Complete Guide to Buying a Home

Figure out how much house you can afford

Before you start the house hunt, you’ll need to narrow down your price range. Knowing what’s feasible for your budget and income will help you focus your search on homes you can afford.

To help you start crunching the numbers, it's first important to know your debt-to-income ratio (DTI). This is how much you spend on debt payments each month (things like student loans, credit cards, car loans and — hopefully soon — a mortgage) divided by your monthly pre-tax income. So if your debt payments total $2,000 a month and your gross income is $6,000 a month, your DTI would be 33 percent.

Not only does your DTI show you what percentage of your income goes toward debt, but it’s also a figure used by mortgage lenders to determine how well you may be able to manage your monthly financial obligations — the higher your DTI, the riskier you appear to a lender.

Most financial pros recommend a DTI of 36 percent or less to improve your chances of being approved for a home loan or to get better loan terms. Many also advise that you spend no more than 28 percent of your gross monthly income on housing expenses. For example, if you make $6,000 a month, your monthly mortgage payment should be no higher than $1,680.

Using these benchmarks can help give you a sense for how much you can afford when you’re buying a home.

Prioritize your must-haves

Once you’ve identified a target price range, it’s important to think carefully about what you really want in a home. Put simply, what are your must-haves, and what are your nice-to-haves (the features that you'd like in a home but don't truly need)? Consider elements such as the number of bedrooms and bathrooms, square footage, school district, proximity to transportation and community amenities.

Your real estate agent can help you identify your key homebuying criteria as well as what trade-offs you may be willing to make between your list of musts and wants.

Another factor to consider is how long you plan to stay in the home, which could impact what you’re looking for. For example, are you shopping for a starter home — i.e., a smaller home at a lower price point, where you plan to stay for about three to five years — or a forever home, where you can put down roots and live long term?

Assess the full costs of homeownership

A number of expenses will impact your budgeting for a new home. Let’s start with the four that will make up your monthly mortgage payment: mortgage principal, interest, taxes and insurance (also known as PITI).

In addition to your monthly mortgage, you may have to pay homeowners association (HOA) fees or condo fees for things like property maintenance, shared community features (e.g., concierge, gym, swimming pool) and landscaping.

Also, don’t forget about all the regular housing costs you’ll be responsible for, some of which you may not have had to pay as a renter. These can include utilities like gas, electric and water; trash and recycling pick-up; and internet and TV. These costs can vary widely depending on where you live, but here’s a rough idea of how much you can expect to spend:

Finally, don’t overlook budgeting for home maintenance costs. One popular guideline is to budget 1 percent of your home’s value every year for maintenance and repairs.

Choosing the right mortgage is crucial when buying a home, so you want to get familiar with how mortgages work. Get a firm handle in our guide to key mortgage terms and understand what your loan options are.

First, let’s take a look at two primary categories of mortgages and how they differ in terms of interest rates.

Prepping your finances

You’ll need to do a little prep work before applying for a mortgage. Start by checking your credit score, since mortgage lenders will look at your credit score (most likely your FICO score) to determine what your mortgage rate should be. Generally, borrowers with a credit score of 740 or higher qualify for the best mortgage rates.

You’re entitled to a free copy of your credit report from each of the three major credit bureaus (Equifax, Experian and TransUnion) at AnnualCreditReport.com. Your credit report doesn’t include your actual score — for that, you’ll have to pay a small fee — but it shows your credit history, including any blemishes like missed debt payments. There are also a number of free ways to get your score; in fact, many banks and credit card companies provide it to customers as a free service.

If your credit score isn’t quite where you’d like it to be, keep in mind that improving it could take several months or years, depending on your score. Be sure to make all your payments on time; in some cases, you may want to reach out to a nonprofit credit counselor to discuss how to raise your score. (You can find one at NFCC.org.)

Once your credit is in a good spot, you may be wondering how to apply for a mortgage. First, you should get a mortgage pre-approval — a written commitment stating that a lender will provide you with a loan of up to a certain amount as long as your loan passes underwriting. You’ll have to provide a lender with a lot of paperwork, including:

• Recent pay stubs that display your year-to-date income
• Two years of federal tax returns
• Two years of W-2 forms
• Proof of funds for the down payment, such as a bank statement
• Recent statements for all your assets, such as checking and savings accounts, as well as any investment accounts, such as CDs, IRAs and other stocks or bonds
• Residential history for the past two years, including landlord contact information

One factor that will greatly affect how much money you’ll end up borrowing is your down payment, or how much cash you’re putting down upfront. It’s usually referenced as a percentage of the home’s sale price. For instance, a 20 percent down payment on a $300,000 home is $60,000.

