Owning your own home is fantastic. It’s your castle, your place. And one of the greatest benefits of owning a home is that you can create wealth for yourself.
But are you scratching your head wondering exactly how to buy a house? After years of giving advice to home buyers, money expert Clark Howard and Team Clark have come up with an easy-to-understand process.
9 steps to buying a new home
Let’s face it: Buying a house can be complicated whether you’re an experienced or first-time home buyer, and there are many mistakes that you’ll want to avoid.
In this article, we’ll take a look at the process of how to buy a house in a step-by-step fashion:
Table of contents:
- Get your finances in order
- Get pre-approved for a mortgage
- Start shopping for homes online
- Find the right real estate agent
- Negotiate the sales price
- Lock in your rate
- Deal with the contingencies
- Arrange your home insurance
- Close the deal
1. Get your finances in order
Becoming a homeowner is likely the biggest financial move you will ever make in your lifetime. But before you can learn how to buy a house, you’ve got some homework to do.
Within this first step, there are four main topics we’ve got to tackle:
- Down payment and emergency fund
- Credit reports and credit score
- Debt-to-income ratio
- Paperwork you’ll need
Save for a down payment and build an emergency fund
Ideally, you should aim to have a down payment equal to 20% of the purchase price of the kind of home you want to buy. But if you can’t come up with that amount, there are other options.
For example, the FHA loan program only requires a 3.5% down payment of the purchase price. The downside to putting that little down is that you’re typically locked into a mortgage insurance premium (MIP) for the life of the loan. MIP protects the FHA in case you default.
Contrast that with putting less than 20% down on a conventional loan. You’ll pay private mortgage insurance (PMI) — which protects the lender just like MIP does — but the PMI can be dumped when your loan-to-value ratio reaches 80%.
Either way you slice it, it’s best to avoid MIP or PMI by coming up with a 20% down payment!
Start by looking at your timeline
That means you have some pre-planning to do. Begin by looking at your home-buying timeline. If you have 24 months until you’re likely to make a home purchase, try to estimate what 20% down would look like and divide that by 24.
For example, if you plan to buy a $200,000 home, 20% down would be $40,000. That’s a pretty big chunk of cash. Divided by 24, you’d have to save about $1,666/month if you want to avoid PMI.
Here are some other examples:
|Purchase price of home||12-month timeline to build up 20% down payment||24-month timeline||36-month timeline|
|$150,000||You must save $2,500/month||Save $1,250/month||Save $833/month|
In addition to saving for a down payment, you also want to build up an emergency fund when you’re getting ready to buy a house.
The costs of buying a house go beyond just taking out a mortgage. When you own a home, there’s no landlord to call when you need to replace the water heater or you need a new HVAC system. So, you’ve got to be ready for these expenses by building up rainy day money.
You want to keep this cash liquid so it can be tapped at a moment’s notice. That’s why it’s best stored in an online savings account.
Check your credit reports and monitor your credit score
Another part of the homework you have to do when you’re getting ready to buy a house is pull your annual credit reports. You also have to check (and rehabilitate, if necessary) your credit score.
Checking your credit reports
Go through the reports thoroughly. You’re looking for two things in particular:
- Errors that you will have to dispute
- Unpaid collections that you will have to pay
Errors technically should take 30 days to correct once you inform the bureau and creditor of their mistake. But in actuality, the process can take up to three or four months. That’s why you need to start this step at least four to six months before you’re actually ready to apply for a mortgage loan. Here’s our step-by-step guide to disputing an error on your credit report.
When it comes to unpaid collections, you want to make sure there are no surprise delinquencies eating up your credit. If there are, many times they’ll be small bills that you just forgot about or that got lost in the mail. Get those things paid off as soon as possible before you apply for a mortgage.
Checking your credit score
Now that you’ve done a background check on your credit profile, the next thing to do is continually monitor your credit score. This will ensure it continues to hold steady or improve as you get closer to applying for a mortgage loan.
“Both coach you on how to bump up your score over time, and they’re very sophisticated with how they do it,” Clark says. “So if the goal is to get a lower interest rate, start working on it nine months before with these sites. You should be able to see a substantial impact on your score that many months out.”
