1. Start with your credit. Credit reports are kept by the three major credit agencies, Experian, Equifax, and TransUnion. They show whether you are habitually late with payments and whether you have run into serious credit problems in the past.
A credit score is a number calculated from a formula created by Fair Isaac based on the information in your credit report. It’s not unusual to have a different score at each agency.
A low credit score may hurt your chances for getting the best interest rate, or getting financing at all. So get a copy of your reports and know your credit scores. You can get a free copy of your credit report from each agency every 12 months. You can request a copy here.
Errors are common on the reports. If you find any, contact the agencies directly to correct them, which can take two or three months to resolve. If the report is accurate but shows past problems, be prepared to explain them to a loan officer.
2. Set your budget. Next, you need to determine how much house you can afford. You can start with an online calculator. For a more accurate figure, ask to be pre-approved by a lender, who will look at your income, debt and credit to determine a loan you can afford.
The rule of thumb is to aim for a home that costs about two-and-a-half times your gross annual salary. If you have significant credit card debt or other financial obligations like alimony or even an expensive hobby, then you may need to set your sights lower.
Another general rule of thumb: All your monthly home payments should not exceed 36% of your gross monthly income.
The size of your down payment will also determine how much you can afford.
3. Line up cash. You’ll need to come up with cash for your down payment and closing costs. Lenders like to see 20% of the home’s price as a down payment. If you can put down more than that, the lender may be willing to approve a larger loan. If you have less, you’ll need to find loans that can accommodate you.
Various private and public agencies — including Fannie Mae, Freddie Mac, the Federal Housing Administration, and the Department of Veterans Affairs — provide low down payment mortgages through banks and mortgage companies. If you qualify, it’s possible to pay as little as 3% up front.
A warning: With a down payment under 20%, you will probably wind up having to pay for private mortgage insurance (PMI), a safety net protecting the bank in case you fail to make payments. PMI adds about 0.5% of the total loan amount to your mortgage payments for the year.
Once you’ve considered the down payment, make sure you’ve got enough to cover fees and closing costs. These may include the appraisal fee, loan fees, attorney’s fees, inspection fees, and the cost of a title search. They can easily add up to more than $10,000 — and often run to 5% of the mortgage amount.
If your available cash doesn’t cover your needs, you have several options. First-time homebuyers can withdraw up to $10,000 without penalty from an Individual Retirement Account, if you have one, though you must pay taxes on the amount. You can also receive a cash gift of up to $15,000 a year from each of your parents without triggering a gift tax.
Check on whether your employer can help; some big companies will chip in on the down payment or help you get a low-interest loan from selected lenders. You can also tap a 401(k) or similar retirement plan for a loan from yourself.
4. Find an agent: Most sellers list their homes through an agent — but those agents work for the seller, not you. They’re paid based on a percentage, usually 5 to 7% of the purchase price, so their interest will be in getting you to pay more.
You need an “exclusive buyer agent.” Sometimes buyer agents are paid directly by you, on an hourly or contracted fee. Other times they split the commission that the seller’s agent gets upon sale. A buyer’s representative has the same access to homes for sale that a seller’s agent does, but his or her allegiance is supposed to be only to you.
5. Search for a home. Your first step here is to figure out what city or neighborhood you want to live in. Look for signs of economic vitality: a mixture of young families and older couples, low unemployment and good incomes.
Pay special attention to districts with good schools, even if you don’t have school-age children. When it comes time to sell, you’ll find that a strong school system is a major advantage in helping your home retain or gain value.