First-time homebuying can be both exciting and nerve-wracking. You must not only find the appropriate residence, but also the appropriate mortgage. With low inventory in many local markets and rising home prices across the nation, it can be difficult to find an affordable home.
You may feel pressured to find a home immediately, but before you visit houses and make offers, you must have your finances in order. This involves ensuring that your credit history and credit score, debt-to-income ratio, as well as overall financial picture are sufficient to persuade a lender of your creditworthiness.
Numerous first-time homebuyers typically make a number of errors during the mortgage and home-purchasing processes. Here are the most prevalent errors to avoid.
• Obvious credit issues, such as a history of late payments, debt collection actions, or substantial debt, may result in less-than-desirable interest rates and terms, or even a complete denial.
• Improve your credit score by paying your bills on time, paying more than the minimum monthly payment on your debts, and not exceeding your available credit limit.
• Sellers are more inclined to consider offers from pre-approved buyers.
• Apply for a mortgage with multiple lenders to gain a clearer understanding of what you can afford and to compare loan products, interest rates, closing costs, and lender fees.
1. Not Monitoring Your Credit
No one enjoys surprises, especially when purchasing a home. Mortgage lenders may offer you less-than-ideal interest rates and terms if you or your spouse have obvious credit issues, such as a history of late payments, debt collection actions, or substantial debt (or deny your application outright). Both situations are aggravating and can delay your ideal timeline.
Check your credit report annually for free at annualcreditreport.com from each of the three credit reporting agencies: TransUnion, Equifax, and Experian. This will allow you to address potential issues in advance. Examine your credit report for errors and dispute any inaccuracies in writing with the credit reporting agency and your creditors, including any supporting documentation. Consider utilizing a few of the best credit monitoring services for proactive assistance.
There is no quick way to remove current, accurate negative items, such as late payments and delinquent accounts. They will remain on your credit report for seven to ten years. However, you can improve your credit score by paying your bills on time, paying more than the minimum monthly payment on your debts, and not utilizing all of your available credit. Ultimately, be patient. A low credit score can take at least one year to improve.
Additionally, determine if your bank, credit union, or credit card issuer provides you with free access to your credit score. If your credit score is below 620, you may have difficulty obtaining a conventional mortgage. To qualify for an FHA loan with the maximum financing (3.5% down payment), a minimum credit score of 580 is required. If your credit score falls between 500 and 579, you are required to make a 10% down payment.
2. Looking for Homes Prior to Receiving Pre-Approval
When the ideal home is discovered, there is no time to waste. In numerous hot markets, you will face multiple bids and intense competition. It is unlikely that sellers will consider offers from buyers without a pre-approval letter from a lender. A pre-approval letter demonstrates to a seller that the lender has performed the necessary due diligence to ensure that you have the ability and motivation to repay the loan, based on your credit history and score, income and employment history, and other key factors.
In a competitive market, sellers will not take you seriously if you do not have a pre-approval letter, and you may lose out on a home you really want. This document details the maximum loan amount for which you are eligible, your interest rate and loan program, and your estimated down payment. In some instances (especially for higher-priced homes or in extremely competitive markets), lenders may require proof of down payment funds. The letter of pre-approval also includes an expiration date, which is typically within 90 days.
3. Not Comparison-Shopping for a Mortgage
Homebuyers can leave a lot of money on the table if they do not compare mortgage rates. Applying for a mortgage with multiple lenders gives you a better idea of what you can afford and allows you to compare loan products, interest rates, closing costs, and lender fees on an equal footing. More importantly, mortgage shopping improves your ability to negotiate with lenders for the best possible deal.
Pay close attention to fees and closing costs when comparing lenders, as they can add up at the closing table. While some of the price differences may not appear substantial on paper, they can result in substantial cost savings over the life of your loan. Keep in mind that some lenders may offer discount "points" as a way to buy down your initial interest rate. This raises your closing expenses. And other lenders who advertise low or no closing costs typically charge higher interest rates to compensate. Closing costs in the United States average $6,837, according to a 2021 survey by ClosingCorp, a real estate closing cost data firm.
