But are you scratching your head wondering exactly how to buy a house? After years of giving advice to home buyers, money expert Clark Howard and Team Clark have come up with an easy-to-understand process.
Table of contents:
Get your finances in order
Get pre-approved for a mortgage
Start shopping for homes online
Find the right real estate agent
Negotiate the sales price
Lock in your rate
Deal with the contingencies
Arrange your home insurance
Close the deal
1. Get your finances in order
Down payment and emergency fund
Credit reports and credit score
Paperwork you’ll need
Save for a down payment and build an emergency fund
For example, the FHA loan program only requires a 3.5% down payment of the purchase price. The downside to putting that little down is that you’re typically locked into a mortgage insurance premium (MIP) for the life of the loan. MIP protects the FHA in case you default.
Contrast that with putting less than 20% down on a conventional loan. You’ll pay private mortgage insurance (PMI) — which protects the lender just like MIP does — but the PMI can be dumped when your loan-to-value ratio reaches 80%.
Either way you slice it, it’s best to avoid MIP or PMI by coming up with a 20% down payment!
Start by looking at your timeline
That means you have some pre-planning to do. Begin by looking at your home-buying timeline. If you have 24 months until you’re likely to make a home purchase, try to estimate what 20% down would look like and divide that by 24.
Here are some other examples:
The money you’re building up for a down payment is best saved in a safe parking space like a online savings account or a CD.
The costs of buying a house go beyond just taking out a mortgage. When you own a home, there’s no landlord to call when you need to replace the water heater or you need a new HVAC system. So, you’ve got to be ready for these expenses by building up rainy day money.
You want to keep this cash liquid so it can be tapped at a moment’s notice. That’s why it’s best stored in an online savings account.
Check your credit reports and monitor your credit score
Checking your credit reports
You can pull a free copy of your credit reports at AnnualCreditReport.com. Be sure to check the reports from Equifax, Experian and TransUnion.
Go through the reports thoroughly. You’re looking for two things in particular:
Errors that you will have to dispute
Unpaid collections that you will have to pay
Errors technically should take 30 days to correct once you inform the bureau and creditor of their mistake. But in actuality, the process can take up to three or four months. That’s why you need to start this step at least four to six months before you’re actually ready to apply for a mortgage loan. Here’s our step-by-step guide to disputing an error on your credit report.
When it comes to unpaid collections, you want to make sure there are no surprise delinquencies eating up your credit. If there are, many times they’ll be small bills that you just forgot about or that got lost in the mail. Get those things paid off as soon as possible before you apply for a mortgage.
Checking your credit score
Now that you’ve done a background check on your credit profile, the next thing to do is continually monitor your credit score. This will ensure it continues to hold steady or improve as you get closer to applying for a mortgage loan.
CreditKarma.com and CreditSesame.com are a couple of websites Clark likes that will let you check your credit and scores for free.
“Both coach you on how to bump up your score over time, and they’re very sophisticated with how they do it,” Clark says. “So if the goal is to get a lower interest rate, start working on it nine months before with these sites. You should be able to see a substantial impact on your score that many months out.”
We’ve got full step-by-step instruction on how to sign up for CreditKarma and CreditSesame here and here, respectively.
Pay down your debt-to-income ratio
Your debt-to-income ratio is a financial term used in the mortgage and other related industries to determine how risky you are as a borrower. The debt-to-income metric is basically a measuring stick by which a lender can decide whether you make enough money to cover your future mortgage obligations each month or not.
Your debt-to-income ratio is calculated by dividing all the money you owe each month (credit card bills, other monthly bills, student loans, other monthly debt obligations, etc.) by your monthly income.
According to the Consumer Financial Protection Bureau, lenders do not want to see this ratio over 43%. Ideally, you want it to be as low as possible.
To reduce your debt-to-income ratio, you’ll have to pay down debts such as credit cards, car notes and other personal loans.
Gather your paperwork
Applying for a mortgage means a lot of paperwork to fill out. Your lender may ask you several times to send the same paperwork over to them. You want to be sure you have it handy to fulfill their requests.
At a minimum, you’ll want to gather the following documents and have them ready:
Getting pre-approved for a mortgage is in an in-depth process that generally involves the bank digging through all your financial documentation, checking your credit and giving you a conditional OK to buy a home up to a certain dollar amount at a preliminary interest rate.
Where you should think about getting pre-approved
Clark Howard’s 90% mortgage rule
Why you should get multiple quotes over 14 days
Why you shouldn’t make major purchases once you’re pre-approved
Look at non-bank lenders for pre-approval
“What’s changed over the years is that banks are now very uncompetitive in the mortgage market,” he notes. “All the action is credit unions and non-bank lenders like Rocket Mortgage or Quicken Loans.”
