How to Buy a House for First Time Homebuyers in 14 Steps
The home buying process might seem like a daunting task. A house is probably the most expensive purchase that you’re ever going to make in your life and there are lots of steps involved. The following is a guide how to buy a house for first time homebuyers.
“What’s the process?”
As a realtor, this is the number one question I get from nervous first-time homebuyers who never went through the purchase process before. I try to provide a broad overview of the process and do my best to simplify and explain each step. It’s a lot to take in, especially in verbal conversation. This post aims to demystify the home buying process.
Summary of the 14 Steps to Buy a House For First Time Homebuyers
- Do your research – narrow down what you want
- Determine how much house can you afford
- Get a preapproval letter from a mortgage lender or bank
- Find and work with a trusted Real Estate Agent
- Begin House Hunting
- Make an offer
- Attorney Review (Some states)
- Apply for a mortgage by completing a loan application
- Complete a Home Inspection
- Getting the Home Appraised – Appraisal Process
- Get Covered with Homeowners Insurance
- Schedule Your Final Walkthrough before Closing
- Attend the Real Estate Closing and Sign All the Necessary Paperwork
- Move In!
Do your research – narrow down what you want
The first step is to do research and define what you are looking for. Think about what you want your house to look like.
This includes
- # of bedrooms
- # of bathrooms
- Size/Square Footage
- Outdoor Space
- Parking
- Basement
- Type of house (condo, co-op, single family home, multifamily home)
- School district
- Commute time to work
Once you have your wish list, go to Zillow, Trulia, Realtor.com, Redfin, or any other real estate listing site. Explore different locations to get an idea of what your money gets you.
When searching through neighborhoods, use google street view to do a virtual drive-by of the neighborhood. Search message boards and google for information on the community, school rankings, cost of living, crime, safety, walkability, medium income and demographics.
Also consider if you want to purchase a house that is move-in ready or if you are willing to do some TLC and get a fixer upper at a discount.
Tip: As you look online at prospective houses, note that pictures may be different than real life. It’s like the Instagram vs reality memes. Professional photographers usually photograph the properties and may use camera tricks and editing to make the house nicer than it might be when you visit.
Determine how much house can you afford
Know your credit score
Your credit score is important in the home buying process and helps lenders determine how likely you are to repay a loan. This score affects how much you can borrow and the interest rate.
You are entitled to a free copy of your credit report each year.
Go to https://www.annualcreditreport.com/ to get your report.
Ensure you have a cash cushion
A rule of thumb is that a home should cost 3 to 5 times one’s annual household income. For instance, if you and your spouse make $150,000, you should target homes that are in the $450k to $750k price range.
You’ll need to save for a down payment and closing costs. In addition, you should have six months of living expenses in an emergency fund. Besides the down payment and closing costs, there’s other housing expenses you should consider as well including moving costs, utilities, new furniture, etc. Lenders will look to see that you have some reserves if they approve your mortgage loan.
Where should you put your down payment?
Your 20% down payment can amount to a significant amount of money and it should be put in relatively safe investment vehicle.
If you are planning to purchase a house within a year, put the down payment money in a high yield savings account that is FDIC insured. I like Marcus by Goldman Sachs which is an online high yield savings account that as of Nov 2021 is yielding 0.5% interest. If you keep your deposit in a regular savings or checking account you’ll earn much less interest (~0.05%) and will lose money to inflation but at least with this account, you might be able to offset some of the inflation with interest you earn.
If your purchase time frame is longer, consider putting your down payment in a penalty-free certificate of deposit (CD). It is not advisable to invest this money in the stock market because the stock market is risky and you can lose money if there is a downturn. Getting back to where you started could take several years and put your house buying plans on hold – don’t take a chance.
Get a preapproval letter from a mortgage lender or bank
Before you start looking at houses, you need to know how much you can spend on a home purchase. Some sellers might not even look at your offer unless it includes a mortgage preapproval letter from a lender.
