Buying your first home can be an exciting and nerve-wracking experience. You not only have to find the right place, but you also have to find the right mortgage. With low inventory in many local markets and rising home prices nationwide, finding an affordable home can be a challenge.
You might feel pressure to find a home right away, but before you visit houses and start making offers, your financing needs to be in order. That involves making sure your credit history and credit score, debt-to-income ratio and overall financial picture will convince a lender that you’re creditworthy enough to borrow money.
Many first-time buyers tend to make a number of missteps in the mortgage and home-buying processes. Here are some of the most common mistakes to avoid.
1. Not Keeping Tabs on Your Credit
No one likes surprises, especially before buying a house. If you (and/or your spouse) have obvious credit issues – such as a history of late payments, debt collection actions, or significant debt – mortgage lenders might offer you less-than-ideal interest rates and terms or deny your application outright. Either situation can be frustrating, and can push back your ideal timeline.
To tackle potential problems in advance, check your credit report for free each year at annualcreditreport.com from each of the three credit reporting agencies: Transunion, Equifax and Experian. Look for errors and dispute any mistakes in writing with the reporting agency and creditor, including supporting documentation to help make your case. If you find current but accurate negative items, such as late payments or delinquent accounts, there’s no way to remove those items quickly. They’ll stay on your credit report for 7 to 10 years. But you can boost your score by paying your bills on time, making more than the minimum monthly payments on debts and not maxing out your available credit. Above all, be patient; it can take at least one year to improve a low credit score.
Also, check to see if your bank, credit union or credit card provider gives you free access to your credit score. If your score is below 620, you may have trouble getting approved for a conventional mortgage. To qualify for an FHA loan, you’ll need a minimum credit score of 580 to use the program’s maximum financing (3.5% down payment), or a minimum score of 500 with a 10% down payment required.
2. Searching for Homes Before Getting Pre-Approved
When you find the perfect house, there’s no time to waste. In many hot markets, you’ll be up against multiple bids and stiff competition. Sellers are unlikely to consider offers from buyers who don’t have a pre-approval letter from a lender. A pre-approval letter shows a seller that the lender has done its due diligence to ensure you have the means and motivation to repay your bills, based on your credit history and score, income and employment history, financial assets, and other key factors.
In a competitive market, sellers won’t take you seriously without a pre-approval letter, and you could lose out on a home you really want. This document lists the loan amount for which you qualify, your interest rate and loan program, and your estimated down payment amount. In some cases (especially for higher-cost homes or in super competitive markets), lenders might ask you to provide proof of funds for a down payment. The pre-approval letter also includes an expiration date, usually within 90 days.
3. Not Shopping Around for a Mortgage
Homebuyers can leave a lot of money on the table when they don’t shop around for a mortgage. Applying for a mortgage with a few different lenders gives you a better sense of what you can afford, and lets you make an apples-to-apples comparison of loan products, interest rates, closing costs and lender fees. More important, shopping for a mortgage puts you in a better position to negotiate with lenders to get the best deal possible.
As you shop lenders, pay attention to fees and closing costs, which can add up at the closing table. While some of the pricing variances may not seem big on paper now, they can add up to significant cost savings over the lifetime of your loan. Keep in mind that some lenders will offer you discount “points,” a way to buy down your interest rate upfront, which increases your closing costs. And other lenders that promote low or no closing costs tend to charge higher interest rates to make up the difference.
In addition to checking with your current financial institution (a bank or credit union), ask a mortgage broker to shop rates on your behalf. Mortgage brokers aren’t lenders; they act as a matchmaker between you and lenders in their network. They can save you time and money by comparing multiple lenders who have products that fit your needs. Also, it’s worth looking into some direct lenders, either online or in-person, to see what they offer.
By applying for a mortgage with several lenders, you’ll receive loan estimates to compare rates and closing costs side by side. Also, if you do most of your rate shopping within 30 days, the multiple credit checks lenders perform will count as one "hard inquiry," as the credit raters call it, and are unlikely to lower your credit score. There’s no golden number of lenders you should shop, but having three to five loan estimates in hand will give you a strong basis for comparison.
4. Buying More House Than You Can Afford
When a lender tells you that you can borrow up to $300,000, it doesn’t mean you should. Why not? If you max out your loan, your monthly payments might not actually be manageable. Typically, most prospective homeowners can afford a loan amount between 2 and 2.5 times their gross annual income. In other words, if you earn $75,000 per year, you might be able to afford a home priced between $150,000 and $187,500. Investopedia's mortgage calculator can help you estimate monthly payments, which is a better barometer of whether you can afford a home in a certain price range.
Buying more house than you can reasonably afford can land you in trouble if you have to stretch your monthly budget to make mortgage payments. In other words, you might wind up feeling “house poor” and feel buyer’s remorse. Also, consider that homeownership comes with added expenses outside of those monthly mortgage payments. You need to save for inevitable maintenance expenses, repairs, homeowner’s association fees (if applicable), and other costs that you haven’t had to pay as a renter.
Stretching your monthly budget to cover your mortgage might also mean you can’t save up for an emergency or those house repairs, and it will eat up your cash flow for other financial goals, too.
Bottom line: Don’t fixate on the maximum loan amount for which you’re approved, but on whether you can afford the monthly mortgage payment at that price point. First-time homebuyers might want to be extra cautious and buy a home below their max budget.
5. Not Hiring a Real Estate Agent
Trying to search for a home on your own is time-consuming and complicated. A professional, experienced real estate agent can help you narrow down your choices and spot issues, both with the physical property and in the negotiation process with sellers. Some states require a real estate attorney to handle the transaction, but attorneys won’t help you search for a home; they can help you draft an offer, negotiate the purchase agreement, and act as a closing agent.
