First-Time Home Buyers Guide

Everything you need to know about buying your first home

If you don’t work in the mortgage industry, nothing can prepare you for buying your first home. Despite the many books and articles out there on the subject, the process can be intricate and confusing.

Each lender has a different process and borrowing criteria, and you also have to deal with sellers, real estate agents, title companies, and more.

To help you through this process, we’ve put together a comprehensive guide that can help you understand what you need to know before you begin shopping around through to closing.

Types of mortgage loans

There are several different types of mortgage loans and, depending on your personal situation, one may be better than another. Here’s a quick summary of the different types you may need as a first-time homebuyer.

Conventional loan

This is a traditional mortgage loan that isn’t backed or insured by a government agency. Mortgage lenders typically require that you have at least a 620 credit score to get a conventional loan, and a 20% down payment or higher ensures that you don’t have to pay private mortgage insurance (more on that later).

FHA loan

Insured by the Federal Housing Administration, FHA loans allow you to get into a home with a down payment as little as 3.5% if your credit score is 580 and above. If your score is between 500 and 579, you can still get approved but with a down payment of 10%.

Instead of charging private mortgage insurance, FHA loans charge mortgage insurance premiums, which can be more expensive than private mortgage insurance over time.

VA loans

VA loans are designed for eligible members of the military community and their families. They’re insured by the U.S. Department of Veterans Affairs. While the VA doesn’t have any credit score requirements, most VA lenders typically require a credit score of 620.

VA loans don’t require a down payment at all so that you can get into one easily. That said, you’ll pay a VA funding fee of up to 3.3%. Your fee will depend on your eligibility status, down payment, and how many VA loans you’ve had.

USDA loans

Insured by the U.S. Department of Agriculture, these loans were created to incentivize people to buy homes in eligible rural areas. They typically have a 580 credit score requirement, but some exceptions can be made for people with a lower score. There’s also no down payment requirement.

USDA loans do charge an upfront and annual guarantee fee, but they’re lower than what you can expect from VA and FHA loans, or private mortgage insurance.

When shopping around for a mortgage, compare at least three or four mortgage lenders to see what rates and other terms they offer. Don’t be afraid to compare even more than that to make sure you’re getting the best deal.

Mortgage closing costs

One of the more frustrating aspects of the home-buying process for first-timers is the closing process with all of its costs. Depending on your situation and lender, closing costs can range from 2% to 5% of your loan amount.

As a result, it’s critical that you keep these in mind when saving up for your house. If you only save for a down payment, the closing costs can eat into it. You can choose to ask the seller to cover the closing costs, but this typically only works if the seller is desperate to get rid of the house.

Alternatively, you can ask the lender to cover the closing costs in exchange for a slightly higher interest rate. But if you plan on staying in the home for a long time, you’ll likely pay more in interest with the higher rate than you would have if you were to pay for the closing costs up front.

Types of closing costs

There are many types of closing costs you might run into. Here’s a list of the main ones:

  • Application fee: Covers the cost of the loan underwriting process.
  • Appraisal fee: Paid to the appraisal company to determine the fair market value of the home.
  • Attorney fee: Covers the cost of having an attorney review the final loan documents. Not required in all states.
  • Courier fee: Covers the cost of expediting documents to ensure you close on time.
  • Credit report fee: Pays the cost to pull your credit report during the underwriting process.
  • Discount points: Allows you to buy down your interest rate with a lump-sum payment.
  • Document preparation fee: Pays for the time spent preparing your loan documents.
  • Escrow fee: Paid to the company responsible for closing your loan, typically a title or escrow company.
  • Escrow deposit: A lump-sum payment to cover a couple of months’ worth of property tax and mortgage insurance.
  • Flood determination fee: Covers the cost of a third party determining if your house is located in a flood zone.
  • Home inspection fee: Paid to verify the condition of the property and determine if repairs are necessary.
  • Homeowners association (HOA) dues: If applicable, may include an investment fee to join, plus some prepaid dues.
  • Homeowners insurance: Typically paid annually and due at closing.
  • Origination fee: Includes administration and processing fees.
  • Prepaid interest: Includes interest that will accrue between closing and your first payment.
  • Recording fee: Paid to the city or county office responsible for recording public land records.
  • Survey fee: Paid to a surveying company to verify property lines.
  • Title insurance: Paid to protect the lender if there’s an issue with the title.
  • Title search fee: Paid to the title company for doing a property records search.
  • Transfer taxes: Paid to transfer the title.

Other mortgage loan costs

Depending on the type of loan you have, you could have other fees and costs to deal with as well. Here’s a breakdown:

Conventional mortgage 

  • Cost: Private mortgage insurance (PMI)
  • Amount:5% to 1% of the loan amount annually
  • How to avoid it: Put down at least 20%

FHA loan

  • Cost: Mortgage insurance premium (MIP)
  • Amount:75% upfront; 0.45% to 1.05% annually
  • How to avoid it: MIP cancels after 11 years if you put down at least 10%; no cancellation if your down payment is less than 10%

VA loan

  • Cost: Funding fee
  • Amount:25% to 3.3% of the loan amount
  • How to avoid it: All VA loans charge a funding fee, but you can get a lower fee by putting down a larger down payment

USDA loan

  • Cost: Guarantee fee
  • Amount: 1% upfront, 0.35% annually
  • How to avoid it: All USDA loans charge an upfront and ongoing guarantee fee

How much house can you afford?

Before you start house hunting, it’s important to set a budget. While getting your dream home may be a priority, it’s important to avoid being “house poor.” This means that your monthly payments are so high that you’re barely scraping by in other areas of your household budget.

