Buying Your First Home:
From Renting-to-Own to
Making It All Yours
You’ve got a good job, you’ve saved up a few
thousand dollars, and you’re ready to find a home you can rent
to own. Congratulations! You’ve taken the first step in achieving
a big part of the American Dream: owning your own home.
However, in my experience of working with dozens of people
who want to make the big move, I’ve found that many of them don’t
have a clear idea of exactly what it’s going to take to be successful.
This special report is designed to help you prepare
for this important financial decision.
The first thing to realize is that buying
a home will probably cost more than renting. Although this sounds
obvious, many people overlook this simple fact. So, when you sign a
contract to rent a home for a year with the hope of buying it at the
end of that time, be sure to find out what your mortgage payment might
be when you get a loan to buy the house. You may find it’s considerably
higher than your rent payments.
Also, when you buy a home, you’ll have to pay the
taxes and insurance. These fees can easily
add $100-150 a month to your mortgage payment. Ask the current owner
of the home you’re considering what these expenses are on a yearly
basis. Add them together, divide by 12 and this is the amount you’ll
pay in addition to your loan payment.
Another added charge that most first-time home buyers
are not aware of is Personal Mortgage Insurance,
or PMI. Most lenders charge this extra fee on loans with less than a
20% down payment. In other words, they’re loaning out more than
80% of the sale price. Once again, you’re probably looking at
an extra $100-150 a month.
As an alternative, the lender may offer an 80-15-5 loan.
This does away with PMI because the first loan is 80% of the total value
of the home. They give you a second loan (at a higher rate) for 15%
of the sale price and you put 5% down. Ask your lender or mortgage broker
to do both calculations and then you’ll know which has lower payments.
A good strategy is to visit with
a mortgage broker before you start looking for a home. They will
review your credit score (FICO), your income and expenses, and your
current loan obligations. They can then tell you how much house you
can qualify for. That way you’ll be able to make a more realistic
search for your new home.
There are two ways to get a better
loan rate, and thereby lower your monthly payments. The first
is to save up a larger down payment. Not only does this reduce the amount
you have to borrow, it shows the lender you have learned to handle your
finances responsibly.
The other way is to
improve your FICO score. This is the number lenders use
to assess the risk they are taking when making a loan. These days it
seems almost anyone with a pulse can get a loan, but you definitely
get the best rates when your score is over 720. If your score is 580,
you are on the borderline. The lender will look beyond the number to
the actual loan histories and see if you are getting better or worse
at paying your current loans on time. You may be able to get a loan
with a score below 580, but the rates will be very high.
I will discuss improving your FICO score in more detail
in another article, but for now
you should at least know your current score so you know where you stand.
If you work with a mortgage broker they can tell you. If you’d
like to do it yourself, go to freecreditreport.com.
You can pull your own credit report once a year for free, but they will
charge a small fee to tell you your actual score.
Another possible way to make a rent-to-own offer work
out for you is to talk with the seller of the house you want. If you’re
not sure you’ll be in good shape to qualify for a good loan in
just 12 months, ask for a longer lease.
They may be able to offer you an 18 or 24 month lease, or the option
of extending a 12 month lease. They may want to increase the price of
the house a bit to account for its increasing value, but it may still
work out for you.
Sometimes a seller may offer to loan
you the money directly so you won’t even have to deal with a bank
loan. This can save you all the fees you would otherwise pay,
including an origination fee, points (a percentage of the loan paid
upfront), and PMI. Not all owners are willing or able to offer seller
financing, but it can’t hurt to ask about it.
No matter who will be creating your loan, it’s
critical that you are never late on your rent payment. Twelve
on time payments in a row will make most lenders feel good about your
ability to handle your financial obligations. (Make copies of your canceled
checks.) Make sure your payments for your car loan, and credit cards
are on time, every time as well.
Here’s an example based on one of my current tenant/buyers:
Home Price: $170,000
Down Payment: $7,000 (4.1% down - includes rent credits)
Loan Amount: $163,000
Interest: 7.5%
Term: 30 Years
Monthly Payment: $1,139.72
They are now paying $1,150 per month for rent, so they
can handle the loan payment. When they add in $120 for PMI and $115
for taxes and insurance, their total monthly payment rises to $1,374.72.
If they can improve their FICO score enough to lower their
interest rate to 7.0%, the loan payment drops to $1,084.44 and their
total amount due monthly becomes $1,319.44, saving them $55 a month
or $660 a year.
So to become a successful home buyer,
find out your FICO score and work to improve it, save up as much as
you can, make sure your future payments aren’t too much above
your rent payments, and ask your seller about owner financing.
