offers a worksheet to help calculate the monthly costs you can expect once you become a homeowner. Don’t forget to budget for maintenance, which can add up to 1% to 2% of the purchase price of your home annually.
- The state of your credit
Building up a credit score takes time, but there are some steps you can take as you prepare to apply for a mortgage. Check your credit report for errors, and dispute any that you find. Also, pay down credit card debt as much as possible. This will improve your credit utilization ratio, which is the percentage of your available credit that you’re using.
Refrain from opening new credit accounts in the months leading up to your mortgage application. New cards and loans lower the average age of your accounts, which can hurt your credit. That’s especially true for millennials. Statistics on average credit scores show that young adults have the lowest average of any generation right now, and applying for additional credit before you begin your mortgage process can bring your score down more.
- Your down-payment options
The ideal down payment is at least 20%, because that allows you to avoid paying for private mortgage insurance, or PMI. However, there are plenty of options for people who bring down payments of 15%, 10%, 5% or even less to the table.
Some buyers who have 20% of the price of their new home saved up end up putting less down so they can use some of the money for other needs. It’s not a good idea to begin your career as a homeowner without a solid emergency fund, and closing costs can add up. Those can range from 3% to 6% of the price of the home, depending on where the home is in and any loan origination fees that apply.
- Your mortgage options
Most buyers choose a 30-year mortgage with a fixed interest rate, but other loan options are available from institutions such as Pioneer Bank. A shorter term — 15 years is common — means your monthly payments will be higher, but you’ll pay less interest over the life of the loan and you’ll be mortgage-free in half the time.
Some buyers also elect to get an adjustable-rate mortgage, or ARM, in which the interest rate can rise or fall according to the market. If rates go up, so might your monthly payments. But most ARMs have a temporary fixed-rate period that can last several years and during which your payments won’t change.
Some ARMs have a lower initial interest rate, so they may appeal to buyers who plan to move before the fixed-rate period expires or who expect to pay down their mortgage principal significantly in the first few years.
The bottom line
Buying a home can be satisfying, especially if you’re well prepared. Here’s hoping your path to homeownership is a smooth one.
Virginia C. McGuire, NerdWallet
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