First-Time Home Buyer Education
Monday, Feb 8 2021
We are excited that you are here and are interested in learning more about homeownership. Our Mission at Focus Federal Credit Union is to focus on your financial goals while providing superior service. We have created this program to help our members understand the homebuying process better and to assist them in making good financial decisions while achieving the dream of homeownership.
If you would like to listen to our Podcast covering the First Time Homebuyer Process, please click here.
You have to know where you are at to get to where you are going. Knowing these key aspects of your financial situation will help you understand what it will take to get you to be a homeowner.
Know Your Numbers
In the home buying process, you have to know your numbers. What are your income, debts, expenses, savings, and credit scores? In other words, what does your financial picture as a whole look like? Knowing these key aspects of your financial situation will help you understand what it will take to get you to be a homeowner. Income comes in many different forms; the key is that you have verifiable income sufficient to support you’re your debts, expenses, and proposed mortgage loan.
Sources of income:
- Social Security
- Child Support
Income used to qualify for a mortgage must be verifiable by acceptable documentation. Paystubs, W2 forms, Tax Returns, Award Letters, etc.
Gross Income = the amount of income you earn before any taxes or deductions are taken out. This amount will be used to qualify you for your mortgage loan.
Net Income = the amount of income you have left after taxes and deductions are taken out. This is the amount that you have left to pay your debts and other expenses. This is the amount you use to create your budget.
John Doe makes $15 per hour at his full-time job. He works 40 hours per week.
Gross income = $15/hour X 40 hours per week X 52 weeks in a year divided by 12 months = $2600/month.
His net income is $775.40 X 26 bi-weekly periods divided by 12 months = $1680.03 per month.
$2600 Gross Income
-$1680 Net Income
Mortgage lenders use the gross income to qualify you, but the net income is what you need to use to make your budget and determine a comfortable payment that you can afford. Don’t stretch yourself thin with a larger mortgage payment and then struggle to make ends meet. Repairs are inevitable, life happens. Buy a home that you can enjoy, not regret.
As with any financial decision, it comes down to how much do I have and what will I have left if I move forward with this purchase. Making a financially responsible decision is hard sometimes, especially in our society today where we prefer immediate satisfaction over things that might take a little longer to achieve. In the long run, you will be better off financially to postpone a decision until you are confident that it is the right one.
Debts are liabilities or obligations that are owed as a result of a contract with a lender.
Typical debts include:
- Car loans
- Credit cards
- Student loans
- Personal/Signature loans
Eliminate as much debt as possible prior to looking at buying a house. Payoff but do not close credit cards – available credit in relation to credit limits is a positive credit factor.
Student loans have quickly become the second biggest amount of consumer debt owed surpassing auto debt. Income-based repayment programs have helped but are prepared to provide documentation showing these arrangements that may not be reflected on credit.
- Personal Debt Inventory Handout
- Take the time to do a complete assessment of your current debts.
- Identify debts that you can eliminate prior to buying a house
There are several different ways to help reduce or eliminate debt. A debt snowball is where you target your smallest debt balance and focus on paying that off first. Then add the paid off payment amount to your next largest debt and keep paying off debts and using this method until all of your debts are paid off. Consolidating your debts into one loan at a lower interest rate and payment is another option. Credit card balance transfers are another way to move debt to a card with more favorable terms and save interest.
Expenses are items other than debts that you spend money on.
Expense examples include:
- Utilities: electricity, cell phone, internet, cable
- Groceries: food, household supplies
- Transportation: fuel, insurance, maintenance
- Living: clothing, pet costs, doctor appts, hair cut, nails
- Entertainment: eating out, concerts, vacations, hobbies
- Children: daycare, school, sports, medical
Expenses can be a huge drain on a budget. Some expenses you really can’t do much about. You must eat and drive your car to work every day and living without electricity or even a cell phone these days isn’t an option. But some expenses are controllable. Some ways to cut expenses might be to take your lunch instead of eating out every day. The cable is great but is it worth the extra $150 per month?
Finding ways to cut expenses and free up extra money to either pay down debt or put back into savings can be a challenge but is well worth the effort.
