A comprehensive guide for first-time homebuyers
This article is part of Fortune‘s quarterly investment guide for Q3 2020.
Richard Stapleton got the keys to his first house a week before the country went into lockdown as the coronavirus spread across the U.S.
Having decided in December to leave his 650-square-foot apartment in Buford, Ga., Stapleton and his girlfriend were ready to move into a home of their own in Gainesville. After browsing over 20 properties, the couple closed on a house on March 16—and not a moment too soon.
“I hate to say it, but it kind of happened at a good time. I got to be able to move in and really get to know the house very quickly, because I really haven’t spent much time out of it, honestly,” Stapleton tells Fortune.
Even in the best of times, buying a home for the first time can be confusing and stressful. Stapleton recalls he was “very blind and kind of naive about the whole process,” and he credits his real estate agent with holding his hand “every step of the way.” Layer on the paralyzing stress of a complete economic shutdown and a global pandemic, and it’s no wonder first-time buyers are struggling to stay calm. Fortune consulted top real estate experts to put together a guide for what every first-time homebuyer needs to know in this market.
- Understand the 2020 market
- Know your stats
- Choose a broker or a bank
- Get preapproved
- Do the math
- Calculate a down payment
- Make an offer
- Get a home inspection
- Go through a home appraisal
- Close on your home
Understand the 2020 market
The consensus is clear: This is “absolutely a seller’s market, no matter what,” Mike Miedler, the president and CEO of realty behemoth Century 21, tells Fortune.
“There’s very little on the market at any price range, especially [for] first-time homebuyers,” says Paige Grove, a real estate agent based in the Atlanta area. That means what is available will likely have a lot of offers and competition, and sellers are often getting full-ask prices for their homes, say agents.
But while you should keep in mind you’ll likely have to fend off other buyers, you’ll also also be getting more bang for your buck: 30-year fixed mortgage rates are at historic lows. That puts “more purchase power in people’s pocket so that they can afford more home right now,” notes Miedler.
Know your stats
If you’re one for checklists, this should be at the very top. Taking stock of your overall spending—and making sure you actually know your credit score—is a key first step in getting approved for a mortgage.
“My advice is keep track of the month or two before you’re going to delve into this. Track all of your spending,” says Jeff Thomas, a senior loan officer at Atlantic Coast Mortgage in Virginia.
But according to agents like Grove, “People are very educated today on what they think their credit score is. They’ll tell us, ‘Oh, Credit Karma or CreditWise says this,’ but those are not [always] correct,” she says. “They’re usually off, sometimes by 25 or 30 points.”
A mortgage lender will pull your credit report when you go to get preapproved for a mortgage, and you can assess your options from there. In general, you’ll need a debt-to-income ratio below 43% to qualify for a mortgage. However, you should be aware some lenders like JPMorgan Chase have recently tightened standards amid the pandemic. You now need a 700 credit score to qualify for most loans through the bank. (Wells Fargo, meanwhile, requires a 680 score for government loans.)
If your credit score is not so hot, you shouldn’t throw in the towel necessarily. “Time can heal a wound,” says Eric Tyson, a personal finance expert who has penned books including Home Buying for Dummies and Mortgages for Dummies. “If you’re [checking your credit] many months in advance of wanting to make an actual purchase, there may be some things you can do.” But don’t wait until the last minute. In that case, there might not be enough time to fix outstanding debts or blemishes before you need to get approved for a mortgage.
If you’re looking for some blunt advice: “Don’t buy anything,” says Thomas. “Once you start the homebuying process, you need to put your credit on lockdown. You want your bills to stay the same or go down.”
Plus, something simple to avoid, say experts: all those rewards credit cards. The benefit is “reducing the credit card charging temptation, which is made worse by people getting rewards,” notes Tyson. He recommends having two cards, but he cautions that canceling a bunch of cards “could lower your credit score in the short term.”
Choose a broker or a bank
Should you opt for a mortgage broker or go to Citibank?
Experts say both options have pros and cons, but most of those who spoke with Fortune agreed mortgage brokers typically give first-time homebuyers a more personalized experience and can work more flexibly with different circumstances (for example, if your credit isn’t perfect).