Pay down your debt-to-income ratio
Your debt-to-income ratio is a financial term used in the mortgage and other related industries to determine how risky you are as a borrower. The debt-to-income metric is basically a measuring stick by which a lender can decide whether you make enough money to cover your future mortgage obligations each month or not.
Your debt-to-income ratio is calculated by dividing all the money you owe each month (credit card bills, other monthly bills, student loans, other monthly debt obligations, etc.) by your monthly income.
According to the Consumer Financial Protection Bureau, lenders do not want to see this ratio over 43%. Ideally, you want it to be as low as possible.
To reduce your debt-to-income ratio, you’ll have to pay down debts such as credit cards, car notes and other personal loans.
Gather your paperwork
Applying for a mortgage means a lot of paperwork to fill out. Your lender may ask you several times to send the same paperwork over to them. You want to be sure you have it handy to fulfill their requests.
At a minimum, you’ll want to gather the following documents and have them ready:
- Two current pay stubs
- Two to three months of bank statements
- Last two years’ worth of tax returns
2. Get pre-approved for a mortgage
Getting pre-approved for a mortgage is in an in-depth process that generally involves the bank digging through all your financial documentation, checking your credit and giving you a conditional OK to buy a home up to a certain dollar amount at a preliminary interest rate.
It’s a critical step in learning how to buy a house. In this section, we’re going to take a look at four key pieces of info:
- Where you should think about getting pre-approved
- Clark Howard’s 90% mortgage rule
- Why you should get multiple quotes over 14 days
- Why you shouldn’t make major purchases once you’re pre-approved
Look at non-bank lenders for pre-approval
Clark says there are any number of places you could get pre-approved when you to buy a house. But there’s one place he never wants you to get that letter —at a big bank!
“What’s changed over the years is that banks are now very uncompetitive in the mortgage market,” he notes. “All the action is credit unions and non-bank lenders like Rocket Mortgage or Quicken Loans.”
As a general rule, credit unions will offer the lowest rates. But Clark is quick to remind people that “not all credit unions are created equal.”
So you’ve got to make sure you’re happy with the level of customer service at a credit union before you give them your mortgage business.
Fortunately, you aren’t locked into doing a loan with the lender that pre-approves you. So this gives you time to shop around further if you decide you don’t like the lender for any reason.
Shopping with a mortgage broker
Another kind of non-bank lender you may want to look at is a mortgage broker. A mortgage broker is basically a salesperson who shops your mortgage application to multiple lenders on your behalf.
The pros of using a mortgage broker include the fact that they can shop unusual loan situations to lenders. That could be, for example, a self-employed person going for a mortgage who has a different level of income each year.
“Behind the scenes, a mortgage broker tells lenders, ‘Look, I know this client doesn’t fit your typical customer profile, but here’s why I think they’re right for your portfolio…’ Clark says. “They basically pitch your loan to different people and market you as a borrower.”
If you’re interested in working with a mortgage broker, get a referral from your real estate agent. You could also ask friends and family who’ve gone through the home buying process if they know of one.
Clark’s 90% mortgage rule
Chances are you’ll be pre-approved for a higher home purchase price than would probably make sense in your life. It’s up to you to think through what that translates to as a monthly payment.
Don’t forget to add to that figure the monthly taxes and insurance, along with possible repairs and maintenance that you wouldn’t otherwise have to pay when you’re a renter.
That’s led Clark over the years to come up with his 90% mortgage rule:
“When it comes to a mortgage, you should step back 10% from what your lender says you qualify for,” he says.
So start by seeing what you qualify for on a traditional 30-year fixed rate loan. Then back off and go house shopping at only 90% of that dollar amount.
Here are some examples:
|Pre-approval amount||Clark’s 90% rule cap|
“By following this rule, you will help create extra financial breathing room in your life,” Clark says. “The expense of housing is like a rubber-band — stretch it too far and it will break. Stay at 90% or lower and your wallet will smile.”
Meanwhile, Clark says another way to think about it is this: Base what you pay for home on what you’ve been comfortable paying for rent. Your rent is already a known expense in your life, so try to stick as closely as possible to that target.