Saving money for the purchase of a house is a necessity. In addition to the down payment and closing costs needed to purchase a home, there will be additional costs associated with moving into a new home such as the moving expenses, deposits for utilities, new furniture, and repairs.
Examples of how to save money:
- Pay yourself first – designate a percentage or fixed amount to put back every paycheck
- Save the change – many people put their spare change in a change jar and designate that for spending later on things such as vacations, entertainment, eating out, etc.
- Take your lunch instead of eating out every day
- Make a budget and track your spending – without knowing exactly where your money goes it is impossible to make a plan to save more money
- Automatic Savings Program – round up each purchase made with your debit card to the next dollar or a designated amount above the purchase amount.
Saving money can be a challenge, but there are a lot of things you can do to be more successful. Here is a link to Dave Ramsey’s website that lists 20 simple tips to save money.
Knowing your credit score, the factors that determine that score, and how to manage your credit score is important in the home buying process as well as in many other areas of your life. Your credit score is a calculation determined by a Credit Reporting Agency (CRA) made up of many different factors. This score represents how likely you are to repay your loan.
Factors that determine your credit score:
- Payment history – how you pay back your creditors – this represents 35% of your overall score.
- Amounts owed – how much debt you have – owing too many creditors or using too much of your available revolving credit is a negative factor. This represents 30% of your overall credit score.
- Length of credit history – how long you have had credit established – this represents 15% of your overall score.
- New credit – are you taking out a lot of new debt – this represents 10% of your overall score.
- Credit mix – do you have a good mix of types of credit – this represents 10% of your overall score.
Most mortgage lenders will pull your credit score from the three major CRAs – Experian, Equifax, and TransUnion. They will use an average of your scores or the middle score to qualify you for your mortgage loan.
How Do You Manage Your Credit Score?
How do you continue to maintain good credit? Your credit report acts as your financial references when you apply for any new credit. The only way to maintain a good credit history is to use credit wisely. Following are 10 tried and true tips for building credit:
- Create a spending plan and live within it. Credit should not be used to live beyond your means.
- Provide complete, accurate, and consistent identification on your credit applications. This information helps set up your credit history correctly from the beginning, ensures that your new accounts will be matched to the correct report, and minimizes the chance that your credit file will be incomplete.
- Pay your bills on time, all of the time. Late payments, called delinquencies, negatively affect your ability to get credit since they indicate a stronger likelihood that you will make late payments again or will be unable to pay your debts in the future.
- Have some credit, but not too much. Having no credit history is almost as bad as having a negative credit history, and you only need a few accounts reported to the credit reporting companies to demonstrate credit management.
- Have a mixture of credit types. It is good to have a history of repaying an installment loan, but a revolving account demonstrates more clearly that you can responsibly manage credit.
- Keep credit card balances low. Keeping your balances low compared with credit limits shows that you aren’t tempted to charge more than you can pay. By charging a small amount on at least one card and paying the balance on time, you will show that you can handle larger amounts of available credit.
- Use caution when closing accounts. Closing an account isn’t always a good thing. It can result in an increase to your balance-to-limit ratio, making you appear to be an increased credit risk.
- Be aware of your debt-to-income ratio. Mortgage lenders consider your monthly payments compared with your monthly income.
- Demonstrate stability. Some creditors consider your length of employment, length of residence, whether you own or rent, and if you have any savings in making credit decisions.
- Contact your lenders if you fall behind on your payments. Many lenders will work with you to set up a different payment schedule or interest rate
How Much House Can You Afford?
Now that we know the important numbers for our income, debts, expenses, and savings, this will help us determine how much of a home we might be able to purchase. A general rule of thumb is 2.5 times your annual income. For example, if you make $50,000 per year, then you should be looking for homes in the $125,000 range. This will get you in the ballpark, but your specific numbers will determine exactly what you can afford.
Let’s look at some variables that affect this question.
The more I have in debt payments, the less available I have for my mortgage payment.
