15 Terms Every First Time Homebuyer Needs to Know
Buying your first home is a huge financial (and personal) moment. You’re putting down roots and also acquiring an asset that could help grow your wealth over the long haul. First-time homebuyers made up over a third of buyers in 2021, according to the National Association of Realtors (NAR). If you’re new to the game, the process of buying a home can be daunting. We’ve got you. Below are 15 key terms every first-time homebuyer should know.
We’re barely scratching the surface here, but if homeownership is on your horizon, this should get you started.
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1. Mortgage
This is the loan used to finance a home purchase. Every mortgage lender is different so it’s wise to shop around for the best rates and terms. At the time of this writing, the average mortgage rate for a 30-year fixed mortgage was 5.1%. Conventional loans and government-backed loans like FHA loans are available to eligible borrowers. Mortgage rates fluctuate and shouldn’t be the main reason why you decide to purchase a home.
2. Preapproval
Getting preapproved for a mortgage usually comes first. It involves submitting core financial information to a mortgage lender, who will then tell you if it’s likely that you’ll be approved for a mortgage. They’ll ask about things like your:
Income
Employment
Debts
Credit score and history
Assets
This information gives the lender a glimpse into your financial health. Those who are preapproved will receive a letter that lays out their expected loan amount, mortgage type, and interest rate.
3. Credit Score
Your credit score plays an important role in getting approved for a mortgage. A lower score may indicate to lenders that you aren’t the most trustworthy borrower. This could leave you stuck with a higher mortgage rate—or disqualify you from getting a mortgage at all.
Requirements vary depending on the lender and loan type, but you’ll likely need a minimum credit score of 620 for a conventional mortgage. You might have more leeway with an FHA loan but will probably have to make a larger down payment to offset the risk.
4. Down Payment
Putting down 20% has long been the golden rule when buying a home, but it might feel unattainable for a first-time homebuyer. A $400,000 house would cost you $80,000 upfront. It does have its benefits, though. Making a larger down payment will leave you with a smaller mortgage and monthly payment. You’ll also have a larger chunk of equity in the home.
It’s more than possible to buy a home with a smaller down payment. FHA loans require just 3.5% down. For conventional loans, you could get in with as little as 3% down. Qualified borrowers taking out a VA loan or USDA loan might not need a down payment at all.
5. Private Mortgage Insurance (PMI)
If you put down less than 20%, chances are your lender will require mortgage insurance. When you pay these premiums, it guarantees that the insurer will step up and take over if you default on your mortgage. It essentially protects the lender. It’s called private mortgage insurance (PMI) for conventional loans. (For FHA loans, it’s called a mortgage insurance premium.) The average PMI policy costs 0.5% to 1% of your loan amount per year, according to Rocket Mortgage.
6. Debt-to-Income Ratio (DTI)
When applying for a mortgage, the lender will take a close look at your debt—specifically how it relates to your income. Your debt-to-income (DTI) ratio represents the percentage of your earnings that’s currently going toward debt. To calculate it, add up your total monthly debt payments, then divide it by your gross (pre-tax) monthly income. The lower your DTI, the better. Most mortgage lenders allow a maximum DTI of 43%.
7. Broker, Real Estate Agent, Realtor
Most homebuyers team up with a professional to help them find the right property. A real estate agent can locate potential homes in your price range that meet your criteria. Their fee is typically covered by the seller, and they’ll likely be knowledgeable when it comes to your local market. Most can also help you put in an offer and negotiate with the seller on your behalf.
A broker has additional education and credentials and often oversees a team of real estate agents. A Realtor is a licensed real estate agent who’s also a member of the National Association of Realtors and upholds their standards.
8. Home Inspection
It’s always wise to arrange a home inspection before closing the deal. It could reveal issues that are better to know about sooner rather than later. In some cases, the results may even prompt you to look for another property. Alternatively, you could negotiate with the seller to make certain repairs or come down on their price. The average home inspection costs around $300 to $500.
9. Title Insurance
Title insurance can protect both you and your lender if any ownership claims crop up after closing on the home. All kinds of issues can threaten your ability to hold full legal ownership of a property—from previous tax liens to disputes between heirs of the previous owner who try to claim ownership themselves. The title insurance company can cover the cost of resolving legal issues that may jeopardize your ownership. The cost varies depending on your state and the price of your home, but the National Association of Realtors says $1,000 per policy is standard.
10. Homeowners Insurance
Mortgage lenders usually require homeowners insurance. This policy can help you pay for repairs stemming from covered events like fire, lightning, theft and vandalism. It can even help you recoup losses if personal belongings are damaged or stolen. Most policies offer liability protection as well. This protects you if someone injures themselves on your property. The average cost of homeowners insurance is about $1,899 per year, according to Policygenius.
11. Closing Costs
When you’re ready to finalize the deal, you can expect to pay a variety of fees at the closing table. These closing costs typically add up to about 2% to 5% of the sale price and cover a number of fees related to making your home loan, according to The Mortgage Reports. This includes fees paid to the mortgage lender, along with costs related to the home inspection, appraisal, title services, potential real estate attorney fees and more.
12. Escrow
Most mortgage lenders require buyers to use an escrow account. It’s set up and managed by the loan servicer. When you make your monthly mortgage payment, you pay extra to cover property taxes and homeowners insurance. This money sits in escrow until the due date comes around, at which point the loan servicer will pay them on your behalf. You’ll likely prepay your insurance and taxes to fund your escrow account at closing.
13. Earnest Money
If you make an offer and the seller accepts it, you may be asked to pay an earnest money deposit. It typically ranges from 1% to 3% of the sale price and is eventually put toward the down payment at closing. In the meantime, it’s meant to deter buyers from making multiple offers on different homes.
You should get the money back if the deal falls apart and it’s covered by a contingency in your contract. For example, a home inspection contingency lets you walk away if an inspection reveals issues with the property.
14. HOA
This is shorthand for homeowners association. Your new community may have one in place to help maintain the neighborhood. HOA fees can include things like landscaping, garbage pickup, security, maintenance, repairs, and community amenities. If you’re buying a home that’s part of an HOA, you’ll want to get clear on their rules and fees beforehand to make sure it gels with your budget and lifestyle.
15. Property Taxes
As we hinted at above, your monthly mortgage bill will likely include more than just your loan payment. Property taxes are often tacked on by loan servicers. The cost will depend largely on where you live and your home’s property type and value. These taxes are used to fund all kinds of government programs, including libraries, law enforcement, road work and more. Your real estate agent should be able to ballpark your expected property taxes so you can factor it into your homebuying budget.
Buying a home is a major financial decision. Give us a shout if you want to talk it over or have any questions. In the meantime, the list above can be a good jumping-off point.