Everything you should know before buying your first house

By Katie Martens

Abstract: what to know when purchasing your first house - first-time buyer incentives, what mortgages are, what “points” are, what closing costs are, and how to prepare for a mortgage application.

My husband and I have purchased two homes together - our first home was only possible because of a federal government program giving first time home buyers $8,000 as a tax credit. That $8,000 literally funded our savings account when we first married. When we sold our first house, moved, and bought our second home, there were still government incentives for homeowners, but nothing as obvious or specific or awesome as $8,000. In this article, we’re going to walk through (1) first-time buyer incentives and state programs, (2) what mortgages are, (3) what “points” are in mortgage-speak, (4) what closing costs are, and (5) how to prepare for a mortgage application. These are important topics to discuss as they generally affect every potential home buyer and equip you with the right tools when start your home buying journey.

First-Time Buyer Incentives and State Programs

The word on the street is that Congress is currently contemplating bringing back the tax credit my husband and I benefited from in 2009. Instead of $8K, Congress is thinking about offering $15K in tax credits for first-time homebuyers. This incentive is known as a tax credit - dollar for dollar reductions to a person’s tax bill to promote specific consumer behaviors. Tax credits are a way for the government to encourage home ownership, and the only other tax credit that currently affects homeownership is if you chose to install solar panels on your property.

Federal programs are open to any U.S. citizen, but not everyone may qualify. Here are some of the most popular government federal programs for first-time home buyers:

  1. Government-backed loans. These loans can allow first-time buyers to get a house with poor credit or a low down payment. There are currently 3 types of government-backed loans:

    1. FHA loans - loans backed by the Federal Housing Administration, which means the lender’s have greater confidence their loans will be paid back when insured by the federal government. Often FHA loans are appealing to first-time home buyers because the loans can be given to those with poor credit, low down payment, and sometimes even having filed a bankruptcy.

    2. USDA loans - loans backed by the United State Department of Agriculture for low-income individuals in select rural areas.

    3. VA loans - available to members of the military forces and backed by the Department of Veterans Affairs.

  2. Good Neighbor Next Door. If you are a teacher (Pre-K - 12th grade), emergency medical technician, firefighter or law enforcement officer, you can take advantage of this program sponsored by the Department of Housing and Urban Development (HUD) that offers foreclosed properties at 50% of their asking price;

HomePath Ready Buyer Program. Only available to first-time home buyers who will live in the home, Fannie Mae offers the chance to purchase foreclosed properties for as little as 3% down.

Most government home buying assistance comes from state and local programs. The U.S. Department of Housing and Urban Development (HUD) maintains a list, by state, of the programs offered by each state.

What are mortgages?

A mortgage is the type of loan used to purchase property, such as a house. Mortgages can be complex, and can vary depending on the circumstances of each home buyer. Generally, you can break down mortgage loans into 3 elements:

  1. The loan term. The term of your loan refers to how long it will take you to pay it back to the lender. Generally, it’s either a 30 year term or 15 year term.

  2. The interest rate type. Generally, there are 2 types of interest rate - fixed rate or adjustable.

  3. The loan type. Mortgage loans are categorized by the size of the loan and whether they’re part of a government program. Each loan type is designed for different situations, and you may only fit one type of loan or you could fit into multiple categories for loans. It’s important to review your eligibility with your lender to find the right fit. Here are 3 general categories of loan types:

    1. Conventional. This is the majority of loans, and typically costs less than FHA loans.

    2. FHA. Marked by requiring low down payments and eligible for those with lower credit scores.

    3. Special Programs. These programs include the VA, USDA, and local state programs as discussed earlier in this article.

What are “points”?

“Points” is a term that mortgage lenders have used for many years. Some lenders may use the word “points” to refer to any upfront fee that is calculated as a percentage of your loan amount, whether or not you receive a lower interest rate. Some lenders may also offer lender credits that are unconnected to the interest rate you pay - for example, as a temporary offer, or to compensate for a problem. For purposes of this article, we’ll be discussing “points” as they are connected to your interest rate.

If you’re considering paying points or receiving lender credits, always ask lenders to clarify what the impact on your interest rate will be.

Points let you make a tradeoff between your upfront costs and your monthly payment. By paying points, you pay more upfront, but you receive a lower interest rate and therefore pay less over time. Points can be a good choice for someone who knows they will keep the loan for a long time.