$1000 in debts
$800 proposed mortgage
$1800 total debts with mortgage
If I make $4000 per month, my debt to income ratio is 45%
A debt to income ratio over 42% is not allowed on most mortgage loans – this is a federal regulation.
The amount of down payment that you have determines your loan amount and therefore your mortgage payment. If you have less than 20% down payment, you will have PMI or private mortgage insurance included in your monthly payment. PMI is insurance that protects the lender in the event of default. Conventional mortgages require a 5% down payment. FHA and VA mortgages have lower down payment requirements but have other restrictions and guidelines that must be met.
Total Housing Expense
In addition to the mortgage payment, lenders must determine your total housing expense to make sure you have the ability to repay your loan.
Items included in your total housing expense are:
- Mortgage Payment
- Property Taxes
- Homeowners Insurance
- Homeowners Association Dues
- Private Mortgage Insurance or PMI
$120,000 Purchase Price
5% down payment = $6000
Mortgage Amount = $114,000
Mortgage payment (principal and interest only) = $511.91
Property Taxes @ $900 per year = $75/month
Homeowners Insurance @ $1200 per year = $100/month
Homeowners Association Dues @ $50/mo
PMI @ $50/mo
Total Housing Expense = $786.91
The best way to determine exactly how much you can afford is to get preapproved with a mortgage lender. Sitting down with a mortgage professional and reviewing all of your numbers will help you know exactly what you can afford. Most realtors will ask if you have been preapproved when starting to look for homes because they want to know that you have done your homework and are serious about buying a home.
Once you meet with a mortgage lender and get preapproved, they can provide you with a preapproval letter that you can give the realtor.
There are lots of different terms associated with a mortgage loan. We have created a glossary with some of the most common ones for you here.
Knowing exactly how much home you can afford and getting all of your questions answered upfront will help your home buying experience be much more enjoyable. You can let your realtor know that you have your mortgage loan ready to go once they help you find your dream home. Negotiating with a seller from a position of confidence that you are preapproved can save you money. The seller may be willing to accept a lower offer or help with more closing costs if they know you have a pre-approved loan offer pending the identification of the property.
Pre-Approval- What information will you need?
The pre-approval process starts by meeting with a mortgage professional to discuss your situation and get some basic information about you. The mortgage professional will ask you questions about your current address and work information. A two-year history is required for each of these. Information about assets and liabilities will be discussed and a credit report will be pulled and reviewed.
Income documentation will be reviewed to determine the verified amount that can be used for the loan approval. All income used on the application must be verifiable according to the lender’s policies. For wage earners, you will need your two most recent paystubs and your W2 form from last year. For self-employed borrowers, you will need tax returns with all schedules for the most recent two years.
Contract laborers that receive 1099 are considered self-employed and must have a two-year history and have filed taxes on that income to use it for loan qualification. This includes side jobs such as Uber, Lyft, or Door Dash.
Fixed Income such as Social Security and VA income will require the most recent Award letter and proof of current receipt usually with a bank statement showing the deposited amount.
Retirement, Annuity, and Pension income will require documentation of the award from the organization and proof of current receipt.
Other forms of income may be used depending on the stability of the income source and the continued probability of receiving it. Documentation of the income and proof of current receipt will be required.
Types of Mortgage Loans
Mortgage loans basically fall into two categories.
Within those two main types of mortgage loans, there can be different loan characteristics such as fixed-rate loans, adjustable-rate loans, balloon loans, jumbo loans, 30-year loans, 15-year loans, etc.
The U.S government isn’t a mortgage lender, but they do guarantee certain types of mortgage loans to help more people obtain a mortgage.
1.FHA Loans – these are backed by the Federal Housing Administration and have lower down payment requirements, typically 3.5%. Items on the credit report are taken into consideration over the actual credit score to allow borrowers with lower credit scores more options.
2.VA Loans – these are backed by the Veterans Administration and provide mortgage loan options to members of the U.S. military (active duty and veterans) and their families.
3.USDA Loans – backed by the U.S. Department of Agriculture, they provide options to low-to-moderate income borrowers in rural areas.
