Credit.org’s Guide to Homeownership

June is National Homeownership Month. We’re always focused on helping to create more successful homeowners, all year round, but June is a special month and we’re eager to help.

To guide you through the entire process of becoming a homeowner, this material is broken down into multiple parts. We’re best able to help people from the very beginning of the home buying process, but no matter where you are on the journey, we have something to offer.

Remember, you don’t have to go through it alone. We have HUD-certified counselors and homebuyer coaches standing by to help. Whether you’re looking into homeownership or finding a way to save your current home, contact us for confidential counseling and expert advice.

Read on for targeted advice for every step of the process:

  1. Preparing Financially for Homeownership
  2. Your Credit History
  3. Getting Pre-Qualified for a Mortgage
  4. Shopping for a Home
  5. Getting the Loan
  6. Insurance
  7. The Loan Closing
  8. Your New Home

1. Preparing financially for homeownership

Part of our nonprofit mission to help people attain financial freedom involves assisting people with the goal of homeownership. We’re here to help at every step of the homeownership journey, but the sooner a homebuyer comes to us for education and advice, the better.

Getting ready for homeownership means getting your finances in order. If you don’t currently have a budget you stick to every month, you must create one now. Come up with a spending plan you can live with that leaves you enough money for the various obligations that come with homeownership.

To get started on a budget, check out our Budget 101 course, available for free from our FIT Academy. If you’re having trouble making ends meet, our Budget 911 course might be useful to you as well. Finally, download our Power of Paycheck Planning materials to find budget forms and tracking sheets you can use to create your budget.

If you are currently renting, you probably pay rent, utilities, and renter’s insurance. Homeowners must pay more for their insurance, plus property taxes, repairs and maintenance costs, and perhaps HOA dues and fees. That means when you create a proposed budget, you should set aside more money for housing costs than just the mortgage payment. And because home repairs will be inevitable, establish a savings fund to pay for those expenses. Check with your tax advisor if you should take a standard deduction or consider the benefit of an itemized deduction on the mortgage interest you paid, as this may further reduce your taxable income.

We’ve only scratched the surface of the added costs of homeownership. Consider lawn care. Do you own a lawn mower? How much more expensive will your heating and AC bills be?

The best way to prepare financially to buy a home is to build up a sizable down payment. While it’s possible to purchase a home with very little up front and in some instances beneficial, there are also financial benefits to having a larger down payment.  If you aren’t able to save up a down payment, are you truly ready for the additional costs of homeownership?

Additionally, if your down payment is less than 20% of the purchase price, you will likely also have to pay for mortgage insurance premium (MIP) from FHA (Federal Housing Administration), or private mortgage insurance (PMI) from conventional lenders.  MIP or PMI, will make your monthly mortgage payment even larger. Check with your tax professional to see if your mortgage insurance premiums are tax deductible based on the income guidelines for eligibility.

Preparing for homeownership is a process that should take some time. You need to be saving up well in advance, and when you create a new budget, you should live with it for at least a few months so you can gauge its effectiveness and make adjustments over time. Only after you’re certain that you can really afford to become a homeowner should you proceed with shopping for a home.

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2. Your credit history

The most thorough credit check that most people will undergo is the check for a mortgage you will likely need for your home purchase. Your mortgage lender will check all three of the major credit reports for information, and use all of your FICO™ scores.  They will also want to review 2 years’ worth of tax returns for your income, as well as know all of your current debts and other financial obligations.

Well before you approach a lender about purchasing a home, you should check your own credit. If your score is in the lower range or you have excessive debt, give yourself a few months to address any issues that might be negatively affecting your credit score.

The number one thing a lender is looking for is evidence that you will repay your debts responsibly. Any history of late or missed debt payments on your credit report will be the biggest problems to address.

Make sure your debts are paid up and current, and if you have a few late payments, you should strive to make full, on-time payments for three to six months before seeking a new home loan. There’s no shortcut to correcting late payments on your credit record; time and consistent payments are the best way to improve your credit.

