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7 Crucial Steps to Buying a Home in 2020
For the first several years of our marriage, Sarah and I dreamed of moving out of our little apartment and buying a home of our own. It’s the “American dream,” after all. When our first child arrived in our lives, the desire to move became more pressing, and when our second child was on the way, it was time to make our move.
If you’re thinking about homeownership, let’s walk through seven basic steps that will take you from apartment living to owning your own home.
1. Decide whether to rent or buy
Let’s start off with a few important facts.
- Homeownership isn’t the right choice for everyone. Not everyone can or should own a home, for a variety of reasons. They’re expensive and time-consuming. While American culture often lauds the “American dream” of homeownership, apartment and rental living is a better choice for many people who don’t want the tasks and expenses of owning a home. Do not be pressured into buying one just because you’re “supposed to” or because someone is encouraging you to do so.
- The expense of a home is far more than the monthly mortgage payment. You pay for maintenance, homeowners insurance, upkeep costs and more, usually adding up to around 1% of the value of the home in an average year (think $2,000 for a $200,000 home). You may also owe homeowner’s association fees, depending on where you buy. The utilities and other services are typically more in a home of your own than in an apartment, and there are often more of them (as the landlord covers some bills in many rental situations). It’s expensive, and if you’re looking at just the mortgage payment, you’re in for a shock.
- Homes aren’t a guaranteed investment; they don’t always rise in value and they certainly don’t always leap up in value. Yes, we’ve all heard stories about homes increasing in value by 10% a year, but that typically only occurs in extremely hot markets and it doesn’t usually last over a long period of time. Most of the time, home prices rise in value a little faster than inflation, but you’re also dumping in a lot of money on maintenance and property taxes and mortgage interest along the way.
Wait, isn’t this a guide to buying a home? Yes, of course, but the most fundamental step in the home-buying process is making sure that homeownership is right for you. If any of those points are giving you serious pause, spend some time thinking seriously about whether homeownership is right for you. Some benefits of renting include a lower overall cost (in most situations), a landlord that can handle property problems, and less time invested in maintenance. On the other hand, some benefits of homeownership include more living space (in most situations), more flexibility and freedom to do what you want with your living space, and the ability to build equity in the home.
Which side of that balance sheet is the right one for you? Remember, the path that’s right for you isn’t necessarily the path that’s right for other people. What your parents or siblings choose should have little bearing on what you choose to do for yourself.
One extremely important factor in this equation is the money factor. In general, homeownership is more expensive, but how much more expensive? I highly recommend spending some time with a good rent or buy calculator, which will help you calculate the various costs of both options and help you figure out if renting or buying is the best option for you from a purely financial perspective. In my opinion, if you’re on the fence about whether you could actually afford the month-to-month cost of owning a home, you should wait. The personal and financial challenges that stem from being in a home that you can’t afford are immense, and you’re better off not putting yourself in that situation if you’re less than sure about it.
If you conclude from all of this that renting is the right choice for you for now, then you’re done. If you think that homeownership might be a good idea in the future, start saving for a down payment now and get your finances in good shape by keeping your bills paid and your debts low.
2. Get pre-approved for a mortgage
The next step in the process, should you decide to buy a home and you don’t have enough to write a check for it outright, is to get pre-approved for a mortgage.
Mortgage pre-approval simply means that a bank or a credit union has indicated that they’re willing to lend you a certain amount of money in order to buy a home, as long as you do so within a certain timeframe. For example, a credit union might pre-approve you for a $200,000 mortgage for the next three months, so as long as you find a home to buy in that timeframe (and the credit union approves of it), you’ll be able to get that mortgage.
Before you decide on which financial institution to get pre-approved with, there are a couple of key things you should do.
First, make sure your credit is healthy. Go to AnnualCreditReport.com and obtain a copy of your credit report. Look through it carefully and make sure everything there is accurate. If you are behind on any bills or have a substantial amount of credit card debt, I would strongly encourage you to delay getting a mortgage and instead focus on getting and staying up to date on your bills and keeping your credit card debt under control for a while. If you are struggling with those things before getting a mortgage, it will be even harder after a mortgage, and your credit report’s blemishes will keep you from getting the best mortgage for you.
Second, shop around among a number of lending options. There are a lot of financial institutions in the mortgage business. Many lenders are direct lenders — banks and credit unions who offer mortgages directly to potential home buyers such as yourself. Some of the banks and credit unions in your community are likely direct lenders. Sometimes, banks or credit unions will quickly sell your mortgage to larger financial institutions under various arrangements; these are often called correspondent lenders. There are also mortgage brokers, who are people who will help you find a great mortgage rate, but they charge for the service.
My personal recommendation is to examine current mortgage rates so that you have a good idea of what’s competitive, then personally visit a few banks and credit unions in your area to see what they can offer you. If you have an unusual employment history or other unusual circumstances, I’d be sure to make room for at least one credit union, as credit unions often take the time to deeply evaluate the specific situation of borrowers in a process called manual underwriting.
What about a down payment? You do not need a down payment to buy a home. However, if you do not have one, most lenders will require you to take out private mortgage insurance (PMI). Your lender will help you to do this but be aware that the cost of PMI usually adds up to an extra 1% of your interest rate. So, if you have a loan approved at 3.75%, the PMI will raise that to something like 4.75%. You will have to keep PMI until you have paid off 20% of the value of the home.
The process of getting pre-approved for a home mortgage can seem intimidating, but most of it boils down to simply answering questions about yourself, your employment history and your income history. Each mortgage lender has its own process for getting pre-approved, but there a lot of things in common. If you have a good recent financial history and are fully honest, there’s nothing to worry about.
3. Start shopping for a house
Once you’re preapproved, now is the time to start looking for a great home that you can afford, one that fits well within your preapproval amount.
