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Financial Planning

Financial Planning for a first time home buyer

Date:
November 2, 2021

Homeownership can be a significant -- and complicated -- milestone, especially if you're a first time homebuyer. Sound financial planning, along with researching suitable loan programs and lenders, can make all the difference.

In 2020, first-time buyers made up 33% of all home buyers. So a lot of resources are out there. A good place to start is with your local housing market. Learn what types of homes are available and the options available to you. Before you talk to a realtor, search listings online, find what looks right for you, and note the asking prices.

What will lenders look for in my finances?

Your income, your savings and other assets, your credit score and all your debts are the primary factors mortgage lenders will review. When you apply for a loan, expect to deliver documents proving all of these, even with new online mortgage lenders. 

Potential lenders are looking at your current financial fitness and how you've managed debt in the past to make sure that you can reliably make regular mortgage payments.

Conventional loans typically require a credit score above 620 and a debt-to-Income ratio of 50% or less. They often require traditional down payments (more than most first-time homebuyer programs require), and they often require private mortgage insurance if your down payment is below 20%.

'Conforming' loans meet Fannie Mac or Freddie Mac guidelines and can offer down payments as low as 3%. Borrowers with no credit can also qualify if they meet certain criteria, like having a good rent history for the past twelve months and if their loan amount doesn't exceed $548,250.

What is the average size of a mortgage for first-time homebuyers?

In 2018, the average size of a first-time homebuyer's mortgage was $231,974, according to Fannie Mae and Freddie Mac.

For that average purchase price, with a government-backed loan and a fair or good credit score, you'll need $16,238 for the down payment, plus closing costs and taxes. 

Home prices vary widely across the US, and they often vary within local markets. A well-informed realtor can help find properties in your budget. So do closing costs and taxes. A well-informed realtor can help find properties in your budget and explain the additional costs of a purchase.

How much should I save for a down payment?

In 2020, the average down payment for first-time homebuyers was just 7%. That's lower than the down payment for homebuyers overall -- because of special programs available to first-time buyers. 

Regardless of your down payment, the best way to approach home buying is with a cushion and a comfortable level of savings, above and beyond emergency funds and other dedicated savings. Extra expenses are inevitable, from closing costs to mortgage insurance.  

Closing costs and related taxes vary widely state by state. The average closing cost with taxes in California was $6,878 in 2021. In Colorado, the same costs were $3,658, and in Delaware, the average was $17,727.

Start saving strategically, with special funds designated for a down payment and closing costs. Allocated savings can help focus your efforts. 

Short-term investments might help meet your goal faster. Moderate-risk mutual funds or ETFs can sometimes grow your money faster than the interest earned in most savings accounts. They're also fairly easy to move money in and out.

How can I lower my down payment?

Government-backed loan programs are designed to make homeownership accessible to more Americans, with lower closing costs and more flexible qualifying terms, including lower down payments. These programs are widespread and available through most mortgage lenders.

Federal Housing Administration (FHA loan) supports borrowers by offering lower down payments. With a credit score as low as 570, you can qualify for a loan with a down payment as low as 3.5%.

Department of Veterans Affairs (VA loan) backs zero down payment home loans for active duty military personnel, veterans and their spouses. They also offer lower interest rates than other loan programs, along with the absence of a minimal credit score or a mortgage insurance payment.

United States Department of Agriculture (USDA loan) fully guarantees home loans for low and moderate income households. These homes need not be in rural areas only, but should be within USDA-eligible areas.

Good Neighbor Next Door Loan Program is an initiative by the Department of Housing and Urban Development, where firefighters, teachers, medical service providers, and law enforcement officials can get a 50% discount on the listed price of a home in certain areas.

State & local first-time homebuyer programs are offered by various local administrations to attract new residents, through grants and loans with low interest rates. These assistance programs are subject to local housing and municipal rules.

How do I qualify as a first-time home buyer?

If you haven't bought a house before, you're automatically a first-time buyer. 

But you might be surprised by the flexibility of that term: if you haven't been an individual homeowner for the past three years, you'll qualify as a first time home buyer regardless of your previous homeownership history.

What If I have a low credit score?

Your credit score is set by organizations like FICO and Vantage Score, who consider factors like your payment history and money owed by you. A bad credit score is any number below 630 on a scale of 300 to 850.

But a bad credit score doesn't mean you're ineligible for a home loan. You could have a low credit score for reasons not under your control and still gain a lender's confidence. And in some cases, other credit-worthy conditions can substitute for your credit score.

If you can prove steady employment, have regularly filed tax returns and have an income high enough to afford your mortgage payments, some lenders might see you as a comfortable risk. 

Sometimes other assets can be held as collateral, in addition to the home you're buying. Significant savings can also persuade some home lenders.

How much should I budget after the purchase?

Down payments and closing costs can guide your pre-purchase financial planning. But make sure you can still afford your mortgage payments after you've moved in. 

A common rule of thumb: plan on spending no more than 28% of your gross (pre-tax) income on your mortgage payment each month.

As a first-time home buyer, you might be unfamiliar with the other costs of homeownership, including property taxes and additional utilities, plus potential HOA fees and the costs of repairs and upkeep. 

Your realtor can tell you about property taxes and any HOA fees. If you're worried about unexpected repairs, consider reputable homeowners insurance, which can run about $100/month depending on your location, with varying items and systems covered.

Can more cash help?

If you have more funds available for a larger down payment, you may find better terms from lenders, from lower interest rates to more flexible qualifying terms, including a lower credit score.

What about a co-signer?

A co-signer for your home loan is willing to sign on and guarantee your home loan with you. They don't have to live with you. But with a good credit score, they can boost your lender's confidence in your loan application.

Co-signers aren't typically co-homeowners, but they will be held accountable if you default on your mortgage payment. It's important they're aware of your financial condition and that they trust your ability to make monthly mortgage payments reliably.

Use Bright to plan strategically

Bright can help you save more than you can on your own. In your Bright Plan, set up a savings fund dedicated for home buying, assign a goal, mark your own pace, and let Bright get to work. 

Bright studies your finances and moves funds automatically, when it makes sense for you, from your bank to the dedicated fund in your Bright Savings. Bright does it in small amounts, week by week, so you're saving more regularly and reducing on interest charges. 

Bright Credit Builder can boost your credit score too. With a secured line of credit, Bright makes automatic payments for you and expands your credit ratio -- an easy way to add points to your credit score.

If you don't have it yet, download the Bright app from the App Store or Google Play. Connect your bank and start saving more in just a few clicks.

MoneyScience™ Team
Bright Money

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