Another aspect of the credit report is public record information. If you’ve declared bankruptcy, been sued, had or have a tax lien, been evicted, etc. then this section could damage your ability to get approved for a mortgage. Make sure everything that appears in this section is paid off or removed from your report if any of the information is erroneous or outdated. It is also helpful to have a letter of explanation ready for any of these types of items.

Inquiries also affect your credit score, but they’re not a significant factor. What’s important though is to avoid applying for loans or other types of credit while you’re building up to a home purchase, as they may affect both your credit score and debt ratios.

If you don’t have much of a credit history, good or bad, your lender will need more information before deciding whether to lend to you. With some lenders you can use “alternate credit” information, like utility & phone bills, insurance, or other monthly obligations you have been successfully paying.

If you need additional advice on correcting your credit record or improving your credit score over time, check out our free “Consumer Guide to Good Credit.” It contains sample dispute letters and more comprehensive information about how to evaluate your credit record.

If you need more personalized help, you can also ask for a credit report review from a certified financial counselor who can answer questions and give you expert advice.

Also, check out our “Understanding Your Credit Report” course, freely available from our FIT Academy.

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3. Getting Pre-qualified for a mortgage

Before shopping for a home, talk to a lender and get pre-qualified for a mortgage loan. A pre-qualification is a quick process; the lender will take your rough financial information and give you an estimate of what kind and amount of loan you may be able to get.

Typically, the lender won’t do a hard pull on your credit reports. A soft pull credit inquiry won’t impact your credit scores, as they aren’t attached to a specific application for credit. The lender will conduct a soft pull, verify your income or other financial information. This process is just to give you a good idea of what you can reasonably afford. This will help guide you on the price range of house you can consider.  If the lender’s loan amount estimate is very low within the area that you want to buy a home in, you might reconsider home shopping and focus on improving your financial situation.

This is a good time in the home shopping process to compare different lenders to see which offers the best rates and options. Just remember, a pre-qualification offer isn’t guaranteed, and the numbers may change later.

If you find a house you are interested in, you can return to your lender for pre-approval. In this case, the lender will do a hard pull check on your credit, verify your financial information, and have you fill out a formal mortgage loan application. Once all documentation is received and verified, your loan information is submitted to an underwriter who will make a final decision on the loan approval.

Obtaining this pre-approval makes it faster and easier when you are ready to make an offer on a property. Only when you have found the home you want to buy will you get full approval on your loan. Part of the loan approval process involves evaluating the property to be purchased to ensure that it is worth what you are proposing to pay, so pre-approval is the best you can do while you’re still shopping for a home.

There are many documents you’ll need at the loan application stage:

  • W2 forms for the past 2 years
  • Your last 2 pay stubs
  • 2 years’ worth of tax returns
  • Bank statements going back at least 2 months
  • Copies of your ID, Social Security number, etc.
  • Any application fees due.

Your lender will pull all of your credit reports, but by now we hope you’ve already pulled your own credit, which you can do for free annually from www.annualcreditreport.com, or completed a credit report review with a certified financial counselor.

If you haven’t completed a “First-Time Homebuyer Education” course from a HUD-approved housing counseling agency, you should do so before you get any farther in the process. This course will answer many questions on the home buying process and assist you in qualifying for certain programs to help you get a mortgage loan.

By now you may also be working with a real estate agent, and they can help you navigate the borrowing process while you look for a home to buy.

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4. Shopping for a home

Many people start the home-buying process with this step. As we’ve shown you in this series, there are several things you need to do first. If you haven’t gotten your finances in order and created a budget that enables you to afford the costs of homeownership, you should stop looking at houses until you do so.

Additionally, you should have already checked your credit to ensure that everything is in order and there are no issues that will prevent you from getting a mortgage.

You should also get pre-qualified or pre-approved by your mortgage lender before you start looking at homes.