Schedule time to talk to a mortgage banker at a local branch of your bank to see what is required to get preapproved. The mortgage banker will ask you to provide some financial information such as income (W2, pay stubs, bank and brokerage accounts, etc) and current debts (car loans, student loans, credit card debt, etc). The lender might check your credit score with a “soft pull” and will review your financial documents to verify sufficient assets for down payment and closing costs.
Note that you don’t need to use the bank where you received your preapproval.
Preapproval letters are usually good for 60 to 90 days. Don’t worry if your home search takes longer than 90 days, the lender can issue another one.
Tip: Share your preapproval letter with your realtor (see the next step). But, when making any offer to purchase, get a new preapproval letter where the preapproval amount is equivalent to your offer amount that you present to a seller. You’re essentially showing your hand if you show that your preapproval is higher than your offer amount. Don’t reveal this information to the seller that you can possibly pay more.
Find and work with a trusted Real Estate Agent
Once you have a preapproval and a wish list for your future house, find a good real estate agent who is experienced and knowledgeable about the area where you plan to search. Leverage your social network to find good realtors. Great real estate agents are usually referred by happy clients through word of mouth. You can also look online for agent reviews (read both the good and bad reviews).
Things to look out for when finding a real estate agent:
- Because an agent might be good at search engine optimization on google, does not make him/her a good agent, just marketing savvy.
- Don’t just walk into a real estate office or cold call a real estate broker. Many offices might pawn you off to an agent that is part of a rotation or who is just readily available. You want your agent to be seasoned, knowledgeable about the buying process, has negotiating skills and is familiar with the area.
- If using Zillow or another real estate website, note that “contact agent” forms on a listing might not contact the listing agent but could be contacting a random real estate agent who is paying for a lead.
- Even if you are trying to contact the listing agent, you should get a different agent to act as your buyer’s agent. Why does this matter? A buyer’s agent must act in the best interests of the buyer, while a seller’s agent must act in the best interests of the seller. If an individual acts as a dual agent, he or she has to represent both sides of the negotiating table – not an easy task. As a dual agent, that person might be entitled to dual commissions as well.
Real Estate Agent Commissions
It might differ depending on the state but in NJ, real estate agent commissions are negotiable. Sellers might not know this but they can negotiate the commission and it is agreed prior to the sale. The typical range in NJ is 4-6% and is built into the listed sales price. If you are a buyer that thinks they can get a deal by dealing directly with the listing agent, that’s not the case. Before a house is listed, the sales agreement states a commission that is paid and the buyer doesn’t have a say here.
How Real Estate agents get paid
No one talks about this but it’s important to understand how people you work with are compensated. This goes for realtors but also financial advisors and other jobs where an agent is involved in the transaction.
In real estate, the commission is split between the buyer’s agent and the seller’s agent. And many people don’t know this but the agents split their share of the commission with their broker. A typical commission split is 50/50.
Example of a Real Estate Commission Split
A home sells for $400,000 and has a 6% commission to the realtors involved in the purchase and sale of the home. $400,000 *.06 = $24,000
$24,000/2 = $12, 000 to each brokerage involved in the transaction
$12,000*50% split = $6000 to the agent and $6000 to the agent’s broker
It’s good to understand how agents are compensated. As you can see, these commissions are not like what Josh Altman or Josh Flagg rake in on Million Dollar Listing Los Angles.
Begin House Hunting
Once you have an agent, he or she can schedule private showings of active property listings in your target area. These homes might not check all of the boxes in your wish list but it’s important to visit a few houses and compare.
Don’t be fooled by beautiful staging done by a professional interior designer. When visiting a house, especially one that you are interested in, do a thorough inspection. Take pictures (if you are allowed) and take notes.
Checklist of items when house hunting
- Check under carpets for damaged or scratched floors
- Test plumbing by flushing toilets and turning on faucets and showers to test water pressure
- Turn on light switches
- Open and close windows to see if they do open. If they do, open the windows and listen if you can hear noise from traffic or neighbors
- Look for any insulation gaps where air is coming in and could lead to higher heating bills
- Check the basement for mold or odors
- Pay attention to any structural damage or cracks in the foundation, walls, or ceiling
- Look for evidence of water damage on the ceilings
- Cross the street and look at the roof and gutters
- Walk around the neighborhood and note how the other houses look. Are they well maintained?
