Through December 31, 2023, Experian, TransUnion and Equifax will offer all U.S. consumers free weekly credit reports through AnnualCreditReport.com to help you protect your financial health during the sudden and unprecedented hardship caused by COVID-19.
In this article:
For many people, buying a house is a big step toward fulfilling the American dream. Because a home is likely the largest purchase you'll ever make, you shouldn't take the process lightly. To buy a home that will bring you happiness but also keep you financially sound, follow our step-by-step guide.
1. Figure Out How Much House You Can Afford
It's smart to begin any shopping excursion by making a budget—and this is especially important when buying a home. You'll need to know how much you have to spend on a down payment and monthly loan payments to see what kind of house you'll be able to afford.
Housing costs vary widely around the country, and even from one neighborhood to the next, so knowing your budget will help guide your housing search. If you have the flexibility to move anywhere, you may find that you can afford a lot more house in another county or state. And even if you're anchored by work or family, you may be able to get into a larger property or better school district if you're willing to commute.
Unless you can pay for a house outright with cash, you'll need to finance your purchase using a mortgage loan. One of the biggest factors that determines what you'll be able to afford is the amount you can offer as a down payment. Your down payment amount will affect the fees and interest you're charged on the mortgage, as well as how much you'll pay each month in a mortgage payment.
Lenders use something called a loan-to-value (LTV) ratio to describe the percentage of a property's value they are lending to you—in other words, the portion of the purchase price you don't put down in cash when you buy the house.
Consider the example of a house that's priced at $250,000. If you make a 10% down payment ($25,000) on the property, the LTV ratio on the mortgage you'd need to buy the property would be $225,000 divided by $250,000, or 90%. If you increase your down payment to $50,000, or 20% of the purchase price, the LTV ratio would decrease to 80%.
"Conforming mortgages," which meet the purchase criteria set by Fannie Mae and Freddie Mac, the government-sponsored enterprises that ultimately buy and manage most of the nation's single-family-home mortgages, must have an LTV ratio of 80% or less—meaning a down payment of 20% or more.
Conventional mortgage lenders may issue "nonconforming" loans with LTV ratios as high as 95% (i.e., a down payment of 5%), but they typically charge significantly higher interest rates and fees on them than they do with conforming loans. They also typically require the purchase of private mortgage insurance on loans with LTVs greater than 80%. If you qualify for a federal home loan program, however, you may be able to get a mortgage with a lower down payment, lower interest rate and fewer fees. More on that below.
In addition to the down payment, you may need to cover some or all of the following expenses during the homebuying process:
- Private mortgage insurance: If your down payment is less than 20% of the purchase price, your lender will likely require you to buy private mortgage insurance to reduce their risk in case you fail to pay your mortgage. This is typically added to your monthly mortgage payments and, in many cases, can be removed once you've paid down your mortgage to under 20% of the house's value.
- Origination fees: Mortgage lenders typically charge processing fees, or "points," in which each point equals 1% of the amount you're borrowing. The sizes of these fees vary, but they're generally about 0.5% to 1.5% of the loan amount. You'll usually pay these fees upfront when the home sale closes. In some cases, the fees are financed along with the rest of the mortgage, which can add significantly to the overall cost of the loan.
- Attorney fees: While not required by your lender, for your own protection it's essential to hire an attorney with experience in real estate law and local property ordinances who can review your offer letter(s) and any sales contracts prior to closing. Your attorney will make sure your interests are protected in the course of the sale.
- Additional costs: Other costs to consider include fees for the following services, which are discussed in more detail below.
- Home inspection
- Home appraisal
- Title search. This allows you to check on any outstanding tax bills, liens or other financial encumbrances that may be attached to the property. It can also help uncover any legal or contractual requirements that limit what you're allowed to do with the property or compel you to give third parties access to it (as in the case of a utility company's right to access pipes or cables that cross or adjoin your property).
2. Get Your Credit Mortgage-Ready
When you apply for a mortgage, your lender will likely begin the process by requesting your credit report and credit score from one or more of the three national credit bureaus (Experian, TransUnion and Equifax). Lenders may decline your application if your credit score falls below a certain minimum. That minimum score varies from lender to lender, but usually falls around 620 on the FICO scale of 300 to 850. Most lenders will reject applicants with a FICO® Score☉ lower than 580.
If your credit score only meets your lender's minimum requirements, you'll probably pay relatively high interest rates and fees on the loan. Lenders typically charge borrowers with lower credit scores more than those with higher scores, and borrowers with exceptional credit (a FICO® Score of 800 or better) typically pay the lowest available interest rates. This can save tens of thousands of dollars over the life of a mortgage.