In addition to checking with your current financial institution (bank or credit union), ask a mortgage broker to compare rates for you. Mortgage brokers are not lenders; they act as matchmakers between you and their network of lenders. They can save you time and money by comparing products from multiple lenders who meet your needs. Additionally, it is worthwhile to investigate direct lenders, either online or in person, to determine what they offer. A mortgage calculator is a useful tool for budgeting certain expenses.
By applying for a mortgage with multiple lenders, you will receive loan estimates that allow you to compare interest rates and closing costs side-by-side. Also, if you conduct the majority of your rate comparisons within 30 days, the multiple credit checks performed by lenders will be counted as one hard inquiry and are unlikely to negatively impact your credit score. There is no ideal number of lenders to approach, but having three to five loan quotes will provide a solid basis for comparison.
4. Buying a Home That Is More Expensive Than You Can Afford
A lender's statement that you can borrow up to $300,000 does not imply that you should. If you borrow up to your credit limit, your monthly payments may not be manageable. Most prospective homeowners can afford a loan amount equal to two to two and a half times their annual gross income.
Thus, if your annual income is $75,000, you may be able to afford a home priced between $150,000 and $187,500. The mortgage calculator on Investopedia can help you estimate monthly payments, which is a more accurate indicator of whether you can afford a home in a particular price range.
If you have to stretch your monthly budget to make mortgage payments, buying a more expensive home than you can reasonably afford can put you in financial trouble. In other words, you may experience "house poor" feelings and buyer's remorse.
In addition to these monthly mortgage payments, consider that homeownership incurs additional expenses. You must save for unavoidable maintenance costs, repairs, insurance, property taxes, and homeowner's association fees (if applicable), which you do not pay as a renter.
If you stretch your monthly budget to cover your mortgage, you may not be able to save for an emergency or make repairs to your home, and it will also reduce your cash flow for other financial goals.
Instead of focusing on the maximum loan amount for which you qualify, consider whether you can afford the monthly mortgage payment at that price. First-time homebuyers may need to be extra cautious and purchase a property that costs less than their maximum budget.
5. Not Using a Real Estate Professional
Attempting to find a home on your own is time-consuming and difficult. Professional, seasoned real estate agents can help you narrow down your options and identify potential problems (both with the physical property and in the negotiation process with sellers). A few states require a real estate attorney to manage the transaction, but attorneys will not help you find a home; they will assist you in drafting an offer, negotiating the purchase agreement, and acting as a closing agent.
A seller's agent may also offer to represent you if you attend showings without your own real estate agent. This can be risky because the agent's objective is to obtain the highest and best offer for the seller, not your best interests. Having a personal agent whose interests are more closely aligned with yours will assist you in making more informed decisions.
The cost of hiring an agent will not come directly out of your own pocket. Typically, as a buyer, you do not pay the buyer agent's commission. Typically, the seller pays the commission to the seller's agent, who then divides it with the buyer's agent.
6. Opening (or Closing) Lines of Credit
You can still be denied a mortgage despite having been pre-approved for one. Before giving you the final go-ahead, mortgage lenders perform a pre-approval credit check and a closing credit check. Maintain the status quo with your credit and finances in the interim. This means not opening new credit lines and not closing existing credit lines. This can reduce your credit score and increase your debt-to-income ratio, two of the primary reasons a lender will deny final approval.
Instead, refrain from opening new credit lines until after the closing on your home (like a car loan or a new credit card). And while it is advantageous to pay off a credit card account or loan before closing on a home, closing the account removes the credit history from your credit report. Credit reporting agencies use the length of credit as one of the primary factors in determining your credit score.
Leave the account active and open, but refrain from using it until after closing.
Some credit card companies may close your account for prolonged inactivity, which can also have a negative impact on your credit. Maintain account activity by making small monthly purchases that are paid in full and immediately.
7. Making Large Credit Purchases
Just as opening or closing credit lines can have a negative impact on your credit score, so can running up existing accounts. Again, maintain credit and financial stability until closing on your home. Use cash instead, or better yet, postpone the purchase of new furnishings or a television until after closing.