Any loan that is not guaranteed by the U.S. government is a conventional loan. Typical down payments for conventional loans are 5% but anything less than 20% down payment will require Private Mortgage Insurance (PMI). Minimum credit scores are required to obtain these loans (640 in most cases).
Mortgage Loan Terms
Mortgage loan terms are the characteristics that make up the actual loan, such as a 15-year fixed-rate loan. This means the loan is payable over 15 years and the interest rate will not change for the 15 years you are paying it back. 30-year mortgages are the most popular length of mortgage loans because of the lower monthly payments. Fixed-rate loans are the most common type of mortgage loans because there is less risk knowing the interest rate and payment amount each month will not change.
30Y vs 15Y Mortgage
$125,000 mortgage loan
30 Year Mortgage 15 Year Mortgage
Interest Rate 3.50% 3.00%
Payment $561.31 $863.23
# of payments 360 180
Total of Payments $202,071.60 $155,381.40
Interest Paid $77,071.60 $30,381.40
IF you can afford the higher payment, a 15-year mortgage is the best option because you pay down the loan faster and save a lot of money in interest.
Working with a Realtor
- What do Realtor’s Do
- Property Search
- Contracts to Closing
What do Relator’s Do?
A realtor is a person who acts as an agent for the sale or purchase of the real property.
They meet with clients to discuss their real estate needs and performs duties related to the sale or purchase of the property.
Some of these duties might include:
- Interviewing prospective clients
- Listing and showing properties to potential buyers
- Providing market analysis to determine the appropriate price range of properties
- Prepare contracts and assist with negotiating terms of contracts between buyers and sellers
- Research properties for their buyers to identify ones that meet their requirements and price range.
- Market properties for sale through various sources such as the MLS, online advertising, magazines, newspapers, etc.
- Provide guidance and information to make the process easier for buyers and sellers
Types of Real Estate Agents
Listing Agent – A listing agent represents the homeowner in the sale of their home. They are working on behalf of the seller and their goal is to obtain the best possible terms for the sale of a home.
Buyers Agent – A buyer’s agent represents the prospective buyer’s interest in a real estate transaction. Their goal is to help the buyer locate and purchase property that meets their needs and is within their budget.
When you meet with a realtor to start identifying potential properties, they will want to know some information to help them find the perfect property for you. Here are some things they will want to know.
- Price Range
- Type of Property
- Property Characteristics
You should be preapproved by a lender and know exactly how much you can afford. Most buyers will have a price range that will vary depending on certain attributes of the property. For example, you may pay more for a house in a certain neighborhood or school district, or if the house has a bigger lot.
The location of a property plays a key role in the overall value of the property. Properties located in areas that are deemed more desirable will simply cost more. If you have children, the local school district will play a role in the value of properties. Distance to work, shopping, health care, and entertainment will all play a role in the value as well.
Types of Properties
There are lots of different types of properties that you could live in. Here are a few to consider.
1.Single Family Residence – a stand-alone residence that is intended for one family.
2.Duplex – a house plan with two living units attached to each other.
3.Condominium – a large property complex that is divided into individual units, like an apartment, but the units are owned by individuals.
4.Townhome – a single-family home that shares one or more walls with other independently-owned units.
5.Manufactured Homes – often referred to as single-wide or double-wide mobile homes, they are factory-built homes that are shipped to their final location.
Here are some property characteristics that you may want to consider when deciding on what you really want in a property.
1.Frame or Brick – references the exterior construction of the property.
2.Urban, Suburban, or Rural – describes the area in which the property is located.
3.Square Footage – how big is the living space of the property?
4.Living space – # of bedrooms, bathrooms, garage size, etc.
5.One Story or Two Story
6.Heating and Cooling systems
7.Gas or Electric – or a combination of both
Contracts to Closing
Once you have identified a property, your realtor will help you make an “offer” on the property. This is the part where they prepare a written document that outlines the terms that you as the buyer are willing to agree to in order to purchase the property. Some of the key terms of the offer will include:
1.Purchase Price – what you are willing to pay for the property
2.Closing Date – what is the date you wish to finalize the transaction
3.Earnest money – money you pay in “good faith” if the terms are accepted.