- Is there ample parking when family and friends visit?
- How far is the house located from public transportation, the supermarket and restaurants?
TIP: Don’t just walk into an open house without being prepared. You should have a buyer’s agent who is working for you. Usually, open houses are hosted by a listing agent or member of a listing agent’s brokerage team. If you are interested in the home, the listing agent will be more than happy to act as a dual agent and earn a dual commission where he/she might not be looking out for your best interests. Open houses are generally used by brokerages to build a rolodex of leads that can generate commissions. By showing up and signing in, you indicated that you’re in the market and the agent will likely reach out to you to help in your search.
Note: The 2020-2022 COVID housing market has been insane where open houses have proven to be extremely effective in getting eyeballs and foot traffic into a home. My observation above is regarding “regular” markets where open houses tend to be a lead generator for agents.
Make an offer
You searched and searched and found a home that you like. Now, it’s time to make an offer!
Before making an offer, ask your realtor to provide “comps” or comparable recent sales in the area for the past 6 months. Use the information from the comparable sales to help structure an offer agreement. Your agent might have suggestions on what to offer as well.
Your real estate agent should be able to draft a contract to purchase the home.
In some states, such as New Jersey, you aren’t expected to fully understand the legal document that you are signing and should retain an attorney to help you through this process. More of this will be in the attorney review step.
Important elements in an offer:
An offer is a legal contract that you agree to purchase the property according to certain conditions. The offer indicates how much you are offering for the property, your down payment, how you are going to make the purchase (all cash or getting a mortgage), and other conditions which may include the following:
Earnest money deposit, sometimes called an escrow deposit, is an upfront deposit to show the seller that you are serious and interested in the house. Depending on what state the property is located, the earnest money deposit can be 3-5% of the purchase price. In New Jersey, 5%-10% is typical. If you back out and do not purchase, the seller can keep the earnest money deposit. This sounds pretty scary but there are certain contingencies built into the agreement where you might have the opportunity to back out and get your entire earnest money deposit back. Consider the conditions of the offer and do not waive your contingencies!
Contingencies listed below will allow you to walk away and get your EMD back. You can’t simply change your mind and back out because you get cold feet.
Mortgage contingency
If a buyer needs to finance the purchase by obtaining a mortgage, this contingency protects the buyer in case they can’t qualify for financing and can’t afford the house without a loan.
Appraisal contingency
When a lender provides a mortgage to an individual, the lender uses the property as collateral which means that the lender can foreclose on the property if you are unable to make payments. The lender wants to reduce its risk and wants to ensure that the house you are buying is worth more than the loan that it is lending out to you. The mortgage company hires an independent third-party appraiser to provide an estimate of value of the home to get a fair market price. The appraiser may visit the property and make an assessment based on recent sales and comparable properties in the area.
If the appraisal comes in lower than your offer amount, the bank may not issue a mortgage unless you put more money down as a down payment or renegotiate the offer price. If the seller is unable to compromise, you have the option to walk away and get your earnest money deposit back.
Home sale contingency
If you have a house that you need to sell in order to have the funds to buy the new home, you can include the home sale contingency in your contact. This contingency allows a buyer a certain period of time to secure a buyer for their current home. If you are unable to find a buyer for your current home, you can get your earnest money deposit back. The home sale contingency is used less and less these days. Many sellers refuse this contingency but it depends on your situation and market conditions.
Inspection contingency
An inspection contingency allows a buyer to hire a professional home inspector within a certain time period. This helps a buyer understand any necessary repairs or potential issues with the house. An inspector provides an inspection report and a buyer can decide if the seller should address these issues, either by making the necessary repairs or adjusting the purchase price. A seller does not have to agree to do anything. If the buyer and the seller cannot come to an agreement, the buyer can walk away and get their earnest money deposit back.
