8 Steps To Buying A Home Anywhere
The home-buying process can be overwhelming, especially for 1st-timers. Even experienced real estate investors have their work cut out for them since every real estate transaction can pose unique challenges. However, the majority of the process (and paperwork, ugh!) is largely the same every time. In this post, I will go over the broad strokes of the home-buying process to help you understand what it takes to become a homeowner. Let’s dive right in!
1. Get your finances in order
Before you start looking at homes, you need to know if you’re even ready to buy one. Ask yourself these questions and find the answers to them:
Are you employed? Have you had steady income for the past 2 years? Proof of employment and income will be necessary to qualify for a loan. That means you should have your past 2 years’ W-2s and the past 2-3 pay stubs from your current employer.
What’s your gross monthly income (amount you make before taxes)? What are your total monthly debt payments? Your lender will most likely require you to have a debt-to-income ratio of less than 50%. That is, your total monthly debt must be lower than 50% of your gross monthly income.
How much cash do you have on hand? How much do you have in liquid assets (e.g. cash, stocks)? You will need liquid assets to cover the down payment of the home, as well as 6-9 months in reserves. Your lender will want to make sure you have extra reserves after you purchase the home to make sure you can continue to make mortgage payments.
What’s your credit score? Based on a variety of things, including credit score, your lender will calculate how trustworthy of a borrower you are. The higher the credit score, the better terms they will give you (better interest rate, for example).
2. Calculate how much home you can truly afford
Just because you have the money to buy a home doesn’t mean you should. Buying a home is typically the largest purchase you’ll ever make. So you don’t want to rush into the process and end up making one of the worst financial decisions of your life. To avoid that, you need to know what “affording” a home really means.
As a rule of thumb, you can use the 28/36 rule, which states that your monthly mortgage payment should not exceed 28% of your gross monthly income. And your total monthly debt payments, like credit card bills, student debt, etc. (including your monthly mortgage), should not exceed 36% of your gross income.
For example, let’s say your gross monthly income is $5,000. Using the 28/36 rule, your monthly mortgage payment shouldn’t exceed more than $1,400. And if your monthly mortgage is $1,400, then you’re only left with $400 per month in other monthly debt payments.
When using this rule to calculate your monthly mortgage payment, I highly recommend including all your recurring home ownership costs, not just the mortgage payment. That means adding up your property taxes, HOA, and home insurance, too!
To state the obvious, the lower your monthly mortgage payment the better. And if you can get the percentage of your total monthly debt payments even lower than 36%, you’ll be even better off!
If you want to understand how much a monthly mortgage will be, just use a mortgage calculator like this one by NerdWallet.
3. Write down what aspects of a home are most important to you
I highly recommend writing down what aspects of a home are important to you and why. Order them by most important to least important. Why? Because there’s no such thing as a perfect home. Sorry to burst your bubble. Every home will have something you don’t like about it. That’s just reality. You have to be willing to compromise, or you’ll never become a homeowner. So if you have an ordered list of the most important aspects of a home written down, knowing when to compromise and when not to will be that much easier.
Here are some common things to think about:
Home prices
Schools
Location: proximity to schools, restaurants, businesses, intersections, freeways, etc.
Crime
Demographics
Which direction the front door is facing. This matters not only for feng shui, but also for knowing which room(s) will have sunlight during which parts of the day. You generally want the sun to rise on the side of the home where the bedrooms are (so you wake up to it) and your main common areas like the family room to get the most sunlight during the day. This generally means a north-facing lot.
Layout of the home (this is hard and costly to change later).
Size of the home
Size of the lot (front and backyard)
Swimming pool
HOA - community park, pool, etc.
Size of the garage (# of cars)
# of bedrooms and bathrooms
Master suite downstairs
1-story or 2-story
Age of the home
This is by no means an exhaustive list, but it’ll at least give you a jumpstart on yours.
4. Find the right lender for you
In steps #1 and #2, you got your finances in order and figured out how much home you can realistically afford. How much home you can afford will also be based on the terms of the loan and what kind of loan you prefer.
Two major contributors to your monthly mortgage payment will be the interest rate and the length of the loan. The longer the loan, the lower the monthly payment. But you will most likely wind up with a higher interest rate. For example, a 30-year fixed mortgage will have a higher interest rate than a 15-year fixed, but the 30-year fixed will have a lower monthly payment than the 15-year fixed. However, you will end up paying more interest over the lifetime of a 30-year loan than you would a 15-year. Choose wisely!
When looking for the best lender, know what you’re looking for:
Lowest interest rate
The loan term - the length of the loan. For example, do you want a 30-year fixed or 15-year fixed? Think about how long you think you’ll be living in this home. It’s hard to predict, but most people don’t live in a home for more than 7-8 years.
What’s the max monthly mortgage payment you can afford?
Don’t be afraid to negotiate here, and ask if a lender can beat another lender’s offer. If not, you can cross them off your list for now. But don’t burn your bridges! You never know if you’ll need them in the future.
Once you narrow down your list to the lender you want to work with, you need to ask for a pre-qualification letter. Better yet, get a fully-underwritten pre-qualification letter by your lender. This will require additional paperwork up front, but it’ll show the seller that you’re a serious buyer who is much more likely to close on time (or even early) because a lot of the paperwork is done in advance! This letter will be attached to the offer you make on homes to show sellers that you’re ready to buy, pre-approved by a lender and are, therefore, a serious buyer. If you don’t have one, oftentimes sellers will outright ignore your offers.
