Adulting toward First-time Homeownership
You have graduated and are ready to tackle the adulting goals of life. Regardless if you are a HENRY (High Earner Not Rich Yet) or just steadily working at your first job, qualifying for your first home loan may be easier than you think. This step-by-step guide will show you how to prepare and secure your first home loan.
What impacts a first-time home buyer's ability to secure a loan
Starting on life's financial journey can be difficult. HENRYs are often burdened with extensive student loan debt from years of graduate school. Others may get through school without much student loan debt but face high credit card debt.
Student loans, lack of credit, high debt-to-income ratio, and other factors can put a negative spin on your ability to secure your first home loan. Hold on, don't automatically consider yourself out of the game. Careful preparation will move you toward your goal.
Use your time wisely
First, remember to be patient. Maybe you don't qualify today, but you can use your time as a renter or while living at home to build good credit, fund a down payment, and budget so you are prepared to meet all of your expenses.
Build or improve your credit score
What factors do credit agencies consider to compute a person's credit score? A credit score, also known as a FICO® score, relies on 5 general reporting elements.
Payment History - Bills are paid in full and on time.
Length of History - The length of time credit has been extended. How long have you had credit?
Credit Available - High credit limits with little balance that is paid in full each month
Credit Type - An auto loan, student loan, or mortgage are more responsible credit types than store credit cards
Credit Inquiries - Frequent new credit requests are frowned upon
Tip: Once you have a job (a means of paying your bills without the help of parents or a significant other), consider opening a credit card. Search for one offering no annual fees. Some come with perks like cash-back rewards. Frequent travelers may find it helpful to establish credit with an air miles reward program. Be mindful of the APR terms. APR is the Annual Percentage Rate credit issuers charge on balances held over from one billing cycle to the next.
Warning: Credit can not be built up if you don't have any established. When used properly, credit is a tool that can build a strong credit score. However, if it is not used properly it will cause harmful debt and a damaging credit score.
What do lenders check to determine a person's loan-worthiness?
You're working on building a solid credit score. Good for you! Remember, one of the building blocks of a credit score is the length of time you have held credit. Don't get discouraged.
Instead, get the clock started on your credit. You still have other work to do in preparation for securing your first home loan. Next, I'll cover what mortgage lenders want to know.
Debt-to-income ratio
Have you heard of the debt-to-income ratio (DTI)? It's a measure that calculates your monthly debt payments as a percentage of your monthly gross income. Typically, lenders want your DTI ratio to be 36% or less. As stated in a recent Investopedia article by Chris B. Murphy, "Typically, borrowers with low debt-to-income ratios are likely to manage their monthly debt payments effectively. As a result, banks and financial credit providers want to see low DTI ratios before issuing loans to a potential borrower" (Murphy, 2024).
Save for a down payment
Most lenders want you to have a down payment that can be applied to the home loan or closing costs. The amount you will need depends on the loan.
A first-time home buyer's down payment will range between 0% - 25%. It's time to do a lot of research. Learn about the opportunities and rates that are available to you.
Depending on your situation you may qualify for special programs to help you acquire your first loan. Research and learn about loans through programs like FHA, VA, and more!
Two forms of credit
Lenders want to see borrowers use their credit. A best practice is actively using two forms of credit. For example, one credit card and a car loan or a student loan coupled with a credit card. Be sure to pay them off monthly! Do not let debt roll to the next month. This will cause you to pay high interest rates and damage your credit score.
Banking best practices
Before approaching a lender, get your banking in order.
Lenders will ask you to produce your last two months of bank statements (60 days). Prepare by practicing squeaky-clean banking habits.
There must be no overdraft events reported during this period. Similarly, non-sufficient Funds (NSF) will not fly with lenders.
Sign up for both a checking and a savings account. In addition to having a down payment set aside, lenders will want you to have sufficient reserves to handle any unforeseen expenses. Having a savings account established will look good to lenders. Be sure to look for a bank that offers FDIC Insurance on your savings account deposits.
Consider humbly approaching the bank of Mom and Dad to ask for help. For a short period (90 days), would your parents consider a loan or gift of cash to be placed in your savings account? Remember, lenders will ask you for your past two months of bank statements. If your parents allow you to hold a small amount of cash in your savings account for 90 days, lenders may not ask for documentation of how you accumulated your savings.
Budgeting for today and the day you become a homeowner
Practicing careful and regular monthly budgeting can lead to feelings of financial independence and well-being. You can not successfully plan for regular expenses and unexpected costs (that will come up), without first hitting the spreadsheets or an app to develop and track your budget.
Yes, budgeting sounds dull, but it is necessary. When you read that it is time to budget, don't fall victim to paralysis analysis. Tackle this obstacle, work toward homeownership, and avoid worries about foreclosure!
After practicing good budgeting habits for at least 4 months, many find they have been paying for items that don't align with their values. Others find that dollars were simply wasted on unnecessary stuff. If you owe, you must pay. However, those who start a regular budgeting routine, quickly realize they have been paying for costly discretionary items like subscriptions for rarely used items.
Furthermore, learning about and fine-tuning your spending habits will allow you to plan forward for the costs associated with homeownership like HOA fees, homeowners insurance, and maintenance.
Conclusion
Homeownership is an attainable goal. It takes time to plan and prepare for the acquisition of your first home loan. Start today by adopting good credit and budgeting habits. Seek help from your parents, hold exploratory talks with your bank and a mortgage lender, and reach out to a qualified financial advisor. Ready yourself to become a first-time homeowner!
About the Author
Marianne Martini Nolte, CFP® provides tax-savvy wealth management for women and a few cool men.
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References
Murphy, C. B. (2024, February 27). Debt-to-income (DTI) ratio: What’s good and how to calculate it. Investopedia. https://www.investopedia.com/terms/d/dti.asp#:~:text=to%2DIncome%20Ratio%3F-,As%20a%20general%20guideline%2C%2043%25%20is%20the%20highest%20DTI%20ratio,varies%20from%20lender%20to%20lender.