Get multiple quotes over 14 days to limit the hurt to your credit score
Each time a lender pulls your credit to give you a quote for a mortgage interest rate, it will ding your credit file.
You can minimize the damage by getting all quotes within a 14-day period. That way it doesn’t look you’re applying for multiple loans from multiple lenders.
Technically, you have 30 days to shop around before it hurts your credit. But Clark prefers you hold yourself to this shorter timeline so two weeks doesn’t bleed over into a month.
Don’t make major purchases once you’re pre-approved
Clark has a firm rule as part of the pre-approval process: Once you get that pre-approval letter, never apply for any other credit within six months of when you expect to buy your home.
“It’s not so much what the credit application will do to your credit score, though that is a concern,” he says. “It’s more that it harms your debt-to-income ratio, which could put you in a more risky lending category. That may mean your mortgage application is denied in the worst-case scenario or just that you find yourself pushed you into a higher interest rate.”
3. Start shopping for homes online
Once you’ve gotten pre-approved, it’s time to start looking for the house where you’re going to live!
The process of learning how to buy a house is different today because of the unprecedented online access to information about homes, neighborhoods, areas and more.
Download the right apps
You can get so much info — about square footage, the number of bedrooms, the number of bathrooms, the age of the home, the price per square foot and so on — right there in the palm of your hand.
The more you “windshield shop” like this, the more you can target your home-buying efforts.
“I have what I like to call my ‘hundred house rule.’ The idea is that you should look at a minimum of 100 homes either in person or online to get a sense of what the real estate market and the inventory is at the moment,” Clark says. “Today that’s so easy to do online. You can look at well more than that in a couple of days.”
Concentrate on identifying zones
Once you get a sense of what you want and what the market is offering, it’s all about being thorough and not focusing on just one house.
It’s more about identifying zones — streets, neighborhoods and areas you’d be comfortable living in — and then having target houses.
What you want to do is develop a list of 10 or 20 target houses in your ideal zones — streets, neighborhoods and areas you’d be comfortable living in.
“Last time I bought a house, after all the searching online, we came up with 18 target homes. And we ended up buying one of those 18,” Clark says.
4. Find the right real estate agent
You’ve already culled the herd of houses for sale by following Clark’s ‘hundred house rule’ and picking up to two dozen target homes in your quest to learn how to buy a house.
The next step is to hire a buyer’s agent. The real estate agent you pick will be able to do something even more important than chauffeur you around to houses: They’ll be able to help you with keeping emotion out of the buying process.
Know what to look for in an agent
As a buyer, you’re not paying a commission. The seller is and that’s how the agent gets compensated. So what should you look for in an agent?
It all boils down to two things: Expertise and experience.
For you as a buyer, if there’s a particular neighborhood you want to buy in, you’re going to need an agent who is a big seller in that area. In the lingo of the trade, you want to know that they “farm” your desired neighborhood. That means they’ll have the inside scoop on available properties and can make the home-buying process much easier.
For example, an agent who farms the areas you’re interested in would be able to tell you why you shouldn’t buy on a certain street. They will have neighborhood-specific knowledge to help you find the right house at the best price.
Identifying the agents who farm an area is easy. You’ll see their sales signs again and again as you drive through the neighborhood. Failing that, you could try asking family and friends for a referral.
Another important factor to consider in finding the right real estate agent is experience. Particularly if you’re a first-time homebuyer, you don’t want to work with a person who is just selling their first house! Look for someone who’s been in their field for a number of years.
5. Negotiate the sales price
A real estate agent can help you greatly with negotiating the price of your purchase as you navigate the process of learning how to buy a house.
Look at the neighborhood comps to base your offer
Your agent will have access to comps — recent sale prices of other similar homes in the neighborhood — that they can provide you as you get ready to make your offer. You can also get the same info from your county’s tax assessor office. And thanks to technology, websites like Redfin and Zillow make it very easy to see this info, too.
Submit your offer
Again, your realtor will help you submit your offer. Because they should know the area, they’ll guide you to make sure you’re not paying too much for a home you put in an offer on.
