Making the leap from renting to purchasing a home is no small feat; it takes a great deal of confidence, a considerable amount of legwork and no shortage of patience. If you have made the decision to purchase your first home, you will likely encounter a number of questions throughout the process. Perhaps no question is as important as that of how you plan to pay for it.
Your credit score matters
The single biggest roadblock between a prospective homeowner and their first home purchase may be their credit score. Since you are not likely to have the money on hand to pay for a significant portion of your home, you will need to borrow money from a lender. Sheyna Steiner, investing analyst and writer for Bankrate.com, notes that your credit will not always be as exceptional as you might believe even if you pay your bills on time.
“The amount of credit you’re using relative to your available credit limit, or your credit utilization ratio, can sink a credit score,” she says. “The lower the utilization rate, the higher your score will be. Ideally, first-time homebuyers would have a lot of credit available, with less than a third of it used.”
In its definition of credit utilization ratio—the outstanding balances on your credit cards divided by the sum of their limits—Investopedia.com writes that “credit issuers like to see a credit utilization ratio of approximately 35 percent or less.”
If you believe that you are above that percentage, Steiner recommends beginning the process of improving your credit by whittling down outstanding balances at least six months before seriously shopping for a home.
Front- and back-end ratios
Lenders also consider the factors of your front-end and back-end ratios. The former refers to how much of your monthly income can be committed to paying for monthly housing expenses, while the latter refers to how much of your monthly income can be committed to all outstanding debts (e.g. mortgage payments, car payments, student loan payments, etc.).
Steiner notes that lenders are generally more concerned with your back-end ratio; while she writes that financial institutions tend to prefer ratios of 36 percent or lower, “some borrowers get approved with back-end ratios of 45 percent or higher.”
Whatever the case may be, it is imperative that you are able to balance your finances appropriately before you can determine how much you are able to afford on a monthly basis. Niccole Schreck, rental experience expert for Rent.com writing for U.S. News & World Report, calls a budget “a fluid document that will require tweaks along the way”; if you are utilizing a six-month window to clean up your credit, use that same time to create a budget based on your month-to-month expenses. This will give you a better idea of how much you are able to afford for your mortgage before beginning your search.
Commonly forgotten costs
When preparing your budget and anticipating initial costs in the home-buying process, there are a number of “hidden costs” that are easily overlooked. Andrea Browne Taylor of Kiplinger.com writes that five of the most common hidden costs are home inspections, appraisal fees, closing costs, setting up an escrow account, and maintenance and repair.
Home inspections and appraisals are fixed costs estimated between $200 and $600 each. Closing costs are an additional 2 to 5 percent of the purchase price on top of any down payment to cover various fees and taxes. Paying into escrow is often required by lenders and sees your monthly mortgage payment increased to accommodate annual tax and insurance bills. Maintenance and repair are variable, ongoing costs, but they are particularly prevalent in the first year of home ownership.
Schreck also adds moving costs as an overlooked source of expense in the home buying process. Her methodology for setting up a budget for moving expenses involves determining how far you plan on moving away from your current location, the anticipated rental rate for vehicles and equipment, anticipated costs with regards to supplies (e.g. cardboard boxes, tape, packing materials) and whether or not you intend to hire movers.
If you believe that you are ready to purchase your first home, consider all costs before making the leap. When it comes to such a life-changing decision, knowledge is the ultimate asset, and it can be the difference between maintaining a blissful homestead and being in over your head.