Tip: Do not waive inspection or mortgage contingency! If you do, you run the risk that you’re overpaying or may be surprised by hidden issues after you make the purchase. In a competitive or “hot” market, some people get caught up in winning a bidding war. These people might sweeten their offer by waiving contingencies but they are waiving their protections and might absorb the future repair costs or have difficulty selling the house at the price that they paid when they are ready to resell the home down the line.
Other housing costs to consider
When making an offer, consider that in addition to a down payment, the transaction will have closing costs which are typically 2% to 5% of purchase price depending on the market. Also, after you do purchase the home, you might have to have money for potential repairs.
Request utility bills from past 12 year to understand and anticipate what your future utility bills are going to be.
Negotiate
A seller might not accept your initial offer and he/she might counter or simply reject it. This is where a seasoned real estate professional can help and work on creative ways to reach an agreement.
If a seller does agree to your offer and its terms, congratulations! You will need to prove your earnest money deposit / good faith deposit and the seller will take the house off the market and list it as “DABO” – Deposit Accepted By Owner or “under contract.” When a property is under contract or DABO, the house will no longer be shown to potential buyers.
Attorney Review (Applicable in some states)
Some states provide time for an attorney to review the contract and ensure that you are legally protected. It’s always good to have a legal professional review any contracts, even if it’s not required. Your real estate agent should be able to provide recommendations and suggest 2-3 attorneys. When looking for an attorney, try to find someone who is responsive, has good reviews, and is licensed to practice law in the state where the property is located. In NJ, attorneys charge a flat fee for real estate transactions.
During attorney review, attorneys on both sides review the agreement and make changes. If the changes are unacceptable and the buyer and the seller reach an impasse, both parties can walk away and the earnest money deposit is returned.
If both sides agree to the revised agreement, then the property is under contract.
An attorney or your real estate agent works closely with a title company which conducts a search about the rightful owner of the property. In order to legally purchase the house, you need to make sure that the seller is the legal owner and has the right to sell. Title work goes on behind the scenes and will uncover any liens or issues that may affect the transfer of ownership.
Apply for a mortgage by completing a loan application
Shopping around for a mortgage to get the best terms
Shop around for a mortgage by going to different lenders such as credit unions, local banks, and other institutions, paying particular attention to interest rates and fees. Lenders might complete a soft inquiry on your credit score. Try to do your research in a relatively short time period so you don’t hit your credit score multiple times. Each lender should provide a loan estimate. If they don’t, ask for one. The loan estimate provides the terms of loan, projected payments, closing costs, and other fees. This document is provided in a universal format that is easy to compare across lenders.
Things to look out for: application fees, points (lower the interest rate), origination fee, and other fees.
Items that you might see:
- Principal – This is the amount that you will borrow to buy the house
- Interest – This is the fee lenders charge to borrow the funds
- Taxes – Property taxes are paid quarterly to the government and depends on the value of your home
- Homeowner’s insurance – This protects your home against damage and theft (required by lenders)
- Association dues – if applicable –These are monthly or quarterly fees that provide funding for shared community expenses. If you are not part of a home owners association, disregard this item.
Filling out your loan Application
When you choose a lender, they will ask you to fill out an application. Most applications will require the following:
- W2 for previous 2 years
- Pay Stubs for 2 months
- Other proof of income (1099 for gig workers)
- Gift money documentation
- Recent bank and brokerage statements
- Long term debts like auto and student loans
- Photo ID
When your application is completed and everything looks good, the loan goes to underwriting and the bank makes a decision about the loan. The underwriters assess the risk of the loan and make a decision to provide you with the mortgage or not.
This process might involve a deep dive into your finances. Be prepared to provide more information. Sometimes, lenders ask for the same documents multiple times. Be organized. Scan your documents and keep them on your computer. The faster you respond to any requests for information, the faster your loan is processed.
Tip: You don’t need to use the bank where you have your checking and savings accounts. In fact, big banks have lots of overhead and charge lots of fees and might not be the best place to get a mortgage. Try credit union, local banks, and mortgage brokers. Ask your agent for a preferred lender.