As a general rule, credit unions will offer the lowest rates. But Clark is quick to remind people that “not all credit unions are created equal.”
Fortunately, you aren’t locked into doing a loan with the lender that pre-approves you. So this gives you time to shop around further if you decide you don’t like the lender for any reason.
The pros of using a mortgage broker include the fact that they can shop unusual loan situations to lenders. That could be, for example, a self-employed person going for a mortgage who has a different level of income each year.
“Behind the scenes, a mortgage broker tells lenders, ‘Look, I know this client doesn’t fit your typical customer profile, but here’s why I think they’re right for your portfolio…’ Clark says. “They basically pitch your loan to different people and market you as a borrower.”
If you’re interested in working with a mortgage broker, get a referral from your real estate agent. You could also ask friends and family who’ve gone through the home buying process if they know of one.
Here are some examples:
“By following this rule, you will help create extra financial breathing room in your life,” Clark says. “The expense of housing is like a rubber-band — stretch it too far and it will break. Stay at 90% or lower and your wallet will smile.”
Meanwhile, Clark says another way to think about it is this: Base what you pay for home on what you’ve been comfortable paying for rent. Your rent is already a known expense in your life, so try to stick as closely as possible to that target.
Get multiple quotes over 14 days to limit the hurt to your credit score
You can minimize the damage by getting all quotes within a 14-day period. That way it doesn’t look you’re applying for multiple loans from multiple lenders.
Technically, you have 30 days to shop around before it hurts your credit. But Clark prefers you hold yourself to this shorter timeline so two weeks doesn’t bleed over into a month.
Don’t make major purchases once you’re pre-approved
“It’s not so much what the credit application will do to your credit score, though that is a concern,” he says. “It’s more that it harms your debt-to-income ratio, which could put you in a more risky lending category. That may mean your mortgage application is denied in the worst-case scenario or just that you find yourself pushed you into a higher interest rate.”
Download the right apps
Apps like Redfin and Zillow both let you look as you’re riding around a neighborhood and explore homes for sale based on your phone’s geolocation capabilities.
“I have what I like to call my ‘hundred house rule.’ The idea is that you should look at a minimum of 100 homes either in person or online to get a sense of what the real estate market and the inventory is at the moment,” Clark says. “Today that’s so easy to do online. You can look at well more than that in a couple of days.”
Concentrate on identifying zones
It’s more about identifying zones — streets, neighborhoods and areas you’d be comfortable living in — and then having target houses.
What you want to do is develop a list of 10 or 20 target houses in your ideal zones — streets, neighborhoods and areas you’d be comfortable living in.
4. Find the right real estate agent
The next step is to hire a buyer’s agent. The real estate agent you pick will be able to do something even more important than chauffeur you around to houses: They’ll be able to help you with keeping emotion out of the buying process.
Know what to look for in an agent
As a buyer, you’re not paying a commission. The seller is and that’s how the agent gets compensated. So what should you look for in an agent?
It all boils down to two things: Expertise and experience.
For you as a buyer, if there’s a particular neighborhood you want to buy in, you’re going to need an agent who is a big seller in that area. In the lingo of the trade, you want to know that they “farm” your desired neighborhood. That means they’ll have the inside scoop on available properties and can make the home-buying process much easier.
For example, an agent who farms the areas you’re interested in would be able to tell you why you shouldn’t buy on a certain street. They will have neighborhood-specific knowledge to help you find the right house at the best price.
Identifying the agents who farm an area is easy. You’ll see their sales signs again and again as you drive through the neighborhood. Failing that, you could try asking family and friends for a referral.
Another important factor to consider in finding the right real estate agent is experience. Particularly if you’re a first-time homebuyer, you don’t want to work with a person who is just selling their first house! Look for someone who’s been in their field for a number of years.
5. Negotiate the sales price
Look at the neighborhood comps to base your offer
Your agent will have access to comps — recent sale prices of other similar homes in the neighborhood — that they can provide you as you get ready to make your offer. You can also get the same info from your county’s tax assessor office. And thanks to technology, websites like Redfin and Zillow make it very easy to see this info, too.
Submit your offer
“The longer the home sits on the market, the more likely it is that you can come in with an aggressive price. The seller is not hungry in the first 45 days after their home is for sale,” Clark says. “Then the market wears them down. They get tired of the uncertainty and they may have committed to buying another house.”
Clark says the tipping point start sometime around six to seven weeks out. That’s when the seller becomes more amenable to making a deal.
So time on market is not automatically a signal that you can make a lowball offer, but there does tend to be a sweet spot once you hit six weeks or longer.
