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First-Time Home Buying

The process of shopping for and buying a home can be an overwhelming experience, especially for first-time homebuyers. Add the element of uncertainty and the whole process can be downright stressful. (What if you don't get approved for the mortgage you want? What if the inspection uncovers problems? What if the closing is delayed?)

The more knowledgeable and prepared you are about the process, the more likely you'll be able to minimize the hassles.

Buying vs. Renting
First-time homebuyers should compare the costs of renting (rent, utilities, renters' insurance) to the costs of owning a home (mortgage payments, insurance, property taxes, utilities and maintenance).

Often the cash flow costs of owning a home will be the same or more than renting. Remember to account for the fact that you'l probably save money on taxes in the form of deductions for mortgage interest and property tax payments. Also, owning a home does come with some certainty: while your landlord can and will raise your rent, your mortgage payment will stay the same each year (assuming you have a fixed rate mortgage).

Time To Buy or Buying At The Top?
There's no guarantee that home prices won't fall after you buy. In fact, there are more signs that home prices are softening and in some areas, prices could be headed for a drop. Rising interest rates on adjustable rate mortgages and high home heating costs could leave more sellers eager to cut a deal. According to a recent report in BusinessWeek, there has been a significant rise in the supply of homes listed for sale in many areas across the country.

Here's a list of increases in inventory of homes listed for sale over the past three months:

Phoenix: 72.3 percent
Miami: 47.7 percent
Tampa: 36.3 percent
Washington: 34.1 percent
Jacksonville: 32.1 percent
Boston: 28.5 percent
Los Angeles: 26.7 percent

Source: BusinessWeek, Dec. 19, 2005

The best way to avoid overpaying when buying a home is to ask a realtor to prepare a comprehensive market analysis before you make a purchase offer. This should include the recent sales prices and the original listing prices of comparable homes in the vicinity, listing prices of similar homes listed for sale, and the asking prices of recently expired listings of homes taken off the market.

Use what you learn from a market analysis to determine what you will offer. For example, if the supply of homes for sale is rising in your local market, more sellers will be competing for you to buy, which means they may be willing to accept a lower offer.

Also, if you have your eye on a house that has been on the market for a few months or more, or if the seller has dropped the asking price several times, this is a sign that the house is overpriced and you may have some room to bargain.

When you make an offer, you will include an inspection contingency clause in the purchase contract. Before you close on the house, this will allow you to get a professional home inspector to inspect the condition of the home, identifying any repairs and problems. If the repairs identified in the inspection are considerable, you may be able to justify reducing your original offer price by the projected cost of the repairs.

Over long periods of time, owning a home has turned out to be a pretty solid investment, as long as you do not over-pay.

Don't Become House Poor
How much house you can afford to buy depends on two things: the money you have on hand and your income.

Your housing payment shouldn't be more than 25 to 30 percent of your gross income. Housing payment includes mortgage payment (principal and interest), property taxes and homeowners insurance; commonly referred to as PITI. So, if your gross income is $4,000 a month, your monthly housing payment shouldn't be more than $1,200.

To determine how much home and mortgage you can afford, ask a realtor or mortgage broker or use a calculator on Web sites such as and

Banks and mortgage lenders may allow you to qualify for a mortgage with a payment that's more than 30 percent of your income (often up to 38 percent), but I wouldn't recommend it. Common sense should tell you that with about 30 percent of your gross income going toward house payments and 25 percent going to income taxes (Fed, State and FICA), you're left with 45 percent of your gross income to pay for living expenses, other debt payments, and saving for retirement, kids college, etc.

Get Your Credit Score
Your credit score has become the most important thing to look at before you apply for a mortgage because lenders will review this score when deciding to approve a loan and the terms they will offer.

The most commonly used credit score is the FICO score, developed by Fair Isaac & Co. Your credit score is a three-digit number, ranging from 300 to 850 which is calculated from the information on your credit bureau reports. About 60 percent of individuals have a credit score of 700 or better.

While there are other similar credit scores calculated and used, the FICO credit risk score is used by the majority of mortgage lenders and the large financial institutions in their evaluation and approvals process for credit applications.

While there is no hard and fast number, financial institutions indicate that a FICO score in the 620 range is the cutoff point below which anyone applying for credit may be considered a higher than average risk and therefore will be charged higher fees or higher interest on a loan.