“The difference between a bank and a mortgage banker is, [with] the bank, if you don’t fit that square, they’re not going to give you that mortgage,” says Atlantic Coast Mortgage’s Thomas.
Others, like Grove, note that brokers are “willing to think outside the box.” And for prospective buyers with less-than-spotless applications, brokers are “willing to sit down and look, as opposed to just sending it through the computer system and saying, ‘You’re out of here,’” she says.
Whatever you choose, experts suggest you shop around, since you’re not tied to using a particular lender, even the one that writes up your preapproval letter.
Having a preapproval letter in hand to show sellers is crucial when vying for a home, “regardless of if it’s a seller’s market, buyer’s market, any market,” notes Lauren Bennett, a real estate broker based in the Long Island City area of New York.
Preapproval for a mortgage (a more intensive step than just prequalification) is when a lender pulls all your credit reports, financial statements, debt, asset accounts, and W-2s and looks at your overall financial situation to determine how big of a mortgage you can afford. This will help you not only look more appealing (and serious) to a seller, but it will also help you set realistic expectations for what kind of home you’ll be able to get.
Preapproval letters are good for a limited time, but loan officers like Thomas say a typical preapproval is good for 90 days as long as the buyer’s credit stays the same.
Do the math
One important thing homebuyers should be aware of: There was a tax law change in 2017 that impacts mortgage interest deductions and state and local property taxes if you itemize your tax return. Now, you can only deduct $10,000 per year (even for married couples, if filing together) for both state and local taxes. Additionally, you can now deduct mortgage interest on a loan only up to $750,000 (it used to be $1 million).
The upshot is that “for a given home purchase, if you can’t take all the property tax off, what you’ve effectively done is you’ve raised the cost of that home to the homebuyer,” says Tyson. But the good news for most first-time homebuyers is they are likely not in the price range (i.e. $750,000) where the mortgage interest deduction change would impact them too much.
You could save money by itemizing your tax return using Form 1098 (which you get from your lender) if the interest you paid on your mortgage is more than just using a standard tax deduction, according to TurboTax.
With 30-year fixed mortgage rates at historic lows, those like Atlantic Coast Mortgage’s Thomas don’t see “any benefit” right now in opting for an adjustable-rate mortgage (which goes up or down over time based on the terms). “Most first-time homebuyers want that feeling that they know every single month their payment is going to be X,” he adds.
Calculate a down payment
Is the age-old rule of thumb still 20% down? Well, not necessarily.
There are those like Miedler and Tyson who believe putting 20% of the home price down on a house is still “the golden rule,” as Miedler puts it, but it’s important to know there are plenty of other options, including those that let you put as little as 0% down.
“Right now with a first-time homebuyer, I personally would encourage them to keep as much money in their pocket as possible,” suggests Grove. There are other financing options like the Federal Housing Administration (FHA) loan, which typically requires a minimum 3.5% down payment.
First-time homebuyers can find mortgages with down payments around 3%, including Freddie Mac’s Home Possible and Fanny Mae’s HomeReady. If you served in the military, you can also qualify for a Department of Veterans Affairs (VA) loan, which can be 0% down.
If you put down less than 20%, you’ll typically have to pay private mortgage insurance, which is an extra monthly fee to further protect your lender. But the good news is, “I don’t think mortgage insurance is this devil that you read about online,” says Thomas. The extra fees for mortgage insurance can be paid monthly until you build up 20% equity in your home, but Thomas suggests the “cheapest way most of the time is to do a lump sum. You either finance it or add it to your closing costs,” he says. Being able to pay a lump sum will depend on how much your down payment is, he notes.
But especially for first-time homebuyers, even coming up with the cash for a down payment could be a challenge in and of itself. For one, Thomas sees clients tapping their retirement accounts for a down payment. First-time homebuyers can withdraw up to $10,000 from their IRA penalty-free (you’re considered a first-time homebuyer if you haven’t owned a home in the past two years), but your withdrawal is subject to taxes. For a Roth IRA you’ve had for five years, you won’t pay taxes. (One note: You have to use your IRA funds within 120 days after you take them out for a purchase.)
