A Practical Guide for First-Time Homebuyers
3 Things You Need to Know Before Getting a Mortgage
In this day and age, information is everywhere. Therefore, we need to choose our information sources wisely. And the complexity of information on real estate, investing, and business may leave you wishing you were watching Netflix instead.
This post is a comprehensive guide on preparing for your first home. I describe only the things you need to know, and inject some helpful bias and humor to lighten the mood.
In this post, you will learn:
- The main factors for getting a mortgage.
- How to put yourself in the best position to purchase a home.
- How to boost your credit score.
- Helpful tips for saving for a home.
This is a topic that most people dread learning about. And trust me, I don’t particularly enjoy talking about it either. But this is how I see it: If you start dating somebody, and you want to know their background, what do you do? You do what any rationale person in America would do. Stalk their Facebook. Take an in-depth look at their history. Hopefully, you won’t become a stage-five clinger. And you will learn a thing or two about who that person is and what they stand for.
“The credit agencies are just like Facebook. They just keep track of your financial history instead.”
Here’s the most important thing you need to know about lenders and credit scores:
If your credit scores are 550, 625, and 655, the lender will always use the middle one, known as the mid-score. I explain this in detail here. In this case, your mid-score would be 625. And if you and your spouse are getting a mortgage together, the lender will use the lowest mid-score. Keep this in mind.
If you have a good credit score, then you can skip the rest of this chapter. And if you don’t know your credit score, click here. While not 100% accurate, it will give you an idea of your status. If that doesn’t cut it for you, and you want to know your exact score, you can purchase that information here.
I was 24, and sat with a credit score of 495. What I didn’t realize then was that destroying your credit has a severe impact on your life. If you have an awful credit score, you know exactly what I mean. There is no immediate way to reverse this, and it will take a whole lot of hard work and patience to improve your score. It will not come fast, but at the end of the day it will be well worth the struggle. This is how I turned my credit score around. And also a video I did on the topic here.
Three Simple Ways to Rebuild Your Credit
- Negotiate anything you have in collections. Having items in collections may feel soul-crushing, but there is an insanely easy solution. Call the company with the collection and negotiate. Use one lump sum to entice them into settling. I’m embarrassed to tell this story, but it could help someone get over their past and focus on their future. I had a $2,800 credit card in collections for five years. While I did not have that amount of cash, I did have $780. So, I called the collection company and said, “Hey, I have $780, and it’s yours if you close the account.” They said no, but offered to put me on a payment plan of $120 a month.” I declined. And then, three months later, I called them up again and said I had $1,000, which they accepted. After they closed the account, I did the same thing with two smaller collections as well. Follow this method, and do not get on a monthly payment plan! You see, removing these debts from collections will allow you to start raising your credit score. It helped me raise my credit score from 495 to 570.
- Chances are you’re going to need some outside help — and your backup should be some form of credit repair agency. There are many agencies to choose from, but I can only speak of the one I used. The company was called Continental Credit. I have no affiliation with them, but I will say that they helped me tremendously. In essence, what they do is flood credit agencies with legal paperwork to prove their claims against you. If they don’t provide the proper paperwork in the allotted time period, they legally have to drop the claims, including collections and late payments. I used this company for nine months, and they helped me raise my score to 760. The payment was $69 a month — not a bad fee considering they helped me fix some major mistakes!
- Get a secured credit card. This is a great way to make some on-time payments and prove that you’re ready for a fresh start. I suggest Capital One Secured Card — it’s the perfect way to build credit responsibly.
If you follow these steps, you will be successful. Like I said, my credit score went from 495 to 760 in 18 months. That may sound like a long time, but it was completely worth the wait.
Remember the Basics
- Pay your bills on time.
- Never use more then 30% of your credit cards.
What’s the magic number for your credit score? What number can help you buy a house? Most people can get a loan with a mid-score of 620. Obviously, higher scores are always better. When you get to 620, evaluate if you’re ready to purchase a home. If not, then simply wait. In addition to increasing your score, waiting will give you more time to save.