The question of how long a home has been on the market factors into the decision about how low you should go on your offer, according to Clark.
“The longer the home sits on the market, the more likely it is that you can come in with an aggressive price. The seller is not hungry in the first 45 days after their home is for sale,” Clark says. “Then the market wears them down. They get tired of the uncertainty and they may have committed to buying another house.”
Clark says the tipping point start sometime around six to seven weeks out. That’s when the seller becomes more amenable to making a deal.
But even then, you’ll reach a natural point of resistance. If a home has been on the market a really long time, sellers may be unwilling to flex on price.
So time on market is not automatically a signal that you can make a lowball offer, but there does tend to be a sweet spot once you hit six weeks or longer.
Get ready for closing costs and points
Closing costs are fees you’ll pay to the lender and title company for facilitating your real estate purchase. They typically average around 3% of the purchase price, but can sometimes be as high as 5% depending on your location.
If the market conditions are right (i.e. it’s a “buyer’s market”), you may ask the seller to contribute to closing costs.
However, Clark says not to get hung up on 3% or 5%. Rather, he prefers you do a holistic look at what kinds of fees you’re going to pay by lender. Each offer you receive should have three columns:
- Interest rate
- Closing costs
The interest rate is the bright, shiny object most people tend to focus all their attention on. But it’s only part of how you compare one loan offer to another. You’ve also got to consider points, if any, and closing costs.
Points are upfront charges for taking out a loan. Each point is 1% of the amount you are borrowing. So one point on a $200,000 loan is a $2,000 fee you have to pay at closing.
Points usually come in two flavors: Origination points and discount points. The first is a commission to the lender for making the loan. The second lets you buy down the interest rate.
“The best way to choose a loan is to choose a zero-zero mortgage, one with no origination points and no discount points,” Clark says.
Finally, look at your closing costs. Lenders now have to give you an estimate of the maximum you will have to pay. This makes it much easier for you to figure out which loan is actually your best deal.
6. Lock in your rate
Mortgage interest rates fluctuate all the time based on larger market conditions. A mortgage rate lock holds your interest rate steady, typically for a period of 30, 45 or 60 days.
Clark says the decision about when to lock in your rate should be based on whether you’re buying new construction or purchasing an existing home.
“If you’re buying a home that’s being built, you never want to apply and lock in too early because builders’ schedules are notorious for running late,” Clark says. “You have to be sure most everything is done by the builder before you lock in your rate when you’re buying new construction.”
Fortunately, the decision about when to lock in your mortgage interest rate is considerably easier when you’re buying an existing home.
“With a used home, it’s easy,” Clark notes. “You already have your closing date, so it’s easy to know when to lock in because you just count backwards that number of days.”
7. Deal with the contingencies
Still with us as we explain how to buy a house? Now it’s time to deal with the contingencies in the home-purchase process, which are things like inspections and appraisals.
Hire the right home inspector
Don’t buy a home without having it inspected first! The inspector will look for structural issues and potentially expensive repairs that need to be made.
“I’m a big believer in finding a ‘deal-killer inspector’ who won’t gloss over things just to get more agent referrals,” Clark says. “You want somebody who tells you what you need to know, not what you want to hear.”
If the home inspector finds something that’s wrong with the house, now is the time to ask the seller to address the issues or ask them to reduce the price by the amount you expect the repairs to cost you once you buy the home.
It’s for this reason that inspectors with engineering backgrounds are great. You can either ask your real estate agent for a referral or you can find one through the American Society of Home Inspectors. ASHI requires its members to adhere to a code of ethics and a standard of practice.
Another good resource is the National Institute of Building Inspectors. NIBI requires that its inspectors carry errors and omissions liability insurance, which means they accept responsibility for any oversight.
You’ll want to be present for the inspection, which you’ll have to pay for upfront — not at the closing. As far as cost, expect to pay somewhere in the general neighborhood of $300 to $500, according to the U.S. Department of Housing and Urban Development. However, that cost can vary by square footage of the home and location in the country.