Also, if you go on showings without your own real estate agent, a seller’s agent might offer to represent you. This can be dicey because that agent doesn’t have your interests in mind; their goal is to get the highest and best offer for the seller. Having your own agent, whose interests are more aligned with yours, will help you make more informed choices.
Best of all, the cost of enlisting an agent won’t come directly out of your pocket. As a buyer, you generally don’t pay the buyer agent’s commission. It’s generally paid by the seller to the seller’s agent who then splits the commission with the buyer’s agent.
6. Opening (or Closing) Lines of Credit
You can still be denied a mortgage even after being pre-approved for one. Mortgage lenders check your credit during pre-approval and again just before closing before giving you the final green light. In the interim, maintain the status quo in your credit and finances. That means not opening new lines of credit or closing existing lines of credit. Doing so can lower your credit score and increase your debt-to-income ratio – both key reasons for a lender to deny final approval.
Instead, wait until after you’ve closed on your home to take out new lines of credit (like a car or auto loan, or a new credit card). And while it’s great to pay off a credit card account or loan before you close on your home, closing the account removes that credit history from your report. Length of credit is one of the key factors credit reporting bureaus use to generate your credit score. Instead, leave the account open and active, but don’t use it until after closing. (Note: Some credit card companies may close your account for long-term inactivity, which can negatively affect your credit, too. Keep accounts active by making small purchases that you pay off immediately and in full every month.)
7. Making Big Purchases on Credit
Just as opening or closing lines of credit can ding your score, so can running up existing accounts. Again, keep your credit and finances stable until you close on your home. Use cash instead or, better yet, delay buying new furniture or a TV until after closing.
Also, you want to get a sense of how your budget will handle your new homeownership costs. You might want to wait a few months before adding more monthly payments for big purchases to the mix.
8. Moving Around Money
Another big no-no in mortgage underwriting: making large deposits or withdrawals from your bank accounts or other assets. If lenders suddenly see unsourced money coming in or going out, it might look like you got a loan, which would impact your debt-to-income ratio. Lenders aren’t worried about transparent deposits, like a bonus from your employer or your IRS tax refund. But if a friend wires you money or you receive business income in your personal account, a lender will demand proof to verify that the deposit isn’t a disguised loan. Expect a lender to ask for a bill of sale (if the deposit is from something you sold), a canceled check, or a pay stub.
You can use a gift from a relative or friend toward your down payment. However, many loan products require a gift letter and documentation to source the deposit and verify that the donor isn’t expecting you to pay back the money.
9. Changing Jobs
While changing jobs may benefit your career, it may complicate your mortgage approval. A lender wants to ensure you have stable income and employment, and that you can afford to repay your mortgage. If you were preapproved for a mortgage based on a certain income and job, any chances in the interim before closing can be a red flag and delay your closing.
For approval, you generally must provide proof of two consecutive years of steady employment and income. When you change jobs, that continuous record of income and employment is disrupted, particularly if you take a lower-paying job. Also, if you switch to a role that pays 25% or more of your salary in commissions, you must prove you’ve earned that income over two straight years. Whenever possible, lenders recommend waiting to switch jobs until after your loan closes. If that’s not doable, tell your lender right away.
10. Skipping the Home Inspection
Unless you have a lot of cash to fix up a home and are willing to risk having to pay for unforeseen repairs, waiving a home inspection can be a costly mistake. Why? Home inspections are meant to find major issues with a home, and they protect you (the buyer). If you don’t get an inspection, you will have no recourse if a major issue, such as cracked pipes or water damage, surfaces after you close on a home. That means you might be footing the entire bill to fix those issues. When you make an offer on a home, you can include a home inspection contingency that gives you a penalty-free exit from the deal if a major issue is uncovered and the seller is unwilling to fix it before closing.
With that contingency in place, you can withdraw your offer and usually get your full earnest money deposit refunded. The home inspection fee is non-refundable and typically paid by the buyer to the home inspector up-front, and can typically range from $300 to $500, depending on location and the size of the property. It’s a small price to pay when you weigh it against potentially shelling out thousands of dollars to replace a furnace, water heater, roof or other big-ticket items. You might consider additional inspections, such as a pest inspection, mold or radon inspection, or a sewer scope, for example, if your lender requests it. These and other inspections can help protect your investment and safety.
11. Not Comparing the Loan Estimate to the Closing Disclosure
Your lender is required by law to provide you with the closing disclosure three business days prior to your closing date. This document lists the exact costs you’re expected to pay at closing, including your down payment, closing costs, loan details and terms, and other important information. It’s a five-page document so take time to compare it against the initial loan estimate you received to make sure you aren’t being charged extra fees (called junk fees) by your lender or other parties involved in the transaction.
Also, if certain fees go up more than expected, ask your lender to explain why. Make sure basic details, such as your name and other identifying information are listed correctly so you don’t run into paperwork issues on closing day. If you find errors or questionable or unexplained extra fees, tell your lender immediately so those issues can be addressed. In some cases, your closing might have to be pushed back to ensure the paperwork is corrected and updated and all issues are resolved.
The Bottom Line
You don’t want to inadvertently sabotage your mortgage – and your home purchase. Some of these mistakes seem innocent, but they can sidetrack your closing and create massive headaches. Talk to your lender about what you should do from pre-approval to closing to ensure a smooth process. And try to keep all of your documents – bank statements, W-2s, deposit records, tax returns, pay stubs, etc. – organized and updated so you can provide documentation if your lender requests it.
When it comes time to buy your first home, being well-read and educated about the lending and real estate process can help you avoid some of these mistakes and save money along the way. Further ensure that the transaction goes smoothly by having trained, experienced professionals by your side to guide you. This can alleviate some of the stress and complexity along the way.