Points are calculated in relation to the loan amount. Each point equals one percent of the loan amount. For example, one point on a $100,000 loan would be one percent of the loan amount, or $1,000. Two points would be two percent of the loan amount, or $2,000. Points don’t have to be round numbers - you can pay 1.375 points ($1,375), or 0.5 points ($500) or even 0.125 points ($125). The points are paid at closing and increase your closing costs.

Closing Costs

“Closing costs” in finishing the mortgage process for buying a new home always reminds me of the same process for buying a car, except at a smaller scale. You generally focus on the cost of the car itself, and then forget about all the registration and taxes you have to pay after finalizing a sale price for a vehicle. So a car that costs $22,000 actually costs closer to $23,000 because of the costs associated with buying that car. “Closing costs” in buying a new home are the same thing - they are expenses or processing fees you pay to your lender in exchange for loan services.

The specific closing costs you’ll need to pay depend on the type of loan you take and where you live.

Closing costs generally make up about 3-6% of the loan amount. If you take out a $300,000 loan, your closing costs can be anywhere between $9,000 - $18,000.

Closing costs are different from your down payment, but you can often negotiate to wrap up your closing costs into the down payment, or into the monthly payments you’ll make on the mortgage loan. Alternatively, as part of the negotiation with the seller of the house, you could split or have the seller pay the closing costs. Having the seller foot some of the closing costs obviously doesn’t work as well when the housing market is hot for sellers.

There are also limitations on how much the seller can cover for closing costs because of laws aimed at preventing fraud. Generally, buyers pay for the bulk of closing costs. As a buyer, what you’ll pay for will depend on where you live, your specific lender, and what type of loan you take.

Below is a list of common closing costs, but it’s important to remember that you are entitled to your Closing Disclosure at least 3 days before you attend your closing meeting. There are many, many costs associated with the closing on the purchase of a house, and in order to save you time, this article will list the top 5 most common closing costs. The costs that didn’t make it into the top 5 can be found in an appendix linked at the bottom of this section.

Common closing costs:

  1. Appraisal. Lenders will order an appraisal in order to get an objective valuation of the home. Sellers will often list their home for sale at a price higher than what the market values the property - don’t we all want to get the most value we can for something we’re selling? But lenders only want to pay market value, not whatever price it takes you to get a home ahead of other buyers. Appraisals are important for lenders because it will give them the amount that the lender will let you borrow for a property. Generally, even if it’s a seller’s market and you want to pay $20K over asking price because that seems to be the only way to get the house of your dreams, if you have to go through a lender, the lender will not approve a loan that doesn’t match the market value of the home. Appraisal fees usually range between $300 - $800.

  2. Attorney fees. Some states don’t allow you to close on a house without an attorney.

  3. Closing Fee. The closing fee goes to the escrow company or attorney who conducts your closing meeting.

  4. Escrow Funds. Escrow funds hold reserved money for property taxes, premiums, homeowners insurance, and mortgage insurance. Your lender keeps your escrow funds in a special account. The lender then uses the escrow funds to make payments on your behalf as part of your regular mortgage payment. At closing, your lender might require you to put a certain number of months’ worth of expenses into an escrow account. Though the number of months depends on your lender, many buyers put down 2 months’ worth of expenses at closing.

  5. Homeowners Insurance. This is a type of protection that compensate you if your home gets damaged. Most mortgage lenders require you to have at least a certain amount of homeowners insurance as a condition of your loan to cover damage. You can also get protection for the contents of your home and liability coverage if someone gets injured on your property. Many lenders require you to pay for a year’s worth of homeowners insurance at closing. A general rule of thumb is to expect to pay $35/month for every $100,000.00 in home value. So if you have a $200,000 home, your homeowners insurance will be $70/month x 12 months in a year = $840 at closing.

Mortgage Application

This article may have put the cart before the horse, so to speak, when addressing the steps to purchasing your first home. Before worrying about what makes up the cost in “closing costs” and what types of loans there are, you need to get preapproved for a loan. This means that you have to apply with mortgage lenders to get a preapproval letter that you can show to prospective sellers and their realtors in order to show that you are a serious buyer. Before you look for lenders, start thinking about these things:

  • Check your credit

  • Assess your spending

  • Budget for new or changed expenses

  • Determine your down payment

  • Decide how much you want to spend on a home

  • Consider whether it’s the right time for you to buy

  • Build a network of advisors

  • Then create a loan application packet.

Lenders will want information about your finances in order to determine whether they want to lend to you. Start gathering this information as early in the process as possible and stay organized, this is a huge help for lenders and will make the preapproval process faster.