Although there are many tools for finding and viewing properties for sale in your local area and you can certainly buy a home without a real estate agent, I encourage first-time home buyers to get a real estate agent to help them with this purchase. In almost all situations, the fees that the real estate agent earns are paid by the seller. The commission for a home sale is usually around 6% of the home’s price and is split between your agent and the seller’s agent, and the commission is already included in the price of the home. Thus, you rarely have to pay anything out of pocket for a real estate agent as a buyer.
A real estate agent will help you find homes in your area that match what you’re looking for and your price range and help you to find something like what you’re looking for at a great price. They’ll help you avoid a lot of potential traps and tricks as well. Remember, they want to make a sale because they’ll get a commission, but they also want you to be very happy with it so you’ll give them good referrals. Reach out to friends, family, and coworkers who have recently bought homes in your area over the last several years and see how they felt about their realtor. If you hear good things, you’ve found the right person for the job.
You should absolutely use tools like Zillow to examine homes for sale in your area, but your agent will likely come up with homes you may have missed that are worth looking at. Make sure to visit a number of properties and stop in at a number of open houses to get a strong idea of what you like and what you might want to buy.
First-time homebuyers should not choose the most expensive home they can afford. Just because you’re pre-approved does not mean you should spend that much on your home. Seriously consider buying a lower-cost starter home at first, then moving to something larger once you’ve built some equity in your first home. The expenses of homeownership can be high, and having a mortgage that you’re struggling to make payments on, particularly during uncertain economic times, can make things very challenging.
4. Make an offer on the house
Once you’ve found the right home, you’ll want to make an offer on it. This is another instance where a real estate agent comes in handy for a first-time homebuyer. Realtors can do a comparative market analysis, which will help you figure out a reasonable price to offer on the home. This simply means that they’ll figure out whether the home is priced above what it should be based on other homes that have recently sold in the area and help you to hone in on a price that you should offer.
Your offer will come with contingencies. This means that your offer is dependent on a number of things. One is a successful home inspection. Another may be that the home’s value is independently appraised and is in line with the price. Another contingency is that your mortgage is fully approved (this usually depends on the home inspection and appraisal if you’ve been pre-approved). You may also have other contingencies, such as minor changes to the property that you want to see before you buy, but if these are too complicated, the buyer may reject your offer. The home inspection may turn up some issues as well, and those matters become contingencies.
You will also need to place a deposit. This is a small amount of money, usually 0.5% to 2% of the home’s value, that indicates that you are making a serious offer and that, if it’s accepted, the buyer will take the home off the market. You’ll lose some or all of the deposit if you back out of the agreement to buy the home for a reason other than the contingencies.
Your real estate agent will help you put these things together, as most of these matters are very standard. Your agent will then submit your offer to the seller’s agent and if they accept, you’re a step closer to buying.
5. Get an inspection
The next step is to get the property inspected by a reputable inspector. You’ll want to do this quickly, as you’ll want to get into the house and the buyer will want to sell the house, plus your pre-approval for the mortgage won’t last forever.
Your real estate agent will likely have a home inspector that they prefer. Do a quick check to make sure that the inspector is reputable (you may want to do this before submitting an offer) and, if so, it’s usually a good idea to go with that inspector.
The inspector will carefully inspect the home and identify any serious issues you may not have noticed during your own home visits. There are little issues with every home — if an inspector finds a problem or two, it’s not cause for panic. Rather, talk with your realtor about whether the inspector’s findings should be added as contingencies to the offer you made. That means that your offer to buy hinges upon the completion of those steps. If the buyer does not wish to do it, then the offer can be taken back and you’ll get your deposit back, but then you won’t be able to buy the house. Your real estate agent will have a good sense of what issues should be added to the offer as contingencies.
6. Get a final mortgage approval
At this point, assuming that the home passes inspection with no major problems, you’ll want to go back to your lender and get final mortgage approval. Your mortgage lender will then evaluate the property on its own and if it’s happy with the market value of the home, it’ll approve the property. At this point, if you’re pre-approved, the lender is mostly just making sure that you’re not buying a “lemon” property.
The lender will want proof of insurance at this point, which means that you should shop around for homeowners insurance. If this is your first time buying a home, you may want to choose carefully about what exactly you want in your first home insurance policy. Consider the risks of not properly insuring your home and personal property, as it could cost you thousands down the road. However, even if you spent hours or days choosing the best homeowners insurance and you end up not liking your policy, you can always switch your home insurance carrier later on.
Your mortgage lender will also typically want to see your financial records since your pre-approval to make sure that you haven’t been making risky financial moves and weren’t misrepresenting your financial state during the pre-approval process.
Provided that you were preapproved, you have an insurance policy lined up and everything is in order, this should be an easy step.
7. Close on your home
This is the final step, and it’s an intimidating one. Most of the time, you’ll meet with a representative of the seller (or the seller themselves), your agent and someone representing the lender (and sometimes a closing agent who ensures that all of the necessary documents are signed and fees are paid), and you’ll go through a number of documents to approve the purchase, legally transfer the title and pay the seller.
You’ll be asked to sign a number of documents pertaining to the mortgage you’re taking out, usually including a promissory note, truth in lending statement, a mortgage or deed of trust and a monthly payment letter.
There are a number of other documents to sign centered around transferring the title to you, a HUD-1 form that spells out all closing costs, and a few other documents that vary from state to state.
You’ll want to bring along a photo ID and any documents related to the sale, including the offer.
The big concern about this day is the closing costs. Many of the documents you’re signing will come with fees, and you’ll want to be prepared for them. Closing costs will typically add up to around 2% of the home’s cost and that money will be expected on the day you close. Your real estate agent will help you to figure out how much money you’ll need to cover the closing costs.
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