Also, you should determine how your budget will accommodate your new homeownership expenses. You may wish to wait a few months before adding additional monthly payments for large purchases.
8. Transferring Money
Another major no-no in the mortgage underwriting process is making large deposits or withdrawals from your bank accounts or other assets. If lenders observe sudden influxes or outflows of unsourced funds, it may appear that you obtained a loan, thereby affecting your debt-to-income ratio.
Lenders are unconcerned about transparent deposits, such as an employer bonus or a tax refund. However, if a friend wires you money or if you receive business income in your personal account, the lender will require proof that the deposit is not a disguised loan. Expect a lender to request a bill of sale, a canceled check, or a pay stub if the deposit is from the sale of an item.
You can use a relative or friend's gift toward your down payment. However, many loan products that require a gift letter and documentation to verify the origin of the deposit and that the donor is not expecting repayment.
9. Changing Jobs
While changing jobs can be advantageous for your career, it can complicate the mortgage approval process. A lender will want to ensure that you have a stable income and job, and can afford to repay your mortgage. If you have been pre-approved for a mortgage based on a certain income and job, any changes in the interim before closing could be a red flag and delay your closing. This continuous record of income and employment is interrupted when you switch jobs, especially if you accept a lower-paying position.
Also, if you switch to a position that pays at least 25% of your salary in commissions, lenders will want to see that you've earned this income for at least two years. When possible, lenders advise postponing job changes until after loan closing. If this is not possible, inform your lender immediately.
10. Avoiding the house inspection
Unless you have a lot of money to invest in a home and are willing to pay for unexpected repairs, forgoing a home inspection can be an expensive mistake. The purpose of home inspections is to identify major issues with a home and to protect the buyer.
If you do not have a home inspection, you will have no recourse if a major problem, such as cracked pipes or water damage, arises after closing. Therefore, you may be responsible for the total cost of addressing these issues. When making an offer on a home, you can include a home inspection contingency that allows you to back out of the deal without incurring any penalties if a major defect is discovered and the seller refuses to fix it before closing.
With this contingency in place, you can withdraw your offer and typically receive a full refund of your earnest money deposit. The home inspection fee is typically non-refundable and paid in advance by the buyer to the home inspector. It typically ranges between $300 and $500, depending on location and property size. It is a small price to pay when compared to the potential costs of replacing a furnace, water heater, roof, or other expensive items, which could total thousands of dollars.
If your lender requests it, you might consider additional inspections, such as a pest inspection, mold or radon inspection, or sewer scope. These and additional inspections can protect your investment and ensure your safety.
11. Failing to evaluate the Loan Estimate and Closing Disclosure
The law mandates that your lender provide you with the closing disclosure three business days before your closing date. This document details the exact closing costs, including your down payment, closing costs, loan details and terms, and other pertinent information. It is a five-page document; take the time to compare it to the initial loan estimate you received to ensure that your lender or other parties involved in the transaction are not charging you junk fees.
Also, if certain fees increase unexpectedly, ask your lender for an explanation. Ensure that your name and other identifying information are listed correctly so that there are no paperwork issues on the day of the closing. Notify your lender immediately if you discover errors or questionable or unexplained extra fees so that these issues can be resolved. In some instances, your closing may need to be delayed to ensure that the paperwork is updated and all issues are resolved.
The Bottom Line
You do not want to unwittingly jeopardize your mortgage and home purchase. Some of these errors may appear harmless, but they can derail your closing and cause enormous headaches.
Discuss with your lender the steps you must take from pre-approval to closing to ensure a smooth transaction. And try to keep all of your documents—bank statements, W-2s, deposit records, tax returns, pay stubs, etc.—organized and up-to-date so that you can provide documentation to your lender if necessary.
When the time comes to purchase your first home, being well-read and knowledgeable about the lending and real estate processes can help you avoid making some of these costly errors and save you money in the process. Having trained, experienced professionals by your side will further ensure that the transaction proceeds without a hitch. This can reduce some of the difficulty and stress along the way.
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