Personal and financial information the lenders will ask for:

  • Pay stub for the last 30 days;

  • W-2 forms, last 2 years

  • Signed federal tax return, last two years

  • Documentation of any other sources of income

  • Bank statements, two most recent

  • Documentation of the source of your down payment - investment or savings account statements showing at least two months’ history of ownership. If some of the funds were a gift, get a signed statement from the giver state that the funds were a gift.

  • Documentation of name change, if recent

  • Proof of your identity (usually a drivers license)

  • Social Security number

  • Certificate of housing counseling or home buyer education, if you have one

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Appendix on remaining closing costs:

  1. Courier Fee. These fees cover the cost of transporting mortgage documents

  2. Application fee. Some lenders charge an application fee to process your loan request.

  3. Credit Reporting Fee. These fees cover the cost of pulling your credit report and looking at your credit score. Usually around $25.

  4. Discount Points. Discussed earlier in this article, lenders allow you to pay money upfront on your loan to reduce your interest rate by buying discount points (essentially, buying down your rate to save interest over the life of the loan). Your fees for any discount points will appear on your Loan Estimate under Origination Charges.

  5. FHA Mortgage Insurance. If you take out an FHA loan, you’ll need to pay a mortgage insurance premium upfront at closing, which is currently at 1.75% of your base loan amount.

  6. Flood Certification. If your home is on or near a flood plain, you may need to pay $15 - $25 for a flood certification. This money goes to the Federal Emergency Management Agency, which uses the data to plan ahead for emergencies and to target high risk zones.

  7. Homeowners Association Transfer Fee. Your homeowners association transfer fee covers the cost of moving the burden of HOA fees from the seller to the buyer. It ensures that the seller is up to date on their HOA dues. It also provides you with a copy of the association’s payment and due schedule as well as their financials. If you live in an area without an HOA, you won’t pay this fee at all.

  8. Loan Origination Fee. These fees cover the cost of processing and underwriting your loan. This fee goes to your lender in exchange for underwriting your loan and creating your loan paperwork. Expect to pay about 1% of your loan’s value in origination fees.

  9. Lender’s Title Insurance. Repays the bank if you lose your home to a title claim. You only need to pay for lender’s title insurance once at closing and is separate from owner’s title insurance.

  10. Lead-Based Paint Inspection. If you’re buying a home built before 1979, it might have lead paint, this fee covers a test for lead in the home.

  11. Owner’s Title Insurance. Optional, but it can cover you in a wide variety of scenarios. A title insurance company will cover you if a previous owner of the property brings a lawsuit against you after you purchase your property.

  12. Pest Inspection Fee. Some states require you to get a pest inspection before you close on your loan. VA loans often require a pest inspection, and can be required if the appraisal brings up issues that may be associated with a pest like termites.

  13. Prepaid Daily Interest Charges. Your lender may ask you to pay any interest that accrues on your loan between closing and the date of your first mortgage payment upfront.

  14. Private Mortgage Insurance (PMI). Your lender will require you to pay private mortgage insurance if you put less than 20% down at closing on a conventional loan. PMI protects the lender if you default on your loan.

  15. Property Tax. Fees that you pay to your local government in exchange for public services like public schools, roads, and fire departments. The amount you’ll pay in property taxes depends on where you live and your home’s value. You may be required to pay up to a year’s worth of property tax dues at closing.

  16. Rate Lock Fee. Some lenders might charge you a fee to lock in your interest rate between the mortgage preapproval and closing.

  17. Recording Fee. A recording fee is paid to your local city or county government to update public land ownership records, usually at the Register of Deeds office.

  18. Survey Fee. Some states require that you complete a land survey before finalizing the sale of a home. The fee goes to the survey company that verifies and confirms your property lines.

  19. Tax monitoring and Tax Status Research Fees. This covers the cost of hiring a company to verify that your calculated property taxes are correct.

  20. Title Search Fees. The title insurance company does title searching to look for claims on the property you want to buy - such as liens, bankruptcies or unpaid back taxes can affect your good title to that property.

  21. Transfer Tax. Goes to your local government in exchange for updating your home’s title and transferring it to you.

  22. Underwriting Fee. Goes to your lender in exchange for verifying your loan paperwork. You might pay up to $795 in underwriting fees on your loan.

VA Funding Fee. Generally, you have to pay a VA funding fee if you buy a home using a VA loan. The fee goes toward administrative costs for the VA loan program. The amount of the fee is based on the down payment and if it’s a purchase or refinance, as well as whether it’s your first time or a subsequent use of your VA benefits.