While those including Tyson suggest you should “try to avoid” tapping your retirement savings for a down payment, others like Thomas encourage clients to ask themselves: “Where is the best place for the money—in the new house or growing in the market? I have found most buyers will withdraw the money and take the tax hit so they can buy today,” he says.
Make an offer
Your real estate agent or broker will look at comparable homes (a.k.a. comps) in the neighborhood, how long they’ve been on the market, and at what prices they sold to help determine how aggressive you should be for your offer, Bennett notes. That process will also include looking at things like the amenities and location of your property.
Given that we’re in a seller’s market right now, experts say, you’re more likely to run into bidding wars and pay top dollar for a house.
“When it goes on the market, there’s a feeding frenzy,” says Grove, of the Atlanta area. “There’s multiple offers on everything.” Anecdotally, Century 21’s Miedler says he hears reports from his agents of properties selling at 120% of the asking price, but experts emphasize the importance knowing the limits of what you’re able to spend so you don’t overpay for a home. (That’s also important when it comes time to get an appraisal.)
“You don’t want to overbuy. You don’t want to put yourself in a situation where you’re potentially one check away from going into foreclosure or missing a payment; that’s not why you’re buying,” notes Thomas.
You can (and perhaps should) make your offer contingent on the appraisal and inspection findings.
Get a home inspection
Ensuring you didn’t just offer to pay top dollar for a house with lots of problems is a key part of the process.
Getting a home inspector to come through and examine your would-be new house is crucial in making sure there aren’t any major defects, like a leaky roof, termite damage, structural issues, etc.
If problems are found, buyers can negotiate with the seller to fix what’s wrong (or even back out of the deal altogether if you put contingencies in your offer). But Grove, for one, says it’s important to choose your battles. She always tells her clients to think about what they can do themselves. “I’m like, ‘Didn’t you say your husband was handy? Let’s not ask for that. Let’s ask for the electrical and plumbing thing because that’s going to cost you more to hire,'” she says.
Go through a home appraisal
After you put an offer on a home, your lender will get an appraisal to make sure the home is a good investment. This step includes looking at what other similar properties are worth, along with any renovations or upgrades your home has, and helps your lender ensure the price you want to pay for the home matches up with the value of the property.
The home appraisal generally costs a few hundred dollars (according to HomeAdvisor, the national average cost is about $337), and along with the inspection is typically paid upfront by the buyer (although they can be added in at closing).
Close on your home
Closing costs vary a lot depending on the property, state, and loan and can range anywhere from 2% to 5% of the price of the home. (For one, Thomas notes, the closing costs for a first-time homebuyer in the Virginia area are typically 3%.) But a few costs you may need to budget for can include anything from underwriting fees, discount or mortgage points (one point is generally equal to 1% of your total mortgage amount and can be used to reduce your interest rate at closing), title fees, and other costs like earnest money (basically a deposit to show you’re serious about buying the house).
Since closing costs can vary so much, those like Bennett suggest buyers speak with an attorney beforehand, who can outline the details and help them plan accordingly.
Wherever you end up, you might be spending more time at home in a post-pandemic world. And as more and more people count their house as their office (and likely much more), first-time homebuyers like Richard Stapleton are glad they’ve got a place of their own.
He adds, “It’s so nice knowing that I don’t have to go anywhere for a long time.”
At the end of the day, the steps the pros recommend can protect you financially, but what may be most important of all is that you take the leap on a property you love. Especially these days, your home may be doubling as your office, gym, and child’s school for some time.
More from Fortune’s Q3 investment guide:
- The best and worst places in the U.S. to invest in real estate during the pandemic
- To buy or to rent? Residential real estate calculus in the time of COVID-19
- Where are housing prices heading? Gain, then pain
- Are people really fleeing cities because of COVID? Here’s what the data shows
- What the post-pandemic housing market might look like, according to the CEO of Century 21
- This is what every generation thinks of real estate—and what each has spent on it
- How to hedge your home