Only after all of these steps have been taken should you start shopping. Your pre-qualification will tell you roughly what you can afford. This is a good time to consider using a real estate agent if you haven’t contacted one yet.

Choose an agent carefully; interview several candidates and go with the one who seems to understand your needs, is readily available to you, and can help you understand the steps in the home buying process. It helps to have an agent who knows the local area and can answer questions about schools, shopping, crime rates, property values over time, and any other things you might need to be aware of before moving to a new area.

If you don’t use a real estate agent, you will probably have to hire an attorney to help you file the paperwork and complete your purchase agreement. In most cases, a qualified agent is the best choice, especially for the home buyer. A home seller might think they can save money by not using a real estate agent, but home buyers rarely do.

When shopping for a home, consider your long-term needs:

  • Will your family be growing in the future?
  • What schools serve your potential neighborhood?

Also, thinking long-term means paying close attention to the mechanical aspects of the home. How old is the roof? The air conditioner and furnace? If major systems and appliances will need to be replaced, you should factor that into your decision.

Strive to remain objective during this process. Some buyers form an emotional attachment to a property, and this will cause them to make mistakes, by either paying too much or ignoring problems that may surface later in the process.

Making an offer on a home may involve negotiating and counter-offers. When both parties have agreed on a price, it’s time to talk to your lender again.

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5. Getting the loan

After you’ve agreed with the seller on a price, you should go back to your lender to secure your funding. If you followed our steps, you have already been pre-qualified or pre-approved, so this isn’t the first time you’ve met with your lender.

Your loan might be a conventional loan, an FHA loan, or some other government-guaranteed product. Your lender can help you determine what the best loan for you will be, and what kinds of programs you qualify for.

The loan itself will break down into different factors:

  1. The Term: most first-time home loans are 30-year notes. You can also get shorter terms, which will involve higher monthly payments, but will save you a lot of money over the life of the loan.
  2. Interest rate: your rate can be fixed or adjustable; we recommend fixed rate loans, as adjustable rates could create huge problems for you if they go up.
  3. Down payments, closing costs, and application fees: You may need cash to pay for these costs at the time of the loan closing. Sometimes, the seller may pay closing costs to help the deal go through. First-time homebuyer programs usually involve lower down payments.

Before the loan can be finalized, you will have to have a home inspection conducted as well. Your real estate agent probably has several inspectors they can recommend to you. The inspector can help you find issues you may have overlooked, and these may affect your negotiation. For example, if the inspector determines that the home’s roof needs to be replaced, you can back out of the deal, request that the seller complete the repairs before you purchase the home, or ask for a price reduction that will allow you to afford to complete the repairs yourself.

Your lender will order an appraisal to make sure the property is worth what you are paying. This involves comparing your home to similar properties in the area. Your lender will not loan you more money than the home’s appraised value, so if you are paying more, you will have to make up the difference yourself.

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6. Insurance

One of the fees you’ll pay at the closing of your home loan is for title insurance. This insurance primarily protects the lender in case there are problems with liens or title disputes that affect the transfer of ownership.

Usually, the lender arranges for title insurance and the fees are paid by the home buyer, but you do have the right to choose your own title insurance company. In fact, it is illegal for mortgage lenders to require you to use a specific title insurance company when granting a loan.

Depending on where the home you are buying is located, you may also need to get specific insurance for natural disasters. If you are buying a home in flood prone areas, the lender will require you to also have flood insurance. Earthquake coverage is is still optional but essential for homes in high quake areas such as Southern California. You might also look into insurance for hurricanes, mudslides, or other natural disasters depending your area.

Homeowners insurance covers fire, theft, personal liability, storm damage, hail, etc. Your lender won’t approve your loan without this insurance, and the annual payment is typically included in your monthly mortgage payment, known as the escrow portion.

When choosing a home insurance agency, ask your real estate agent and lender for recommendations, and talk to your auto insurance agent. Many insurance companies offer discounts to customers who get their home and auto coverage from the same company. If the property is in an area that has had recent disasters, such as extensive fires, you will want to check ahead for the insurance costs before making a buying decision in that area.

