Homeownership is a dream for many and a significant milestone that marks a new chapter in life. For first-time homebuyers, the process may seem daunting, overwhelming, and sometimes confusing. Buying a house involves many critical decisions and financial investments that require careful planning and consideration. From choosing the right location to understanding the legal and financial aspects of homeownership, there are several essential things that every homeowner should know before buying a house. This article will explore some of the most important homeowner essentials that can help you make informed decisions and turn your homeownership dream into a reality.
Homeownership Definition: Here’s What It Means to Own a Home
Homeowners own their homes in two different ways. Some homeowners own their homes without a mortgage because they’ve either paid it off already or bought a home with cash. You’re still a homeowner even if you use a mortgage to pay for your home. Of course, failing to pay a mortgage can cause a bank to foreclose on your home.
Becoming a Homeowner
For most, becoming a homeowner means becoming a borrower. That’s because the average person requires a mortgage from a bank or lending institution to purchase a home. The common loans used to buy homes in the United States today include:
- Conventional Loan: A popular option among borrowers with good credit, a conventional loan typically offers better interest rates than government-backed loans. However, qualifying for this loan is harder. Be prepared to show up with a credit score of at least 620. While you can put down as little as 3% with a conventional loan, most borrowers put down 20% to avoid paying private mortgage insurance (PMI). PMI Payments will stick around until you have 20% equity in a home.
- FHA Loan: Backed by the Federal Housing Administration (FHA,), this loan is available to borrowers with a minimum credit score of 500. While borrowers with 580 credit scores can put down just 3%, borrowers with scores between 500 and 579 must put down at least 10%. PMI is mandatory with FHA loans.
- VA Loan: This loan backed by the U.S. Department of Veterans Affairs (VA) is available to current military members, veterans, and eligible spouses. Most VA loans don’t require down payments. There’s no minimum credit score required.
- USDA Loan: If you’re shopping for homes in designated rural areas, a loan from the U.S. Department of Agriculture (USDA) can help low-income and moderate-income buyers purchase homes with no down payment or mortgage insurance.
- Jumbo Mortgage: “Jumbo” refers to this loan exceeding all conforming loan limits. It is used to buy luxury and high-value homes that may cost $1 million or more. Buyers typically need to put down at least 20% for a down payment without compromise.
When making mortgage decisions, most buyers choose something called a fixed-rate mortgage. Under a fixed-rate mortgage, a home loan’s interest rate stays the same for the duration of the loan unless the owner refinances. That means the rate your lender provides on the closing disclosure document is the rate you’ll pay for the next 15 to 30 years. The perk of a fixed-rate mortgage is that it offers predictability for budgeting. Aside from property taxes and homeowner insurance rates, your monthly homeownership cost is fixed!
You will need to refinance to get a lower rate if the interest rate falls after they lock in a fixed-rate mortgage. Moreover, fixed-rate mortgage interest rates are often higher than the rivaling adjustable-rate mortgage (ARM). This is why you may prefer to take out loans with fluctuating interest rates based on market conditions.
An ARM generally comes with lower starting interest rates that change with the market. You might even lock in a low rate for several years before the loan switches to a variable rate. Most ARMs adjust every six months to 12 months once the variable rate kicks in. The risk with this is that it’s impossible to know how much you’ll pay monthly once your introductory interest rate phases out. While you may save a lot at the start of your loan, there is always the possibility that a loan becomes unaffordable if rates balloon.
Fixed-rate mortgages are steady, “worry-free” loans ideal for anyone planning to stay in a home for at least five years. While ARMs come with risks, they could be good for buyers 100% planning to move within two to five years. The bottom line is that you must know the risks when courting interest savings!
The Perks of Homeownership
Someone looking at buying a home for the first time may wonder why so many are willing to pay hefty down payments and closing costs to own a home.
The truth is that a home is a vehicle for building wealth. In many cases, a home is the biggest asset a person will own. Data from the Federal Reserve shows that homeowners in the United States have 40 times the wealth of renters! While the median net worth for homeowners is $255,000, the median net worth for renters is just $6,300. Here’s a dive into the perks of homeownership:
- The ability to control your monthly payment instead of worrying about rising rents.
- Watching equity grow with each monthly payment instead of simply losing rent money.
- Enjoying appreciation if the value of your home rises. Real estate can be a smarter investment compared to stocks for someone who doesn’t want to deal with market volatility.
- Property taxes and mortgage insurance costs can be included in your itemized tax deductions. That’s like getting two tax credits for being a homeowner.
- Owning a home can boost your credit score to help you obtain loans and financing at better rates.
You might not want to buy a home “today” because you think you can’t tap into the wealth their home is building until you’re ready to sell it later in life. However, you can tap into your home’s equity much sooner than you might think! When borrowers use home equity to get loans, they tend to get better rates with no restrictions about what the cash can be used for. That means a home’s equity can help finance business plans, debt payments, education, vacations, home improvements, and more. Here’s a look at some ways to tap into a home’s value before a mortgage is even paid off:
- Cash-out Refinancing: A homeowner refinances to a loan bigger than needed to pocket the extra cash.
- Home Equity Loans: This common option allows you to borrow against the equity in your home while still carrying your existing mortgage. The loan comes in a lump sum with a fixed rate.
- Home Equity Line of Credit (HELOC): HELOCs function like credit cards that are backed by your home. Borrowers only pay back what they use. The same credit line can even be used repeatedly as long as you’re paying back what you’ve taken out in full.
- Reverse Mortgages: Also known as a Home Equity Conversion Mortgage (HECM), a reverse mortgage is an option that allows homeowners 62 years and older to turn home equity into cash.
Of course, you don’t need to use any of these “fancy” techniques to make money from your home. Most homesellers simply use the money they make when selling their first home to move up to something bigger or more expensive when they purchase their second home. In some cases, the profit can easily cover the full down payment on a more expensive home.
Deciding If Home Ownership Is Right for You
Getting preapproved for a loan is the first step for anyone considering homeownership. Most real estate agents won’t show properties to buyers who show up without preapproval letters. While a preapproval isn’t set in stone, it gives you a good idea of the loan amount and terms you’ll be approved for when applying for a real loan after finding the home you want to buy. Here’s what a lender will ask for:
- Proof of income in the form of stubs, W2 forms, or receipts
- Proof of assets showing the size of your available down payment
- Credit score
- Employment verification
Suppose your borrowing power comes in lower than expected. In that case, you may decide that it’s time to boost your credit score and reduce your debt-to-income (DTI) ratio by saving more, paying off bills, addressing negative items on your credit report, or trying to increase your income level.
Questions to Ask Yourself Before Becoming a Homeowner
First, be honest about your ability to afford a home. Buyers must be prepared to pay for a down payment, closing costs totaling 3% to 6% of the loan, and all costs associated with moving.
Once you’re in a home, repairs, replacement of appliances or systems, maintenance issues, landscaping, and home improvements can all require major investments. The costs that used to be your landlord’s “problems” now rest squarely on your shoulders! Of course, the extra responsibility is more than worth it if you’re eager to own a place of your own.
Next, consider how long you plan to stay in the area. If your career history has caused you to move every three to four years, buying a home may not pay off because you won’t be in it long enough to watch its value increase. Moreover, the early stages of mortgage payment skew heavily toward interest payments instead of principal payments. That means that you won’t start building equity right away. You can lose money in closing costs and moving costs if you need to sell every time you move.
Finally, be honest about your intentions. Getting swept up in the frenzy of owning a home on social media, in your social circle, or the news can cause you to jump into something you’re not truly ready for just yet! The decision to become a homeowner should be made based on both your lifestyle and financial health.