4.Stipulations – any circumstance that you request as part of the contract such as home inspections, the closing cost paid by the seller, etc.
5.Time for Acceptance – how long the seller has to decide to accept or decline your offer.
Your realtor will have information on recent sales of similar homes in the area that will help you determine a fair price to offer for the property. If the property has everything that you are wanting, a higher starting price may make sure you don’t lose the property to another buyer. Homes that have been listed for sale longer may have a better chance of accepting a lower price than newly listed homes.
The seller is obligated to pay certain closing costs associated with the sale of the property, such as getting the title to the property updated and the prorated part of the property taxes they owe for the time they owned the property for the year.
Other closing costs that are typically paid by the buyer can be negotiated with the seller in the purchase agreement as well. The seller may not accept the offer paying your closing costs, but they may submit a counteroffer accepting to pay some of them or will agree to pay all of them at a higher purchase price.
Earnest money is a deposit made by the buyers when submitting their purchase agreement to the seller. If the purchase agreement is accepted by the seller, this money is held is escrow by the closing company as a commitment that the buyer will fulfill their agreement to purchase the property if all conditions of the agreement are met.
If the buyer backs out of the purchase agreement, the earnest money is forfeited to the seller.
Home Inspection – a home inspection will cover the condition of the home’s major systems, such as the heat and air system, plumbing system, electrical system, foundation, roof, windows, and doors.
Pest Inspection – a pest inspection examines the property for signs of a pest infestation. Signs of damage due to termites, mice, and other insects and rodents will be checked to make sure there are no problems that need to be addressed.
Well, and Septic inspection – if purchasing a property that doesn’t have public water and sewer service, you will want a well and septic inspection. This will determine if there are any issues with these major areas of the home.
Once you have an accepted purchase agreement, the preapproval that you obtained from your lender will be updated with the property information and an appraisal will be ordered. The appraisal is a determination of the fair market value of the property based on property characteristics, condition, and comparison of the property to recent home sales in the immediate area. As part of the loan process, the appraisal is ordered by the lender through a third-party appraisal management company.
After your inspections and appraisal, and when your loan is approved, you will be ready to close on your home and finalize the purchase of your property. The title company that helped the seller update their abstract (title or deed to the property) will help finalize the transaction.
The lender will send their loan documents to the title company and they will prepare the final closing disclosure that lists the terms of transaction from the purchase price, earnest money, all closing costs and who is responsible to pay them, and the final amount needed from the buyer to finish the transaction.
The title company will coordinate a day and time for the buyers and sellers to meet and sign the loan documents as well as the legal documents that transfer the ownership from the sellers to the buyers. The title company will file these legal documents with the county agencies and submit payments to the various agencies and companies that were involved in the transaction. You will be provided copies of all documents associated with the transaction for your records.
CONGRATULATIONS – YOU ARE NOW A HOMEOWNER!!!
- Maintenance and Upkeep
- Major Repairs
- Property Taxes
- Homeowners Insurance
Maintenance and Upkeep
A home is most likely the biggest investment you will make in your life. Taking the necessary steps to maintain and keep your home in good shape is essential. From minor updates such as paint to large repairs such as replacing the heat and air unit or the roof, you will need to plan for these inevitable repairs. As part of your monthly budget, designate an amount for home maintenance and repairs. Having money set aside for repairs will prevent panic and reduce stress when something comes up. Routine maintenance can prevent costly repairs in the future and most of these simple tasks can be done with basic tools and skills.
1.Check your HVAC filters monthly – clean or replace them as needed
2.Look for leaks – toilets, sinks, faucets, windows, doors, roof. Keep an eye out for any of these and address them immediately.
3.Dryer vent – clean regularly to prevent lent buildup and fire risk.
4.Smoke and carbon monoxide detectors – test regularly and change batteries when you change clocks for daylight savings time.
5.Trim trees and bushes away from the house and roof to prevent unnecessary damage during a storm.
