Home Buying 101: Where Do I Begin?
Unlike a lot of young American couples today, Mercedez and Rafael Rassi have gotten the jump on home ownership. The two purchased a house this past spring at the tender ages of 24 and 26.
Growing up, Mercedez’s family in San Angelo, Texas, were always renters, so educating herself about home buying involved a steep learning curve. She’s a mother of a one-year-old girl and works in the school system’s migrant recruitment program. Much of the task fell to her since her husband works 12-hour days. She got the early part of her home-buying education in Dallas where she and her husband were living until last year. Conditions in Big D were youth. “The market was on fire,” she said.
The couple decided to move back to San Angelo, a city of 100,000 in west-central Texas. This part of the state has some of the most affordable housing in the country. The median home there is valued at about $120,000 — nearly half the national median.
The three most important financial considerations when buying a home: credit score, credit score, credit score.
The first item they tackled was to scrutinize their credit history. According to Budge Huskey, CEO of Coldwell Banker Real Estate, that’s the first step anyone thinking of buying a home should take. That can save some scrambling later on to make sure the mortgage price is right.
Maximizing a credit score can save tens of thousands in financing dollar costs over the course of a mortgage loan, but achieving a high score can prove tough for Millennials, many of whom have entered the labor market during a tepid economy and have had to cope with college loans.
“It’s still possible for them to carry student loan debt and still be homeowners, but it’s hard to buy with poor credit scores,” said Huskey.
The Rassi’s had a couple of financial challenges: They hadn’t much in savings and they had accumulated some debt. In addition, as a commission salesman, Raphael had very variable earnings and had just gotten a new job in San Angelo. Their mortgage approval would have to be based entirely on Mercedez’s credit profile. She had little experience in borrowing money.
“I didn’t even know what my credit score was and I didn’t know how much it affects how much a mortgage costs,” she said. “But I also knew I hadn’t been late on any payments.”
The couple saved up for a down payment by moving back home and living with her parents. Mercedez also built her score up by paying off some debt. After six months or so, they felt they could afford a starter home in the area.
It pays to examine your credit early because some consumers have no idea how much credit is available to them. Take Anna Bischoff, a single resident of the St. Louis area who works as a corporate attorney. At age 34, she still hadn’t graduated from the pipe-dream stage of home buying. She thought heavy student loan debt disqualified her from getting a substantial mortgage. But she found that her excellent record of on-time payments, plus a substantial income, made her eligible for a lot bigger mortgage than she thought.
“A new job more than doubled my salary and kept up payments on my student loans,” she said.
She was pre-approved for a $400,000 loan, more than ample for her needs. She started to seriously house hunt.
“I hated the idea of throwing money at a landlord every month,” said Bischoff.
She, like the Rassis, decided she was better off buying.
Fixed or adjustable?
Once sure they can afford to buy, house hunters must decide whether to choose a fixed-rate mortgage or an adjustable mortgage. Fixed rates enable borrowers to know exactly how much they will owe in monthly payments over the life of the loan while ARMs enable them to make smaller payments during the first few years, when they’re most likely to be under financial stress.
But interest rates are so low these days that ARMs don’t lower payments all that much, so for most buyers, a more important choice is how many years to take to pay off the loan. The longer the term, the lower the payments, but the higher the interest rate and the higher the final total payments.
On a $200,000 balance, for example, a 30-year loan at today’s low interest rate of about 3.7%, borrowers will pay about $921 a month, more than $331,400 over the full term of the loan. Borrowers opting for a 15-year mortgage will lower their interest rate to about 3% and their total pay-out to just $248,580, but their payments come to more than $1,381 a month for those 15 years.
Another choice is whether to pay upfront “points.” Doing so lowers the interest rate (and monthly payments), but that can be a sacrifice for first-time home buyers struggling to come up with the initial cash they need. Rule of thumb: If they can afford the initial cost and are planning to stay in the home for a number of years, they should consider paying points.
In the next post, we’ll discover what steps you can take once you have all of your financial ducks in a row.