Closing costs are fees you’ll pay to the lender and title company for facilitating your real estate purchase. They typically average around 3% of the purchase price, but can sometimes be as high as 5% depending on your location.
However, Clark says not to get hung up on 3% or 5%. Rather, he prefers you do a holistic look at what kinds of fees you’re going to pay by lender. Each offer you receive should have three columns:
The interest rate is the bright, shiny object most people tend to focus all their attention on. But it’s only part of how you compare one loan offer to another. You’ve also got to consider points, if any, and closing costs.
Finally, look at your closing costs. Lenders now have to give you an estimate of the maximum you will have to pay. This makes it much easier for you to figure out which loan is actually your best deal.
6. Lock in your rate
“If you’re buying a home that’s being built, you never want to apply and lock in too early because builders’ schedules are notorious for running late,” Clark says. “You have to be sure most everything is done by the builder before you lock in your rate when you’re buying new construction.”
7. Deal with the contingencies
“I’m a big believer in finding a ‘deal-killer inspector’ who won’t gloss over things just to get more agent referrals,” Clark says. “You want somebody who tells you what you need to know, not what you want to hear.”
If the home inspector finds something that’s wrong with the house, now is the time to ask the seller to address the issues or ask them to reduce the price by the amount you expect the repairs to cost you once you buy the home.
It’s for this reason that inspectors with engineering backgrounds are great. You can either ask your real estate agent for a referral or you can find one through the American Society of Home Inspectors. ASHI requires its members to adhere to a code of ethics and a standard of practice.
Another good resource is the National Institute of Building Inspectors. NIBI requires that its inspectors carry errors and omissions liability insurance, which means they accept responsibility for any oversight.
You’ll want to be present for the inspection, which you’ll have to pay for upfront — not at the closing. As far as cost, expect to pay somewhere in the general neighborhood of $300 to $500, according to the U.S. Department of Housing and Urban Development. However, that cost can vary by square footage of the home and location in the country.
Finally, you may also want to consider paying for a specialized home inspection. This might entail an inspection to address pest control concerns or to detect the presence of radon or mold. These types of specialized inspections will be an additional expense you’ll have to budget for.
Get an appraisal
Getting an appraisal of a property you’re getting ready to buy is the best way to insulate yourself from the possibility of paying too much for a home. With an appraisal, you get a realistic sense of what the property is worth.
If you’re getting a home loan, your lender will require an appraisal. You as the buyer typically pay for up-front for the cost of an appraisal, often $300 or $400 — and there’s a very good reason for that.
As mentioned before, the purpose of an appraisal is to protect you from overpaying for a home. So what happens if the deal falls apart because of the results of the appraisal? The buyer is still responsible for paying the appraisal fee. After all, the work was done by the appraiser — regardless of the outcome of the deal — and the appraiser ne to be compensated for his or her time.
You may not think of home insurance when you’re learning how to buy a house. But this is an important step of the process. In fact, many lenders ask you to prepay for a year of home insurance before you can close on your mortgage.
Research quality companies
Clark trusts the opinions of several sources like Consumer Reports and J.D. Power when it comes to identifying the best home insurance companies. But no need to go to those websites and read through their data — we’ve already done it for you!
Take a high deductible
When you’re taking out a home insurance policy, you want to be sure to take the highest deductible that you can handle and that your mortgage holder will allow you to have. Doing that will both lower your premium and discourage you from unnecessarily making small claims.
That last part is very important, according to Clark.
Pick reputation over low premiums
All insurance is regulated at the state level. So before you decide on an insurer, be sure to contact the insurance commissioner’s office in your state. Ask them how many consumer complaints have been filed against a particular company you’re thinking about doing business with for your new home. The results may be eye-opening!
9. Close the deal
Be sure to review them carefully and ask any questions you may have about unfamiliar terms. Remember, buying a home is likely to be one of the largest financial transactions you make in your life, so you want to go into it with a full understanding of everything!
When the big day finally arrives, you’ll go to the title company. This is the very final step when you’re learning how to buy a house. Be prepared to sign a lot of papers. The seller may not be there, but you will be handed the keys to your new home. Imagine how good that will feel!
“I call real estate the ‘get rich slow’ method,” Clark says. “Housing prices normally increase just one or two percentage points more than the rate of inflation. Housing goes up a little faster than inflation because over time land becomes harder to find and as the population grows, housing becomes more scarce.”
If you have additional questions about how to buy a house or you need more detailed advice specific to your situation, contact Clark’s Consumer Action Center. It’s a FREE help line open Monday-Thursday from 10 a.m. – 7 p.m and Friday from 10 a.m. – 4 p.m. EST. We have volunteers available to answer YOUR concerns! Call Team Clark @ 404-892-8227.