Another optional product is a home warranty. In many cases, the seller will offer to cover the first years cost of the warranty to make the home sale more attractive.

First-time homebuyers may want to make sure they have a home warranty if they are concerned about doing home repairs themselves, including work on appliances or other systems, such as air conditioning or aged water heaters. A warranty might cover specific systems, like heating and cooling, appliances, water heater, etc. In all cases, compare the annual fee along with the service call fee charges and total coverage amounts as the warranty is typically inexpensive, but if repairs are needed, the costs could get high.

Most experts advise that home warranties are worth the cost, but like all insurance plans, one hopes they are never needed. If you’re handy with plumbing and/or electrical repairs, and your home appliances are relatively new, you may opt to not get a home warranty if your seller isn’t offering one.

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7. The loan closing

The loan closing, or settlement, is the final step in the home purchase process. The seller may not have to attend, but the buyer, a closing agent, and real estate agent will meet to finalize the process.

The closing agent may be someone who works for your lender, or a title company. Your lender may also hire an attorney to handle the closing.

You will have to pay any money that you owe at this point, including closing costs, taxes, etc. This is your last chance to resolve any outstanding issues or disputes. Once the loan is closed, everything is set in stone and the home is your responsibility.

Your lender will have provided Loan Estimate, also referred to as the “LE” which provides details on all of the fees and costs associated with the mortgage loans.  It also includes an estimate of amounts that you would need to have when you close on the loan. Just before the closing, at least 3 days prior, you will also receive a Closing Disclosure, referred to as the “CD”, which provides all of the final amounts needed to close the loan and purchase the property.

You’ll sign many documents at the closing, read them carefully and ask all of your questions before you sign them. When you’re done, you’ll be given a copy of all of these documents. Keep them somewhere safe, as you may need them if you sell the home in the future, or for tax purposes.

When the closing is complete, the seller will be given a check, and you will be given the keys to your new home.

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8. Your new home

Your first step as a homeowner is to have all of the utilities transferred to your name. Some services can be transferred without having to be shut off.

If your closing went as it should, the seller will have paid off all utilities as of the closing date, leaving you with a fresh start.

Your mortgage payment is now your most important financial obligation; you should make sure you make this payment in full and on time every month. If possible, set up automatic payments through your bank to be sure you don’t miss any mortgage payments.

Most likely, your taxes and insurance will be escrowed; that means they’ll be included in your monthly mortgage payment and you won’t have to worry about making separate payments.

If your taxes aren’t escrowed, you should set up a savings account to pay them when the time comes. In this case, add the total of your annual insurance and tax dues and divide by 12. This is the amount you need to set aside every month.

If you run into financial trouble and foresee having difficulty making your mortgage payments, seek help as soon as possible. The sooner you reach out for assistance, the more options you will have to correct your situation. Contact a HUD-approved housing counseling agency if you need help with your mortgage.

If credit card bills are causing your financial distress, credit counseling may be able to help you. Credit.org has both housing and credit counselors available to help you at no charge.

If you are over 62 and are a homeowner, you may be able to get a reverse mortgage. Check out www.homeownership.org’s reverse mortgage page for more information.

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First-time home buyer education is essential for anyone interested in homeownership, whether they are a first-time home buyer or are returning to homeownership after some time away. Personalized home buyer coaching is available as well; since buying a home is the largest purchase most of us will likely ever make, it makes sense to get all the help you can.

And if something goes wrong, reach out to us for help. We’re a HUD-Certified housing counseling agency, and we can help with situations like what to do if your home purchase fell through, or how to avoid predatory lending scams.

Homeownership is an essential way to build & store wealth and set yourself up for a stable retirement that keeps a roof over your head.

Our Pre-Purchase Coaching and Home Buyer Education will help you become a successful homeowner.Our Pre-Purchase Coaching and Home Buyer Education will help you become a successful homeowner.