As a homeowner, eventually you will have to deal with a major repair…that is just part of homeownership. Roof replacement is one of those major repairs you will encounter. Having a good homeowners insurance policy and understanding what is covered and what your responsibility (deductible) is will help you save for it.
Heat and Air Unit – depending on the size of your home and the type of system you have, replacing this can be a big expense. Most HVAC units will last 10-20 years, depending on factors such as frequency of use, cleanliness, and maintenance of the system’s parts. Having a service plan to check your system in the spring and fall will help prolong the life expectancy of your unit.
Water Damage – whether it is from a roof leak or a major plumbing issue, water damage can cause significant repair expenses. Carpet replacement, mold remediation, drywall repair, and paint all add to the costs.
Foundation Repairs – all homes settle, especially here in Oklahoma with our clay soils that expand and contract with the change in seasons. Major cracks in sidewalks and walls could indicate a more serious foundation problem.
Equity, when related to your home, is the value of ownership defined by taking what your home is valued at and subtracting what you owe on the home. If your home is valued at $100,000 and you have a mortgage loan with a balance owed of $80,000, then you have $20,000 in equity. If you were to sell your home, your profit would be the $20,000, less any fees associated with selling the home. The equity that you have in your home can be used for major repairs or renovations, or for other reasons as well.
Home equity loans are loans that use the equity in your home and a second mortgage is filed against your property. Home equity lines of credit are like home equity loans with the difference being that it has an open line of credit that can be used for a set timeframe. A $25,000 home equity line of credit with a 6-year draw period means you can access the available funds on your line of credit for six years. Any balance still owed after 6 years goes into a repayment period.
Property tax is a tax paid on property owned by an individual to a local government agency. Property taxes are paid to the local county assessor and those funds are then distributed to pay for maintenance of the local roads, schools, etc. The amount of property taxes paid depends on the value of the property and the local tax rate.
Property taxes can be paid to your lender as part of your monthly payment and held in an escrow account to be paid to the assessor when they are due in December.
Homeowners insurance is property insurance that covers losses and damage to an individual’s residence, along with their furnishings and personal property in the home. It also provides liability insurance in the event someone has an accident on your property and sues you. Mortgage lenders require you to have adequate coverage to ensure their interest in the property. They want to know that if something happens to your property, the insurance company will either pay to fix the damage or payoff the mortgage loan against the property.
Most homeowner’s insurance policies cover against perils such as fire, lightning, hail, wind, vandalism, and other named perils in the policy. Flood damage and destruction from earthquakes are generally not covered in a standard homeowner’s policy. There are special flood insurance and earthquake policies that can be purchased separately. If your home is located in a flood zone, which is determined by the Federal Emergency Management Agency (FEMA), your lender will require you to have flood insurance.
The cost of homeowner’s insurance, also known as the premium, is determined by many factors. The age and size of the home, age of the roof, security features (alarm and fire systems), proximity to public services, deductible, and other insurance discounts offered all contribute to the final premium. Bundling insurance coverages by having your home and auto policies with the same company can lower your overall premiums quite a bit. Like property taxes, the homeowner insurance premium can be included with your monthly mortgage payment and held in escrow until the payment is due.
The deductible, which is the amount that you pay toward a claim before the insurance company pays its part, plays a key role in determining the overall premium of your homeowner’s insurance policy. The lower the deductible, the higher the premium, and vice versa. Deductibles can be a set dollar amount, such as $1000, or they can be a percentage of the coverage. For example, if your deductible is 1% of your coverage amount of $150,000, your deductible would be $1500. Some policies have a split coverage where you pay a set dollar deductible for most perils, but a percentage deductible for others.
Working with a good insurance agent and having a good grasp of your budget to know exactly how much money you have available for your deductible is important to make sure you select the best coverage options for you.
Ask for Help
We want to be a resource for you when you’re ready to navigate your first Homebuying experience. Reach out to our knowledgeable team with any questions you might have about the process and we’d be happy to help. To start your application online, click here. Or call us at 405-230-1328 and ask to speak to someone in our Mortgage Department.
Best of luck on your first Homebuying process!