Ideally, you’ll have at least a 20 percent down payment; otherwise, your lender will likely require you to pay private mortgage insurance, which would be tacked onto your monthly mortgage payment. PMI typically costs between 0.55 percent and 2.25 percent of the original loan amount per year. So, for a $300,000 mortgage, PMI would cost between $1,650 and $6,750 annually.

Budget for closing costs

Closing costs are fees paid to the service providers who are involved with completing your home purchase, such as mortgage lenders, title companies, underwriters and real estate attorneys. Closing costs will typically run somewhere around 3 percent of a home’s purchase price. So, for a $300,000 home, you’d pay about $6,000 to $15,000 in closing costs.

Here are some typical fees that make up closing costs:

• Discount points, or mortgage points (Mortgage points are fees paid to your lender to lower your mortgage’s interest rate. Each point usually costs about 1 percent of the total loan amount.)
• Loan origination fee
• Underwriting fee
• Home appraisal fee
• Home inspection fee
• Title search fee
• Title insurance fee
• Prepaid property taxes
• Prepaid interest
• Recording fees for the deed and mortgage

Once you've narrowed down your price range, it’s time to start the house hunt. Is working with a realtor a good idea? While it may be tempting to go it alone, the answer is likely to be yes, especially if you’re a first-time homebuyer.

First, understand the differences in how real estate agents label themselves. Broadly, a real estate agent is anyone who is licensed to sell, buy and rent real estate. A real estate broker is someone who has taken more coursework that gets deeper into the business of real estate and has passed additional licensing requirements in their state. A Realtor is someone who specifically belongs to the National Association of Realtors and adheres to its standards. While any of these professionals can help you buy a home, choose someone with the level of experience and credentials you’re comfortable with.

In a typical real estate transaction, there’s a buyer’s and a seller’s agent involved. A buyer’s agent provides a range of services, such as helping you find potential homes, write and negotiate offers, and negotiate a home inspection and repairs. Usually working with a buyer’s agent won’t cost you a penny, since the home seller typically pays for the commission.

Your real estate agent can also be an invaluable resource when you tour homes, whether you do a virtual home tour or visit in person. They can help you narrow down and balance which features you really need versus what you want and can give you insight on local housing trends in your desired neighborhoods.

Attending an open house

When you attend an open house, you’ll want to make the most of your visit. Here are some things to watch for when you’re touring the property.

Making a bid

After you’ve found “the one” and you’re ready to make a bid, your real estate agent will help you put together an offer, including the offer price, the earnest money amount (the portion of your down payment you put down as a deposit) and what contingencies you want to include. These details will be finalized in the purchase agreement you and the seller will eventually sign, after which the home is considered “under contract.”

Contingencies are provisions that must be met in order for the sale to take place. Common contingencies include performing a home inspection, securing mortgage financing and requiring that the home appraise for the purchase price.

Waiving contingencies can make your offer more attractive, especially in a hot real estate market, although it means you’re taking on some risk. Many agents also recommend that buyers always keep a home inspection contingency. That’s because if a home inspector were to find problems like a leaky roof, faulty plumbing or cracks in the foundation, you could ask the seller to make the repairs in order for the sale to go through. If the seller says no, you’d be able to walk away without losing your earnest money.

Trying to win a bidding war? Don’t underestimate the power of appealing to the seller’s emotions. Write a personal letter to the homeowner expressing what you love about their home. If you know they raised kids in that home, explain how you’re looking to do the same. You can also use the letter to highlight common goals — for instance, if you know the seller wants to close on the home quickly, let them know you’re willing to be flexible on the closing date.

The closing, or settlement, is where you sit down and sign a pile of paperwork to make your purchase official — where you’re actually buying your home. There are typically several other people present as well, including the buyer’s and seller’s agents and attorneys, a lender’s rep, a title company rep and the closing agent. At the end, you receive the keys to your new home.

Here’s what you can expect to review and sign at closing.

Speaking of homeowners insurance, you need to make sure you have enough coverage in place before you buy your home. A typical homeowners insurance policy will cover theft or damage to your home. It can also protect you if someone sues you after getting hurt on your property.

There are also other types of supplemental homeowners insurance you may want to consider adding to your policy, like flood insurance, earthquake insurance, home-based business insurance, condo insurance and a rider for valuables. Umbrella insurance can also protect you if you’re brought into a lawsuit that falls beyond the coverage offered by your homeowners or auto insurance.

Finally, buying a home is a major life change, which makes it a good time to review your life insurance. It's important to make sure you have enough coverage so that, should something happen to you, your family can continue to stay in the home they know and love.