At least three to six months before you begin house hunting or seeking preapproval for a mortgage, it's a good idea to check your credit report and credit score to know where you stand. You can get a copy of your credit report from each credit bureau once a year at AnnualCreditReport.com, or get your Experan credit report and score for free. Once you've done so, take the following steps to get your credit mortgage-ready:
- If you see any inaccuracies on your credit report, they could be hurting your credit score, so follow up with the credit bureaus to correct the record.
- If your credit score is lower than you'd like, consider taking six months to a year to try to improve your credit score before you apply for a mortgage.
- If you're ready to proceed with your home search, avoid applying for new loans or credit cards at least six months before applying for your mortgage (or mortgage preapproval). The credit checks associated with those applications temporarily lower your credit scores, which can work against you when you apply for a mortgage.
Taking on additional debt also increases your debt-to-income (DTI) ratio, the percentage of your gross monthly income that goes toward repaying debt. Many lenders look at DTI ratio, along with credit scores and income, when considering mortgage applications. A DTI ratio greater than 40% will give many lenders pause, and a DTI ratio of 50% or more is typically grounds for declining an application.
3. Find the Right Real Estate Agent
It's important to work with a real estate agent who will represent your interests, particularly if you're new to homebuying or are searching for a home in an unfamiliar area. A buyer's agent can help you arrange mortgage preapproval, research similar properties to help you negotiate a fair price, advise you about the pros and cons of different communities and neighborhoods, and escort you to view homes.
Talk with several agents, ideally from different brokerages or offices, to find one who suits your style and instills confidence. Once you've found an agent you like, it's wise to sign a contract that provides them with a commission after a successful sale. The seller of the home pays the commission, but as the buyer you're responsible for seeing that it gets to your agent.
Once you've selected your agent, inform any other agents you meet (at open houses, for example) that you're already working with someone, to avoid any potential conflicts.
4. Consider a Loan Program
Find out whether you qualify for any federal loan programs designed to help you get a home loan. These programs can be especially helpful if you're a first-time homebuyer, you have a credit score below the minimum required for a conventional loan, you have a low income or you are a member of the military.
Available programs include:
Federal Housing Administration (FHA) loans: FHA loans are designed to help first-time buyers get into their first home by having less stringent requirements than conventional loans. You can get an FHA loan with as little as a 3.5% down payment.
U.S. Department of Agriculture (USDA) loans: USDA loans are low-interest, zero down payment loans available for select properties in rural and suburban areas of the country.
U.S. Department of Veterans Affairs (VA) loans: Qualifying U.S. veterans, service members and surviving spouses may take advantage of zero down payment VA loans.
5. Get Preapproved for a Mortgage
During mortgage preapproval, you work with a lender to go through most of the home loan application process, including credit checks and verification of your employment and income. The lender then provides you with a document indicating how much they're willing to lend you and at what interest rate. Mortgage preapproval confirms your ability to make a purchase and adds credibility to any offer you make on a property.
Because mortgage preapproval requires going through nearly every step in the mortgage application process, it makes sense to compare the deals you can get from multiple lenders in an effort to get the best borrowing terms. Be aware that lending terms (interest rates, fees, etc.) won't be locked in until you formalize a loan application, but seeking preapproval from multiple lenders can help you get the best available deal.
When selecting potential mortgage issuers, it's a good idea to get a mix of local and national lenders, and perhaps trying one or two online mortgage companies as well. Your own bank or credit union is always a good starting point, and your real estate agent may be able to suggest lending institutions or mortgage brokers as well.
6. See and Compare Multiple Homes
The ideal house for you and your family may not have been built yet, and if it exists, it may not be for sale in the area where you are house hunting. Buying an existing home can require some compromises on your wish list of housing features, but it can also bring welcome surprises, such as design touches or landscaping flourishes you didn't know you'd love. The only way to find the best option for you is to check out plenty of houses.
A thorough exploration of the local market, with guidance from your real estate agent, can help you understand the full range of choices, trade-offs and deals at your disposal. Attend open houses and have your agent arrange plenty of private walk-throughs on properties that fit your budget, geographical requirements and other needs. (If there are only a few properties available to compare, you may want to consider loosening some of your criteria so you have a wider range of choices.)