Complete Your Home Inspection
Schedule your home inspection as soon as your house is in contract. The contract will stipulate the period of time that you can inspect the property and the amount of time the seller has to respond to repairs and any issues.
Attend the home inspection. Don’t rely on others. You might want to bring a knowledgeable friend or family member who has purchased a house before.
Let the inspector do his or her jobs and ask questions. As the inspector is working, you should also be testing switches, opening drawers, opening and closing windows and looking around for any issues. Point things out to the inspector and have the inspector note any issues in his/her report.
The inspection report is very important and should highlight any damage, necessary repairs, or issues. The major systems (heating/cooling) or the roof may be end of life which means they may need to be replaced soon which can be costly. The contract might say that end of life systems will not be replaced unless they are not working.
You’ll receive the inspection report soon after the inspection. Note the items that the inspector highlighted and pick the items that you want the seller to fix or compensate you for by adjusting the price. You will need to put together a list of issues and share with your attorney. The seller will either agree to do none, some, or all of the repairs. You might be able to negotiate compensation or lower the purchase price. If the seller disagrees, you can walk away and get your earnest money deposit back (as a worst case scenario – assuming you had an inspection contingency in the agreement).
If the seller agrees to repairs, make a punch list of items to check during your final walkthrough.
Getting the Home Appraised – Appraisal Process
The real estate agents will work with the third-party appraiser to provide the necessary access so that the appraiser can estimate the value of the home.
Depending on the state, the mortgage lender will send you a copy of the appraisal report. As mentioned previously, Ii the appraisal comes in lower than your offer amount, the bank may not issue a mortgage unless you put more money down as a down payment or renegotiate the offer price.
If the appraisal comes in at the offer price, that’s great. The appraiser is saying you’re paying the market price for this property.
If the appraisal comes in higher than the offer price, you made a good deal.
Get Covered with Homeowners Insurance
Most lenders require it as a condition of the mortgage. Homeowner’s insurance covers damage to home and structure and includes theft. Shop around to a handful of insurance companies to get the best quote. The price varies depending on the area and the company.
Tip: If you have auto insurance, bundle with your homeowner’s insurance for extra savings.
Schedule Your Final Walkthrough before Closing
The mortgage lender will provide a date that they’ll be ready to close and transfer the funds to the title company and seller. When you have an idea of when the closing date is, schedule a final walk through of the house either the day of or the day before your closing. Use this time to ensure all requested issues form the inspection were addressed. Check everything and make sure there are no surprises. Take your time and be thorough. After closing, you’re responsible for issues since you own the property. I had a client who was supposed to have their closing the day after Hurricane Ida. During the final walkthrough, the buyers found water in the basement since the ground was super-saturated and the water had no place to go. Since the property is not owned by you yet, the seller may have to address any issues.
Attend the Real Estate Closing and Sign All the Necessary Paperwork
You will receive a Closing Disclosure(CD) that outlines the transaction, costs, and charges. By law, your lender will send this out at least 3 days before closing. Look at the closing disclosure and make sure everything looks right. I’ve had a few transactions where the bank made mistakes that had to be corrected. The closing disclosure will also indicate the amount of money you need to bring to closing in order to complete the transaction.
At closing, the title of the house changes from the seller to you. The title company or closing agent might oversee the closing process and confirm that all required documents are signed and ensure proper payments are made. Once you sign the documents, the transfer of ownership will be recorded by the local county clerk’s office.
It might take weeks for you to receive all the finalized documents, including the deed.
A closing is not a fancy event. Most times, the seller might sign all the documents ahead of time and a closing can be quick or take several hours depending how complete all the documentation is.
Move in
Congratulations! You made it through the home purchase process!
Now you own the house.
Set up your utilities including water, sewer, gas, electric, cable, and internet.
If you are part of a homeowner’s association (HOA) make sure you find out where to send your association fees.
Summary:
Learning about the process to buy a home ahead of time makes it easier and less scary. Buying a house doesn’t have to be daunting. Use the above steps as a guide how to buy a house for first and work with your real estate agent if you have specific questions