5. Identify a realtor to help you find & purchase a home
Make sure you shop around for a realtor that fits your personality. Oftentimes, realtors can be very pushy or too hands-off. Personally, I want someone who actually works for their commission and goes out of their way to find the home that meets as much of my criteria as possible. I don’t want someone who’s just trying to sell me a home as quickly as possible, nor do I want someone who simply sets me up with an annoying, daily email containing a list of homes on the market. That’s counterproductive and quite overwhelming.
Once you find the right realtor for you, that list you created in step #3 above will come in handy so they can help narrow down the search for you. And once you find a home that fits the majority of your criteria, you need to work with your realtor to figure out what offer you’re willing to make. Remember to stick to the budget you created in step #2!
6. Negotiate & get into contract
Oftentimes, a seller will make a counteroffer. Though usually the counter is about the offer price, they can also counter some of the other items in your contract like striking out your contingencies entirely or perhaps asking you to reduce the number of days some of your contingencies can last. Contingencies are put in place by you, the buyer. They are part of your offer and provide you a way out of the purchase contract. For example, you can have a financing contingency for 21 days. If you cannot secure financing in 21 days, you have the option of backing out of the deal entirely and get all your earnest money back, as well.
Common types of contingencies include:
Appraisal. Appraisals are usually ordered by your lender. And the lender will usually only lend up to some percentage (e.g. 80%) of the appraised value. This can really be a big deal to you, the buyer.
For example, let’s say you enter into a contract with a purchase price of $500K. You only have enough to cover a 20% ($100K) down payment. That means you are relying on an 80% loan ($400K). But if the appraisal report says the home is only valued at $450K, then your lender will only lend you up to $360K (80% of $450K). In this case, if you don’t have an appraisal contingency built into the contract, you’re on the hook to cover the difference in cash, which comes out to $140K ($500K purchase price - $360K lower loan amount than expected). And if you don’t have the cash to cover that, you may be forced to cancel your contract and lose your entire earnest money.
Financing. If you cannot secure financing in the financing contingency period, you can back out or renegotiate the deal with the seller.
Home sale. If the sale of another property doesn’t happen as expected (or in the time you expect it to), then you can back out of the purchase.
Inspection. If a 3rd party inspection report has any line items you don’t like, you can back out of the deal. This is sort of known as a “get out of jail free” card because you can literally back out of the deal for any tiny reason.
Title. If the home’s ownership record doesn’t come back “clear,” then it’s possible a past owner may contest ownership or a lender may ask you pay off a previous debt.
It’s up to you and your realtor to come to an agreement that you’re comfortable with so you can ultimately get your offer accepted by the seller. This negotiation period can sometimes last several days, but hopefully it’s no more than 24 hours. Once your offer is accepted, congratulations! You will now need to wire your earnest money to the title company and get started on all your paperwork (see next section) as soon as possible. But you’re past the hard part. You’re now officially in contract!
7. Paperwork and action items while in contract
The paperwork and process can vary quite drastically depending on the state you live in. But generally speaking, it looks like this:
Get the home inspected by a 3rd party home inspector. Once you receive the inspection report, you can decide if you want to back out of the purchase, continue as planned, or renegotiate with the seller to get credited for items in the report you want repaired or request the seller to repair some or all of the items. Beware: If you renegotiate at all, the seller can back out of the deal, too! Your realtor should guide you through this process and suggest what’s realistic to ask.
Officially kick off your loan approval process with your lender. Your lender will send out an appraiser to the home to assess what the property is actually worth. Depending on what the report comes back with, there may be nothing for you to do. In some cases, if the home is appraised under your purchase price, you’ll be on the hook to paying the difference out of pocket! And if you don’t have an appraisal contingency in your purchase contract, there’s no way for you to back out of the deal. Hopefully, you knew that before making an offer and have plenty of cash in the bank to pay the difference.
Do a final walkthrough of the home. If the seller agreed to any repair requests during the home inspection phase, this is your chance to double check everything was completed as obligated.
Closing date. The title company (the 3rd party handling the entire transaction) will tell you precise details of how and where to wire your funds. Additionally, you will have to sign and get all the paperwork notarized on your closing date. The notary public should take care of delivering or mailing the paperwork to the title company on your behalf. Be sure to ask the title company for a soft copy of all fully signed documents after you close. It’ll be important to keep that documentation around for tax purposes!
8. Become a homeowner
Congratulations, welcome to the homeowner club!
I highly recommend setting up autopay for your monthly mortgage payments so you never forget. If your property taxes and home insurance are part of your monthly mortgage payment (via an escrow account), then most of your housing bills are paid continuously. But if you don’t have an escrow account, you have to remember to pay your property tax bills, home insurance, HOA, utilities, etc. all manually. So be sure to set up monthly reminders to pay those bills on time!
Conclusion
Hopefully you’ve learned a thing or two about the home-buying process at this point. It’s true that the process can be tedious, but if you follow the steps I’ve outlined in this post, you’re going to be well-positioned to buy a home for yourself when you’re ready.
In one of my previous blog posts, I highlight some unique tips for 1st-time home buyers (veteran home buyers can benefit, too!). Give that article a read, especially if you’re struggling to get your offer accepted!
If you have any additional questions about the process or anything else related to buying a home, comment below or contact me directly! Happy house-hunting!