Few people talk about debt-to-income ratio. But if you’re part of the new trend that we’re seeing, you need to know about it. In the past, most people would buy a “starter home.” Everyone knows what that is, so I won’t waste your time with an explanation.
What we’re seeing now, however, is that people are skipping the whole “starter home” idea. The new generation is waiting until 27, 31, or even 35 years old to buy their first home. And that’s neither good nor bad. Quite simply, by skipping the “starter home” entirely, buyers can purchase a bigger house with better amenities. And this translates to more money. So knowing your debt-to-income ratio and what it means for you is more important then ever.
If you’re not a part of this trend, and you plan on buying a starter home, this advice is still valid. In theory, what you’re trying to do is convince the bank to give you money. The best way to do that, aside from having a good credit score, is to have a good debt-to-income ratio. What is this nonsense? Well, it’s a very simple calculation. Debt % / Income = Ratio. Check out my video here.
Only incorporate your monthly debts and monthly income into the ratio.
- Debts include credit cards, cars, student loans, payday loans, etc. They do not pertain to rent, power, car insurance, or any basic bills. Here is a rule of thumb: If you don’t pay interest on the bill, then it’s not included in your debt-to-income ratio.
- Income includes anything you make from work, freelance projects, rental income, and dividend payments. Don’t forget child support if you receive it!
Take a few minutes to calculate all your debt and income, and put it in the calculator here.
Now that you have your number, how does it match up? Banks want to see 36% or lower* — that’s the rule of thumb. And you know what comes next, right? This is the part where I lecture you on paying off your debt! But I would never do such a thing. You’re an adult, and you know exactly what you need to do in your life.
“On one level, wisdom is nothing more profound than an ability to follow one’s own advice.”-Sam Harris
If you’ve ever had the slightest interest in real estate investing…
This is where your debt-to-income ratio factors in. Let’s say you purchase a home, and decide to buy a bigger home after four years. If you can secure a lease agreement with a renter before applying for another mortgage, then your original mortgage payment will not be considered a debt because it is being covered by someone else. This will allow you to secure another mortgage without affecting your future buying power. We’ll discuss this in more detail in future ebooks.
*Disclaimer: I’ve personally seen people get a mortgage with a 46% debt-to-income ratio. Rules of thumb aren’t set in stone.
Saving for a Home
You need to estimate how much money you’ll need on closing day. I created a video on how to estimate that here. Now, I could make this complicated and go in extreme depths of detail. But that’s not how people learn. I would lose you, and risk losing myself as well. So here is exactly what you need to know.
- Most working- and middle-class people can get a loan for a 3.5% down payment to a bank if these factors are in order:
- You (and your spouse) have good credit scores. Good is a mid-score of 650–750. You learned about mid-scores in the first chapter, and from my video here.
- You (and your spouse) have a debt-to-income ratio of 36% or lower (and in certain cases, higher). You learned about that in the second chapter and in the video here.
- You (and your spouse) have a big enough income to support what you’re looking for in a home. Use the calculator here to help determine what you can potentially afford. I also did a video to help describe that calculator here.
- Most buyers can get their closing costs covered. You learned about that here. There are only two options.
- Get a gift from anyone you know (i.e., wedding money, birthday money, etc.). This happens more than you’d think. And these gifts can be used for your closing costs or down payment.
- Make a good enough offer that the seller will cover your closing costs. This is typical. It’s not ideal to pay full price, which somehow hurts our fragile pride (I’m no exception). But if that’s what you need to do because you lack the savings not to, then do it. If you want to wait and save more, then that is great as well. You have to make the best decision for you and your family. Now, whole books have been written on negotiation, so here’s my shot at simplifying it:
“Homes are worth exactly what a buyer and seller agree to. This is based on local market appreciation, inventory, and condition of the home. Write an offer based on the circumstance you’re in, not the one you were hoping for.”
Learning to Save
Saving is hard. As a society, we view most addictions in a negative light. But when it comes to the addiction of money, we smile and ask for more. This is why it’s so hard to save money — because our addiction to spending is so deeply engrained in our subconscious that saving money almost seems painful.
