For the first-time homebuyer: 10 financial mistakes to avoid
If this is your first rodeo as a homebuyer or it's been many years since you last bought a home, knowledge is power. Here are 10 common financial mistakes first-time buyers make - and how to steer clear of these missteps.
1. Looking for a home before applying for a mortgage
Many first-time buyers make the mistake of viewing homes before ever meeting with a mortgage lender. This puts you behind the ball if a home hits the market you love, or you look at homes that you can't afford.
In some large markets, housing inventory is still tight and competition is fierce. You might find yourself willing to stretch your budget to buy a property or lose a property because you aren't preapproved for a mortgage.
What to do instead: Before you fall in love with that gorgeous dream house you've been eyeing, be sure to get a fully underwritten preapproval. Being preapproved sends the message that you're a serious buyer whose credit and finances pass muster to successfully get a loan.
2. Talking to only one lender
This one is a biggie. First-time buyers might get a mortgage from the first (and only) lender or bank they talk to, potentially leaving thousands of dollars on the table. The more you shop around, the better basis for comparison you'll have to ensure you're getting a good deal.
A good mortgage loan officer can look at your situation and diagnose any potential roadblocks ahead to give you a clear understanding of your home-buying options.
What to do instead: Shop around with at least three different lenders, as well as a mortgage broker. Compare rates, lender fees and loan terms. Don't discount customer service and lender responsiveness; both play key roles in making the mortgage approval process run smoothly.
3. Buying more house than you can afford
It's easy to fall in love with homes that might stretch your budget, but overextending yourself can lead to regret and worse later. It can put you at higher risk of losing your home if you fall on tough financial times.
What to do instead: Focus on what monthly payment you can afford rather than fixating on the maximum loan amount you qualify for. Just because you can qualify for a $300,000 loan, that doesn't mean you can afford the monthly payments that come with it. Factor in your other obligations that don't show on a credit report when determining how much house you can afford.
4. Draining your savings
Spending all or most of their savings on the down payment and closing costs is one of the biggest mistakes first-time homebuyers make.
Some people scrape all their money together to make the 20 percent down payment so they don't have to pay for mortgage insurance, but they are picking the wrong poison because they are left with no savings.
What to do instead: Aim to have three to six months of living expenses in an emergency fund. Paying mortgage insurance isn't ideal, but depleting your emergency or retirement savings to make a large down payment is riskier.
5. Being careless with credit
Lenders pull credit reports at preapproval to make sure things check out and again just before closing. They want to make sure nothing has changed in your financial picture. Any new loans or credit card accounts on your credit report can jeopardize the closing. Buyers, especially first-timers, often learn this lesson the hard way.
The goal: keep the status quo in your finances from preapproval to closing. Otherwise, you could lower your credit score, run up your debt-to-income ratio and imperil your final loan approval.
What to do instead: Don't open new credit cards, close existing accounts, take out new loans or make large purchases on existing credit accounts in the months leading up to applying for a mortgage through closing day. Pay down your existing balances to below 30 percent of your available credit limit, and pay your bills on time and in full every month.
6. Assuming you need a 20 percent down payment
The long-held belief that you must put 20 percent down payment is a myth. While a 20 percent down payment does help you avoid paying private mortgage insurance, many buyers today don't want (or can't) put down that much money. In fact, the median down payment on a home is 13 percent, according to the National Association of Realtors.
Delaying your home purchase to save up 20 percent could take years, and you could limit cash flow that could be put to better use maximizing your retirement savings, adding to your emergency fund or paying down high-interest debt.
What to consider instead: You can put as little as 3 percent down for a conventional mortgage (note: you'll pay mortgage insurance). Some government-insured loans require 3.5 percent down or zero down, in some cases.
7. Overlooking FHA , VA and USDA loans
First-time buyers might be cash-strapped in this environment of rising home prices and higher mortgage rates. As a result, it can be harder for them to qualify for a conventional loan and they might assume they have no financing options. That's where government-insured loans enter the picture.
What to do instead: Look into one of the three government-insured loan programs backed by the Federal Housing Administration (FHA loans), U.S. Department of Veterans Affairs (VA loans) and U.S Department of Agriculture (USDA loans). Here's a brief overview of each:
FHA loans require just 3.5 percent down with a minimum 580 credit score. FHA loans can fill the gap for borrowers who don't have top-notch credit or little money saved up. The major drawback to these loans, though, is mandatory mortgage insurance, paid both annually and upfront at closing.
VA loans are backed by the VA for eligible active-duty and veteran military service members and their spouses. These loans don't require a down payment, but some borrowers may pay a funding fee. VA loans are offered through private lenders, and come with a cap on lender fees to keep borrowing costs affordable.
USDA loans help moderate- to low-income borrowers buy homes in rural areas. You must purchase a home in a USDA-eligible area and meet certain income limits to qualify. Some USDA loans do not require a down payment for eligible borrowers with low incomes.
8. Miscalculating the hidden costs of homeownership
If you had sticker shock from seeing your new monthly principal and interest payment, wait until you add up the other costs of owning a home. As a new homeowner, you'll pay for property taxes, mortgage insurance, homeowners insurance, hazard insurance, repairs, maintenance and utilities, to name a few. A Bankrate.com survey found that the average homeowner pays $2,000 annually on maintenance services.
What to do instead: Your agent or lender can help you crunch numbers on taxes, mortgage insurance and utility bills. Shop around for insurance coverage to get compare quotes. Finally, aim to set aside at least 1 percent to 3 percent of the home's purchase price annually for repairs and maintenance expenses.
9. Not lining up gift money
Many loan programs allow you to use a gift from a family, friend, employer or charity toward your down payment. Not sorting who will provide this money and when, though, can throw a wrench into a loan approval.
What to do instead: Have a frank discussion with anyone who offers money as a gift toward your down payment about how much they are offering and when you'll receive the money. Make a copy of the check or electronic transfer showing how and when the money traded hands from the gift donor to you.
10. Not negotiating a homebuyer rebate
The concept of homebuyer rebates, also known as commission rebates, is an obscure one to most first-time buyers. This is a rebate of up to 1 percent of the home's sales price, and it comes out of the buyer agent's commission. Homebuyer rebates are available in most U.S. states, but not all.
What to do instead: If you live in a state that allows homebuyer rebates, see if your agent is willing to provide this rebate at closing. On a $300,000 home purchase, this can be a $3,000 savings for you so it's worth asking.