Finally, you may also want to consider paying for a specialized home inspection. This might entail an inspection to address pest control concerns or to detect the presence of radon or mold. These types of specialized inspections will be an additional expense you’ll have to budget for.
Get an appraisal
Getting an appraisal of a property you’re getting ready to buy is the best way to insulate yourself from the possibility of paying too much for a home. With an appraisal, you get a realistic sense of what the property is worth.
If you’re getting a home loan, your lender will require an appraisal. You as the buyer typically pay for up-front for the cost of an appraisal, often $300 or $400 — and there’s a very good reason for that.
As mentioned before, the purpose of an appraisal is to protect you from overpaying for a home. So what happens if the deal falls apart because of the results of the appraisal? The buyer is still responsible for paying the appraisal fee. After all, the work was done by the appraiser — regardless of the outcome of the deal — and the appraiser needs to be compensated for his or her time.
Unlike with a home inspection, it isn’t necessary for you to be present for the appraisal.
8. Arrange your home insurance
You may not think of home insurance when you’re learning how to buy a house. But this is an important step of the process. In fact, many lenders ask you to prepay for a year of home insurance before you can close on your mortgage.
Research quality companies
When it comes to home insurance, you want to consider an insurance company’s reputation with both customer complaints and customer satisfaction should you have to make a claim on your property.
Clark trusts the opinions of several sources like Consumer Reports and J.D. Power when it comes to identifying the best home insurance companies. But no need to go to those websites and read through their data — we’ve already done it for you!
Our guide to the best and worst home insurance companies lets you see all the top insurers at a glance, along with Clark’s picks for his three favorite home insurers.
Take a high deductible
When you’re taking out a home insurance policy, you want to be sure to take the highest deductible that you can handle and that your mortgage holder will allow you to have. Doing that will both lower your premium and discourage you from unnecessarily making small claims.
That last part is very important, according to Clark.
“You should think of homeowners insurance as ‘use it and lose it’ kind of proposition,” he says. “It’s not for use except in the case of a catastrophe.”
Pick reputation over low premiums
Remember, when it comes to picking the right home insurance, it’s not just about getting the lowest premium. You want to make sure the company will be there to make you whole when the chips are down.
Customer satisfaction is a key metric to pay attention to. Going hand-in-hand with that is the number of complaints an insurance company has from customers.
All insurance is regulated at the state level. So before you decide on an insurer, be sure to contact the insurance commissioner’s office in your state. Ask them how many consumer complaints have been filed against a particular company you’re thinking about doing business with for your new home. The results may be eye-opening!
9. Close the deal
OK, you’ve reached the last big hurdle you have to cross before getting the keys to your new home!
In the days leading up to closing, you’ll get the final numbers that show what you need to close on the home of your dreams.
Be sure to review them carefully and ask any questions you may have about unfamiliar terms. Remember, buying a home is likely to be one of the largest financial transactions you make in your life, so you want to go into it with a full understanding of everything!
On the day of closing
When the big day finally arrives, you’ll go to the title company. This is the very final step when you’re learning how to buy a house. Be prepared to sign a lot of papers. The seller may not be there, but you will be handed the keys to your new home. Imagine how good that will feel!
Buying a home represents so many things to us as Americans. First and foremost, owning a home is a dream, one of the major accomplishments of a person’s life. More practically, it’s a place to live.
Building equity by paying down the mortgage, and from the rising value of the house, is one of the main ways to build wealth for most people and families.
“I call real estate the ‘get rich slow’ method,” Clark says. “Housing prices normally increase just one or two percentage points more than the rate of inflation. Housing goes up a little faster than inflation because over time land becomes harder to find and as the population grows, housing becomes more scarce.”
The bottom-line is that paying rent puts money in someone else’s pocket. So when you’re ready to own your own home, we hope this guide is there with you every step of the way!
If you have additional questions about how to buy a house or you need more detailed advice specific to your situation, contact Clark’s Consumer Action Center. It’s a FREE help line open Monday-Thursday from 10 a.m. – 7 p.m and Friday from 10 a.m. – 4 p.m. EST. We have volunteers available to answer YOUR concerns! Call Team Clark @ 404-892-8227.