Planning to Buy Your First Home
Someone asked me the other day when people should start planning for buying their first home. I replied that 8th grade would not be too early for a class in home ownership – I was only sort of joking.
When you go to buy your first home, you’ll find you’re competing against folks who have been planning and preparing for years. Imagine trying to learn to play the piano for a year before entering an international competition against young adults who have been studying for 20 years. Your chances of success are not high. Like soccer, gymnastics, music, science or even dancing, today home buying is a competitive sport that requires at least several years of preparation, whether we like it or not.
There is an old saying that real estate is a game of musical chairs, but you have to buy your first chair to get in the game. Parents needs to teach their children about the fundamentals of buying and owning real estate and impart on their children the value that real estate is still the best long-term investment, especially since you have to have a place to live anyway. (Bonus for parents – your children will move out sooner.)
So what are the fundamentals?
Planning means building the three legs of the “qualifying” stool – income, assets and credit.
We’ll start with credit:
You must have at least two trade lines (Credit cards or loans of some sort) with a good payment history over two years to establish credit. Get your first credit card when you first get to college. The limit doesn’t have to be high – in fact it shouldn’t be. But use it and pay it off every month. Ask your creditor to raise your credit limit after every year of good payments. Get a second credit card sometime during college and do the same. Never let you unpaid balance after making your payment be higher than 15% of your credit limit, and plan to have your balances at zero by the time you want to buy a home.
Get a car loan as soon as you graduate from college. DON’T go get a BMW. Get an inexpensive, used, smaller car. You establish credit with a small car loan as well as you do with a large one. Car loans count more than credit cards, because you are demonstrating that you can handle installment payments. Plan to have it paid off by the time you are ready to shop for a home.
Monitor your credit to make sure that what is on it is accurate. You can get a free copy of your credit report once a year from www.AnnualCreditReport.com. This is the site that is operated by the three major credit bureaus, Experian, Tans Union, and Equifax. All other “free” credit report sites come with offers designed to sell you things and services you don’t need.
Speaking of which, log on to www.OptOutPreScreen.com and add your name to the opt-out list. This will halt all pre-screened offers of credit and credit services. You know that credit card offer you got in the mail? Shred it. You can find a much better deal on line. As a bonus, opting out of pre-screened offers raises your credit score.
Saving for the down payment (Building assets)
To build assets, be frugal during your college days. You’ll have plenty of time for fancy meals and vacations when you’ve established your career. For now, live on campus or share a low-rent apartment with buddies. Keep your expenses low.
People who want to buy their first home as soon as possible will often save half of their take-home pay from every pay check. How do you do that and still live? Put half in savings, and live off the rest. You may be living like a pauper – for now – but you will be thankful that you did when you find your first home.
Making enough income
Income is harder to have control over, but you must have enough income to support all your debts and housing costs when you buy your first home. So, plan to pay off your credit cards every month and your car loan before you go home shopping to give yourself as much room as possible.
It’s important that you know, however, that not all income is counted the same in underwriting. You may think you make one amount; the underwriter has rules they must apply depending on your situation that could establish your income (for underwriting purposes) as something totally different.
First, you’ll need to have at least one year working in your field; two or more if you are paid hourly, on commission or are self-employed. W2 salary is counted differently than hourly, commission or self-employment income, because W2 salary income is predictable – we can just use your current salary, even if you’ve been getting great raises. With the others we have to average your last two years. If you’ve been getting raises or increasing your income through hard work, you won’t get all of the benefit of your efforts.
Stock options can’t be counted at all, however, and bonuses have to be averaged and your employer has to state that they are likely to continue. So when negotiating your first job, take more in salary and less in incentive pay if buying a home is your goal.
Establishing your baseline
Finally, at the first moment when it makes sense for you to do so, meet with a professional mortgage advisor to get a baseline and to help you determine what you need to do to qualify for the loan you want. They will run your credit and evaluate your income and assets using underwriting guidelines, so you’ll know exactly what you need to work on to get ready to buy a home.
Don’t wait until a month before you want to go shopping. Meet with the mortgage professional a year or more beforehand. You might be confident that you can qualify now, but raising your credit score, having a down payment that exceeds certain thresholds, or have a debt-to-income ratio below certain thresholds can dramatically decrease the cost of your financing. It’s nice to know be armed with that knowledge, too.
That’s it – qualifying is all about having enough cash to buy the home, enough income to make the payments, and good credit so that the lender believes you’ll make the payments. Get these things right and you’ll be the first to join the game of musical chairs of all your friends!