Lenders use credit scores because they feel these scores provide a predictive assessment of how customers will perform on loan payments and this allows them to better balance the credit risks they take into their overall loan portfolios.

Home buyers should get their credit score months before they intend to apply for a mortgage. The point is: you need to know your credit score and what you can do to improve it before a prospective lender checks you over for a loan.

Although you have to pay to get your FICO score, there are other credit scores provided for free. Those scores are based on similar factors and are available from sources such as

You can buy your credit score by logging on to,, and .

Pre-Approval and Shopping for a Mortgage
Buying a home involves a lot of shopping, not just for the home but for the right mortgage.

Many lenders are willing to pre-approve you for a mortgage for free in hopes that you'll give them your mortgage business. It will help your negotiating power to let a buyer know that you are pre-approved for the mortgage you'll need. Just don't tip your hand too much by telling them the amount of the mortgage you're qualified to borrow; they could use this against you when negotiating the price.

Most first-time home buyers are best served with a fixed rate mortgage, where payments will not change. That's because when you own a home for the first time, there will be many surprises and additional expenses; one of these should not be an unexpected hike in your monthly mortgage payment. Of course, whether you go with a 30-year or a 15-year term will depend on what you can afford…the shorter the term to repay the loan, the larger the payment.

Adjustable rate mortgages allow for a lower initial rate (and payments) in the first several years, such as a fixed rate for the first five years before any rate adjustments are made or payments increase. But in an environment of rising interest rates, the recalculated rate is higher than the initial rate.

These types of mortgages are tricky and require the borrower to live with changes in their mortgage payments based on the direction of interest rates. When their interest rate adjusts and is higher, they will have to decide whether to refinance the mortgage or continue to pay the new payment, which is likely to be higher.

For some folks, however, the decision includes another factor: the length of time they expect to own the home. Typically, if your employment includes possible relocation within five years, or the move to a larger house to accommodate an expanding family, then a five-year adjustable rate mortgage would have been the best option to consider. But right now, according to a search on, home buyers can get a 30-year fixed rate mortgage at a 6.25 percent interest rate, or a five-year adjustable, or 5/1 ARM with a rate of 6.125 percent, which is only 0.125 percentage points lower.

Right now the decision is easy: go with the 30-year fixed rate mortgage because adjustable rate mortgages don't offer enough of a savings to compensate for the risk of future increases in your mortgage payments.

In all cases, never use an adjustable rate, or interest only, mortgage because it provides the low initial payment that is all you can afford to pay. Your rate and payment will increase, putting your homeownership on shaky financial ground.

Bank or Mortgage Broker?
A mortgage broker can represent many lenders and claim that they will "shop the market" for the lowest rate for you. Banks, on the other hand, only have their mortgage products to offer.

You should shop both banks and mortgage brokers before you decide. That's because rates in the mortgage market will vary day to day depending on the supply of money various lenders have available for loans. Sometimes the large banks and local lenders offer rates that can't be matched by the brokers. Also, there are often significant differences in rates between various brokers due to the volume of loans they write each month.

Ask your realtor or attorney for the names of lenders in your area. Also check out or to find some of the best deals online. Look for special relationship deals such as a break on the interest rate if you allow automatic deduction of mortgage payments from your checking account and payment of taxes and insurance through an escrow account.

The Down Payment
The amount of money you'll need on hand depends on the price of the home you're buying, the type of mortgage you'll be getting and closing costs. The best deal on a mortgage comes when you put down 20 percent or more. If you make a down payment that's less than 20 percent, your selection of mortgages will be limited to "non-conforming" mortgages that charge higher interest rates and mortgage default insurance (called Primary Mortgage Insurance, or PMI).

One strategy to help come up with a larger down payment is to get a loan or gift of cash from your parents or family members. You are obligated to disclose to the lender if you do so, but if the cash is a gift, many lenders will accept these additional funds as such and not count this as more debt.

You'll also need to come up with at least several thousand dollars for the closing costs associated with the purchase transaction, for items such as:

  • Application fees
  • Appraisal Fees
  • Inspection Fees (pest, radon, asbestos, lead paint etc.)
  • Title Insurance (the biggest of all)
  • Homeowners Insurance (the first year premium)
  • Attorney Fees (you pay for the banks attorney and your own)
  • Property Taxes prepaid by the Seller
  • Deed Recording Fees
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