The last couple of years have been wild for the real estate market. From home prices skyrocketing during 2021 and the first half of 2022, to now a bust due to increasing interest rates and an overall economic slowdown, it has been a tough environment for home buyers, especially first-timer buyers. Following this seven-step process will help you focus on what is within your control, so you are ready when the opportunity presents itself.
1. Budget: Before you even start looking at homes, it’s important to know how much house you can afford to buy and what your monthly payment would look like. If you haven’t already, create a budget that shows where your income is currently being allocated. This step is crucial because you might have other conflicting goals, such as repaying your student loans, or saving for retirement. You want to make sure those goals don’t go by the wayside just because your mortgage payment is too high.
A good rule of thumb is to spend less than 30% of your pre-tax income toward housing expenses. This not only includes your mortgage payment, but also home insurance, property taxes, utilities, and if applicable, HOA fees and Private Mortgage Insurance (PMI).
2. Establish a purchase price range: Once you know what monthly mortgage payment you can afford, you need to establish a purchase price range. You can use an online mortgage calculator to do this. Just enter a hypothetical purchase price and down payment, and you will see the breakdown of the total monthly payment. Most mortgage calculators should have good estimates of local property taxes, home insurance premiums, and mortgage interest rates. Adjust the home price and down payment as needed to fit within your monthly budget from step 1.
3. Save for a down payment: Part of establishing your price range will be determining how much you want to accumulate for a down payment. In an ideal world, you would want to put 20% down to avoid PMI (e.g., for a $600K house, that is $120K). In reality, this might take a while to accomplish, especially early in your career. Fortunately, putting 20% down is not your only option. For example, some lenders will accept down payments as low as 3% for borrowers with good credit if they get PMI. You may also be able to find an “attorney” mortgage that allows you to avoid the PMI even with less than 20% down. Lastly, don’t forget to save for closing costs. Those typically range between 3-5% of the total purchase price1.
Once you know how much you need to save for your down payment and closing costs, create a savings strategy (e.g., save $1,000/month in a high-yield savings account). This will give you a good idea of when you can expect to be ready to start actively looking for your home.
4. Improve your credit score: Before you apply for a mortgage, you will want to make sure your credit score is as high as possible. According to the Fair Isaac Corporation (FICO), anything above 740 is considered very good2. You can take the following steps to improve your credit score:
- Make payments on time: Between now and the time you apply for a mortgage, it’s very important that you make your payments on time. This includes credit cards, auto loans, student loans, etc.
- Lower your credit utilization: FICO is looking to see a credit utilization of less than 30%. This means that if you have a $10K limit on your credit card, you want to try and keep your balance below $3K at all times. Increasing your credit limit (even if you don’t need it) is often a good way to lower your credit utilization below 30%.
- Avoid opening new credit: Every time you open new credit (credit card, auto loan, refinancing student loans, furniture loan, etc.), the lender makes a hard inquiry into your credit history, which damages your credit score for up to a year. Opening new credit will also lower your average credit length history, which also damages your credit score.
- Check your credit reports: Check for inaccuracies or red flags on your credit reports and promptly remedy the issues if there are any (e.g., unpaid medical bill that was sent to an incorrect address). You get one free report from each credit bureau every year, so take advantage!
5. Find a local realtor: Although it might be attractive to represent yourself in the homebuying process to save on realtor cost, I would think twice before doing so. Realtors (at least good ones) should know the different neighborhoods in your area very well and have a deep understanding of real estate contracts. For example, they will know whether we are in a buyer’s market or a seller’s market, which might impact what you include in your offer. Let your realtor know your price range (see steps 1-3), and they will be able to point you in the right direction.
6. Get a pre-approval letter from a lender: This letter will show sellers that you are pre-approved for a mortgage, and that you are a qualified buyer. It’s important that you get this done early in the process, as you might fall in love with a house one day and need to quickly make an offer. When you first contact a lender, make sure to ask if they have special mortgage programs for lawyers. As noted above, this may allow you to avoid PMI even if you are not putting down the traditional 20%. Also, note that mortgage lenders make hard inquiries into your credit history even for loan pre-approval, so make sure you have accumulated the money for your down payment before you get the process started.
7 Add homestead exemption (post-closing): Depending on the state in which you live, you may be able to apply a homestead exemption to your house and reduce your property tax burden. For example, if your home is appraised for $600K and you are able to remove $40K with the homestead exemption, property taxes would only be assessed at a $560K value ($600K - $40K)*.