If you're looking for a significant bargain, you can even ask your agent to look into homes under foreclosure. If you do, recognize that these homes may have been vacant for a time, and could be in a state of disrepair or outright neglect, so proceed with caution (and be prepared to roll up your sleeves or hire contractors to get the property in shape).
The more homes you compare, the better sense you'll get of which ones are overpriced and which are bargains—and you may find yourself shifting away from your original preferences as well. If you start out looking for a charming older home, for instance, but find yourself gravitating to the designs and materials found in newer construction (or vice versa), that's fine. It's OK to let your criteria evolve as you learn more about the market—and experiencing lots of properties is one of the best ways to learn.
7. Make an Offer
Once you've found the house you want, notify the seller of your bid in a document known as an offer letter. This should be a brief one-page note indicating your willingness to purchase the property, how much you're willing to pay, and a proposed timeline for closing the deal. Timing on some of these events may be subject to state or local laws, so take your real estate agent's cues on how to best communicate your flexibility and willingness to accommodate the seller.
Determining the right bid is a mix of art and science, and your real estate agent should be a major resource here. Factors that influence your bid include the seller's asking price and how realistically it compares to sales of similar properties nearby; the level of demand for houses in the neighborhood, and how quickly neighboring properties are selling; and the likelihood that competing bids will be under consideration along with yours.
Your offer letter should communicate your serious intention to buy the house and, if it's realistic for you, can convey willingness to accelerate the closing process or otherwise streamline the sale for the seller. Your agent typically will include a copy of your mortgage preapproval letter along with the offer, to show that you are equipped to complete the sale.
Winning offer letters often include a few personal touches. You might indicate, for instance why the property is so appealing (in terms that are complimentary to the seller). You might also briefly state what it would mean to you and your family to live there.
Once the offer letter is prepared, your real estate agent can manage the submission, working with the listing agent who represents the seller. You can expect one of three responses:
- Acceptance (hooray!). A signed letter of acceptance from the seller puts you and the seller "under contract," paving the way for a home inspection and scheduling of a closing date.
- Counteroffer. The seller's counteroffer might suggest a higher price than you bid, or perhaps seek to modify your closing timeline. You can choose to walk away at this point or, working with your agent, accept the counteroffer or submit another offer of your own.
- Rejection. Strictly speaking, a seller can simply ignore an offer they don't want to consider. Your agent and the seller's agent should be in communication, however, so you'll learn whether your offer is turned down and, ideally, why it was. Sometimes the reason has nothing to do with you (the seller has second thoughts about putting the house on the market, for instance). In other cases, however, you may learn something that will help you make a better offer (or offer letter) the next time.
8. Get a Home Inspection and Appraisal
Once your home is under contract, it's critical—and required by virtually every lender—that you get the home examined by a licensed home inspector. The inspector will check the building for structural problems such as a leaky roof or windows, insect damage or infestation, and outdated or faulty electrical or plumbing work.
While you pay for the home inspection, you're not on the hook for needed repairs. Depending on the extent of any issues the inspector uncovers (and per provisions spelled out in your offer letter), you can negotiate with the seller to make fixes as a condition of the sale; discount the sale price based on the estimated cost of any remedies or repairs; or void the sale altogether.
If you're financing your home, your lender will also require you to pay for an appraisal by a professional of their choice. The appraisal is intended to document that the home's resale value aligns with those of similar properties in the area. This protects the lender in case you fail to make your mortgage payments and they have to foreclose and sell the house to recoup what you've borrowed.
9. Close on Your House
On closing day, you, your attorney, and representatives of the mortgage lender and seller will meet at a neutral location—often the office of one of the attorneys, or of a title company that tracks and facilitates real estate transactions.
You'll need to bring the following items:
- A cashier's check in the amount of your down payment plus any applicable fees.
- Proof that you've insured the home for the full amount of its sale value. In addition to basic fire and casualty insurance, in some areas you may need supplemental coverage for flooding, earthquakes, windstorms, and so on.
- Depending on location, you may need documents that prove you've paid any applicable "transfer taxes" on the sale.
- Any reports you have from building inspectors or other professionals, including estimates of any repair or remediation costs that are to be accommodated in the sale price.
Once all the documents are wrangled and judged acceptable by all parties, you'll sign the sales contract and related documents, and acknowledge various disclosures and explanations. Don't sign anything you don't understand, and don't be afraid to ask questions, especially of your attorney.
Once you've "passed papers" and signed all the documents, you'll receive the keys to your house. The process of buying a home can be nerve-wracking, but as long as you've followed these important steps, the thrill of entering your new home for the first time can make it more than worthwhile.