Buying Your First Home Part 1: Get Your Financial House In Order

Andrea McClelland

Looking to buy your first home? Congratulations on this big step! For most people, a home is the largest purchase they will ever make. There are many decisions and choices to be made, and the process can be daunting.

Particularly in a seller's market, it's easy to feel rushed and be tempted to stretch financially. A bit of preparation can help you hone in on your priorities, and understand your financial comfort zone before you fall in love with a house. In this article, we’ll look at some preparatory steps you can take before beginning the home-buying process in earnest. The second article in this two-part series will get cover strategies to determine what you can comfortably afford.

First Things First

Homeownership provides many benefits, and can feel like a natural step in one's adult life. Many of our parents and grandparents built a large portion of their wealth through homeownership, and may advise that it is financial folly to continue to rent into adulthood. However, there's no guarantee that buying a home will help build wealth - a lesson learned the hard way by many during the housing bubble of the early 2000's.

It's best to view your primary residence as just that - a place to live. Look at a home purchase as a personal choice designed fit within your financial means, rather than framing it as a wealth-building move. This piece from Money Under 30 offers excellent perspective on this topic. Note that it's generally to your advantage to make your first home purchase when you're relatively confident you'll be able to stay put for at least 7-10 years. Given the hefty costs of buying and/or selling a home, along with the risk of volatility in the housing market, settling in for a while helps increase the likelihood that you'll see a net profit on the eventual sale - though there are no guarantees.

Lay The Groundwork

Let’s assume you've decided that buying is for you, and you already have a short list of neighborhoods that interest you. If you’re purchasing with a partner or spouse, it’s best to have frank discussions about your priorities before you get too far into the process. You might consider writing up separate ranked “wish lists” (i.e. high, medium and low priority) for your future home. You may discover that you have different priorities – for example, one of you feels strongly that the home must be in a top-ranked school district, on a quiet cul-de-sac, and have an en suite master bathroom. The other may prioritize an eat-in kitchen, space for a deck, and walkability to local restaurants. Looking at these differences early in the process can help open channels of communication and get clear on your joint priorities.

Don’t Go It Alone

An excellent realtor can help you sort through your options and priorities. Look for an agent with experience and expertise in the neighborhoods you are considering, and be sure that you have references for the realtor as a buyer’s agent – while most agents work with both buyers and sellers, some specialize in one area or the other. An agent who is a whiz at staging and selling may not be as skilled when it comes to helping you decide whether that water damage in the basement is no biggie or a deal-breaker. Most agents are willing to set up a time to chat with you so you can get a feel for their personality and approach. It’s a good idea to interview more than one agent to be sure you find a good fit. Choose an agent who is willing to explain all the steps of the home buying process as you go along – this is especially important for first-time homebuyers.

Planning Ahead

If you’re thinking about purchasing a home, it’s wise to check your credit score well in advance of applying for a mortgage, as your credit may impact the type of loans for which you qualify, as well as the interest rates you are offered. There are several ways to get your credit score – many credit card companies offer your score as a free service.

In addition to checking your credit score, it’s good practice to check your credit report, which details your credit activity and history. You can request a free copy of your credit report once a year from each of the three credit reporting agencies (Equifax, Experian and Transunion) at annualcreditreport.com – check for any errors or issues that might be dragging down your score. For most mortgage types, you need a credit score of at least 620 to qualify, though some loan types are available to those with lower scores. Buyers with a score of 740 or above are generally offered the lowest rates. 

Earn Some Extra Credit

If your credit score could use some improvement, start working on it now. Your credit score is based upon five key elements: payment history (whether you pay your bills on time), credit usage (how much of your available credit you utilize), age of credit accounts (older is generally better), credit mix (utilizing different types of credit such as credit cards, student loans, mortgage, etc.) and new credit inquiries (recent applications for new credit, such as a credit card). 

While it’s always good practice to pay your bills on time, it’s especially important while you’re in the process of applying for a mortgage, as payment history is the biggest factor in your credit score, comprising 35% of your total score. Credit utilization comprises 30% of your score - aim to keep your utilization at or below 30%. That is, if you have a total credit limit of $10,000 amongst your credit cards, don’t let the total balance go over $3,000. Best practice is to avoid charging above 30% of the credit limit on each card, as both your per-card and total credit utilization may impact your credit score. If you discover that you’re using more than 30% of your credit limit, call your credit card(s) to see if you can get a credit limit increase. 

Smaller factors contributing to your credit score include age of credit accounts (15%), credit mix (10%) and new credit inquiries (10%). Your score is improved by having a well-established credit history. Keep credit accounts open, even if you’re not using them. While closing them will not remove them from your history, the limits on these accounts contribute to your available credit limit, and closing them affects your credit utilization ratio. It's helpful to have different types of credit on your file to improve your credit mix, i.e. a credit card plus a student loan, but it may be detrimental to apply for new credit in an attempt improve your mix in the near term. When you apply for new credit, a "hard credit inquiry" is performed, which causes a small dip in your score. From the time you’re preparing to request pre-approval for a mortgage through closing on your new home, limit any requests for new credit, as this is a simple way to avoid any dings to your score.

What's Next?

You've got your list of priorities in hand, chosen a real estate agent, and checked your credit - what now? In the second article of this two-part series, we'll look at determining how much house you can afford, how lenders look at your loan application, and considerations for how much you should pay in cash vs. how much to finance. 

This content is developed from sources believed to be providing accurate information as of the date of publication, and is intended for informational purposes only. Please consult your financial professionals for specific information regarding your individual situation. Past performance does not guarantee future results. All investing involves risk, including risk of loss.