There is one topic that few people ever talk about. The emotional factor of money is so personal that most of us can’t even acknowledge it, let alone discuss it openly.
Ask yourself this question: If I had $10,000 dollars, what would I do with it?
I mean it — really ask yourself to identify your biggest priority in life right now. If you’re reading this, I assume that one major priority in your life is to buy a home. Saving can be hard because we don’t know our priorities. And if you don’t know your priorities, then you might as well be like Arya Stark, wandering aimlessly with no direction. (Hopefully you got the GoT reference.)
“Saving is easier when you know your priorities.”
I could spend hours discussing the emotional side of money. The topic truly fascinates me. In fact, I think it’s something that society doesn’t talk about enough; and when we do, we focus on how we should save money by foregoing our morning coffee, or other small indulgences. To keep things simple, I believe we need to immerse ourselves in the three crucial aspects of money:
- How to make money
- How to save money
- How to invest money
There is a distinction between all of these. You can be great at making money, but terrible at saving money. Wealthy people become so by being good at all three aspects of money.
But that’s enough metaphilosophical talk. Let’s discuss the actual tactics of saving money for a home. Here’s what has helped me:
Four Ways I’m Saving for a Home
- Taxes. When you sign up for your job and fill out your W-2 form, you have the option to claim 0, 1, 2, 3, etc. Basically, when you choose 0, you’re telling the government to take as much money as they legally can. If you claim 1, they take less, and so on and so fourth. Here’s how I see it: I pay interest when I take a loan out from the government; and when the government takes a loan out from me, I get it back, but it’s worth less (a dollar today will always be worth more than tomorrow). If you like getting a big refund, this might be a shock for you. But trust me — you’ll save your money better than the government ever can. When I was a W-2 employee and switched from 0 to 3, I saw a $160 increase in my paycheck. That was an extra $320 a month! If you’re scared of owing taxes at the end of the year, then just raise your claim from 0 to 1, or from 1 to 2.
- Save 10% of everything you earn. This sounds simple… and that’s because it is. So, what’s stopping you from doing it? Personally, when I get my check, I divide it by 10, put that amount into savings, and spend the rest on bills and life — no matter what! Make a goal to save 10% of your next six paychecks, and then decide whether you want to continue. This has been vital in helping me shift my mentality toward saving. If you’d like to learn more about this philosophy, check out the book The Richest Man in Babylon.
- YNAB.com is a budgeting software system. Take a look at my walkthrough video here. Budgeting is an ongoing struggle, and it tends to make you more aware of your spending faults. Since nobody likes to feel those negative emotions, we simply stop. YNAB isn’t just a software system, however — they have created a budgeting philosophy that is practical and useful in everyday life. You can check out all their content here. Most of us Americans aren’t taught how to navigate our finances, which I consider one of the key elements of a happy life. If you take the time to learn about budgeting, you will experience countless practical benefits.
- Optimize your bills. This is the quickest way to save money. Don’t get me wrong — it’s about as exciting as watching reruns of Billy Mays infomercials. But it’s worth it. A podcast that gave me some guidance is available here, episode 13. I spent roughly two days making phone calls and scouring the web, and this is what I did.
- DIRECTV $55/month — cancelled
- Car Insurance $26-month — lowered
- Internet $22/month — lowered
- Gym $15/month — lowered
- Cell Phone $48/month — lowered
- Hulu $15/month — cancelled
- WWE Network $10/month — cancelled (Yes, I love wresting. I went to Wrestlemania 30, and yes, it was awesome.)
$191 saved in one month = $2,292 per year
$320 saved from taxes every month (tip 1) = $3,840 per year
Total saved in one year: $6,132
In my opinion, saving money is the hardest step. It can be a battle. But once you start, there is no better feeling in the world. The security and freedom that saving can bring are invaluable. That said, there are far better teachers on the subject of money. For example, I learn a great deal from the DoughRoller.net about investing and handling debt. His podcast is particularly good. And I learn about new ways to raise my income from the SmartPassiveIncome.com — his blog and podcast are awesome. Both sources are honest and practical.