To determine how much house you can afford, focus on the monthly payment rather than the total home price. Your monthly payment will be made up of the following elements:

  • Principal and interest: This is the basic payment to satisfy the loan.
  • Mortgage insurance: Depending on your loan type and down payment amount, this may not be required. Read on to learn more about mortgage insurance and how much it can cost.
  • Property taxes: Your county assessor’s office will determine your property tax amount based on a percentage. Take that percentage and divide it by 12 to get the monthly amount.
  • Homeowners insurance: This is always required when you finance a home, and it’s also smart to have it.
  • HOA fees: If applicable.

Depending on your budget and goals, you can generally choose between a 15-, 20-, or 30-year mortgage. The shorter the repayment period, the higher the monthly payment.

“I try to encourage first-time homebuyers to consider a 30-year mortgage,” says Michael Dinich, a financial advisor, “because payments will be much lower. It seems like no matter how much you research or plan ahead, something unexpected will pop up.”

Having a lower monthly payment can give you the flexibility to pay more if you can afford it, or save more for big repairs and maintenance costs. As you tally up these costs, it’s important to know whether you can afford your dream home.

Here are some rules of thumb to guide you.

Mortgage rules of thumb

There are two main rules of thumb to consider when determining how much of a home you can afford. The first is the 28% rule and the second is the 36% rule.

28% rule

Your total housing expenses should be no less than 28% of your gross monthly income. This includes things like mortgage insurance and property taxes. So, if you earn $4,000 per month before taxes, the maximum amount you should pay toward your total mortgage payment plus escrow is $1,120.

36% rule

Your total debt payments should be no less than 36%. This includes all of your debt payments, such as student loans, auto loans, credit cards, etc.

If your gross monthly income is $4,000, that means your total monthly debt obligations should be no more than $1,440. If you have high debt payments in other areas, you may need to find a more affordable house to meet requirements.

Note, however, that in some cases, a lender may be willing to offer you a loan if your debt-to-income ratio is as high as 43%.

Calculating the home value

Once you know how much payment you can afford, you can use current market interest rates to get a ballpark figure of how much of a home you can afford.

For example, let’s say your total monthly mortgage payment can be $1,120 and the market rate is around 4.5%. If you get a 30-year mortgage, you can expect to qualify for a mortgage worth roughly $221,000.

If you have $20,000 saved for a down payment, that means you can get a home worth closer to $241,000. Just remember to keep closing costs in mind as you do these calculations.

How to find the right real estate agent

Since you’re new to this, chances are you don’t have the skills necessary to know what’s a good deal and what isn’t. A good real estate agent understands the lay of the land and can help you see things that you wouldn’t see on your own.

They can also help you find the types of homes that you’re looking for based on your preferences, negotiate with the seller to help you get a better deal, and guide you and answer questions during the mortgage process.

This is the person you’ll lean on the most throughout the home-buying process. All in all, real estate agents can be expensive, but they’re worth it if you don’t know what you’re doing.

Tips for finding the right realtor

If you want to get the right real estate agent for your needs, use some or all of these tips:

Ask around

Chances are you know several people in the area who have bought a home recently. Ask for recommendations from people you trust. To be clear, make sure these are people they’ve worked with recently, not just friends who happen to be realtors.

Interview them

This may take some time, but it’s important to make sure that a realtor can meet your needs. They may have been great for your friend, but you’ll want to make sure they’re good for you too.

“A good real estate agent should understand the type of home you’re looking for and your budget,” says Dinich. “If you find that the agent is only interested in showing you their listings or listings outside of your price range, consider a different agent.”

Do some research

The internet makes this part of the process incredibly easy. Take some time to research the agent. Visit LinkedIn, realtor websites, and review pages to see how much experience the agent has, whether they have any special certifications, and how they treat their clients.

If you can’t find any information, it’s likely that they’re new to this. Since this is your first time, focus on finding someone who has been in the game for a long time.

How to choose the right home

Once you know how much you can afford and have a good real estate agent by your side, now it’s time to find the right house. This stage of the process can be the trickiest to do right because of the emotions involved.

As you visit different houses, you may fall in love with several of them, thinking that you absolutely have to live there. Resist the urge to allow your emotions to guide such a long-term financial decision.

Instead, start firmly by home size and feature requirements with your agent. For example, do you want two or three bedrooms? How big should the home be? Does the pantry need to be large? Do you need a mudroom? How big should the backyard be?

Establish some things that are non-negotiables and others that are nice but not required. Then, keep that information in mind as you look at different homes in your price range.

If you love a home that doesn’t include all of your non-negotiables, ask yourself whether you’ll be happy with the home in five years. Also, be sure to get pre-approved for a mortgage loan before you start house hunting.

If you want to make an offer on a home, the seller will want to know if you’re likely to go through with the deal. A pre-approval can show them that you can manage it financially.

Now what?

Now that you have a good understanding of the basics of the home-buying and mortgage process take the time to determine whether you’re financially ready for a home. If you are, start by establishing a budget then look for a real estate agent.

Then, before you start looking at houses and applying for a mortgage, shop around and compare mortgage rates from several lenders to make sure you get the best deal.

Also, consider working with a mortgage broker to improve your chances of getting a good rate.

“Working with a broker can make sense if anything is out of the ordinary with your situation,” says Dinich. “Brokers tend to know which lenders are more likely to be agreeable to your unique situation, and may end up saving you money.”

As you take the time to go through the process the right way, you’ll not only have a better chance of getting a great home that you can afford, but you’ll also be better off financially in the long run.

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