A mortgage is a home loan to finance a residential property. Financial institutions reported more than 23 million home loan applications in 2021, according to data from the Consumer Financial Protection Bureau (CFPB).
It’s unclear how many Americans use cash or other sources to purchase homes, but the volume of transactions, according to the CFPB, suggests home loans are a common funding source.
Regardless of how you plan to pay for your house, we’ll share how to determine the amount you can spend on a home, how to shop for a loan and place, when you need an appraisal and a home inspection, when to get insurance, and other essential homebuying steps.
In this guide:
- How much house can you afford?
- How to shop for a loan
- How to shop for a home
- How to make an offer on a home
- Do you need an appraisal?
- Do you need a home inspection?
- When to get insurance quotes
- What happens when I close on a mortgage?
How much house can you afford?
According to U.S. Bureau of Labor Statistics data, consumers spend an average of 33.8% of their expenditures on housing, the single most significant consumer expenditure. It’s essential to evaluate how much house you can afford. Reviewing your finances and budget is the most crucial step.
Before shopping for a home, examine your monthly budget to determine how much you can afford to spend on housing. Review your overall finances to determine how much cash you can put toward the purchase and your credit rating.
As you analyze how much you can spend on housing, consider these factors:
- Your monthly budget. A rule of thumb is to spend no more than 30% of your monthly income on housing. For budgeting purposes, besides your principal and interest (P&I) payment, insurance, and property taxes, factor in costs for needs such as lawn care, maintenance or repairs, and HOA fees. Be sure to consider how your transportation costs may change for homes inside and outside metropolitan areas.
- Your overall level of debt. When lenders evaluate your ability to repay the loan, they’ll analyze your debt-to-income (DTI) ratio. Calculate it by dividing all your monthly debt payments (including the new mortgage) by your gross monthly income. You’ll often need a DTI of 43% or lower.
- How you’ve managed your credit in the past. Lenders also evaluate your willingness to repay the loan based on your credit history and score. You are more likely to get approved if you have good credit, and better credit yields better rates and terms.
- How much of a down payment you can make. The bigger the down payment, the lower your monthly payment and borrowing costs will be. Down payments of 20% often yield lower borrowing costs (e.g., you’ll pay less interest and won’t need PMI), but you may be able to put as little as 0% to 5% down.
Another factor to consider is how much cash you can spend on closing costs. On average, you can expect to spend 3% to 4% of your home’s price on closing costs. These fees include charges for mortgage origination or processing fees, appraisal fees, and title fees.
Also, consider how much cash you need to set aside for costs you’ll incur after you buy the home. For example, you may want to improve or repair the home (e.g., add blinds, update the flooring, refresh the landscaping, or buy appliances). You might also need to purchase furnishings.
If you plan to pay cash for your home, you don’t have any borrowing costs to consider. However, you still need to factor in costs associated with home ownership, such as maintenance, insurance, taxes, utilities, and repairs. Plus, you may need to pay title fees to transfer the home into your name.
For individuals who plan to purchase a home with cash, once you’ve determined how much you can afford, you’re ready to shop for a home. If you plan to get a loan to fund the home purchase, your next step in the homebuying process is to shop for a loan.
How to shop for a loan
When shopping for a loan, the first step is to gather the documents you might need to provide to your lender. These include recent bank statements, tax returns, and pay stubs. The next step is to search for several reputable lenders that offer mortgages in your area.
You can search for reputable lenders online or ask a finance expert for advice. Your bank or credit union may also be a wise place to shop for a mortgage. Plus, special programs and resources exist for people with bad credit, veterans, and self-employed borrowers.
A mortgage is usually the best financing for a home purchase. However, in some instances, you might consider getting what’s known as a purchase money second home equity loan. This type of loan can be helpful if you plan to make improvements or repairs to the home once you close.
Before applying, verify whether the lender will use a soft or hard credit check. With a soft credit check, you’ll get rate and term estimates to review with no credit score impact. A hard credit check will only occur if you agree to proceed. Once you apply, you may get the following from your lender:
- Prequalification letter: Certain lenders will give you a prequalification letter that says you prequalify for a mortgage up to a certain amount based on a preliminary review of your credit and application. It will note it’s subject to change based on a full credit review.
- Preapproval letter: Depending on the lender’s terminology, preapproval might be the same as prequalification. However, many lenders perform a deeper review before issuing a preapproval, such as reviewing asset and income documents. This letter will also state it’s subject to a full credit review.
- Approval letter: Once the lender completes its underwriting—including an analysis of the home you’re buying—it will issue an approval letter stating you’re approved for the loan as long as nothing changes (e.g., you don’t change jobs or buy a different home).
You can expect to complete the prequalification or preapproval process as soon as the same day for a basic credit review or as long as 10 business days for a review of your documentation. You’ll work on the final approval process after you find a home.
You can expedite the process by giving your lender all the required documentation upfront (e.g., tax returns, pay stubs, bank statements) and quickly responding to information requests. The more organized and quicker you are to respond, the easier you’ll find the home loan process.
Two reasons to shop for a loan before house hunting are:
- You’ll confirm the loan size, rates, and terms you may get.
- Sellers are more likely to accept offers from prequalified or preapproved buyers.
Once you’re preapproved or prequalified, you can start home shopping.
If you can’t get approved, it doesn’t necessarily mean you can’t buy a home. You might instead search for homes where the seller is willing to offer a rent-to-own purchase option. This allows you to get into a home while you work on fixing your credit.
How to shop for a home
The process you should use to shop for a home depends on your preferences and needs. A licensed real estate agent is an excellent choice if you want expert guidance. Not only are they familiar with the local market, but they’re well-versed in real estate laws and processes.
When you hire a licensed real estate agent, they get paid from the home sale proceeds. In most cases, the seller pays the real estate agents involved in the transaction a portion of the home’s sale price via a commission, so you benefit from the agent’s expertise with no out-of-pocket costs.
If you buy a property listed for sale by the owner, you might decide you don’t need a real estate agent. You can still use one, but the seller might ask you to pay the commission. If you decide not to use one, consider hiring another expert (e.g., a title agency) to help with the legal documents.
Real estate agents often send you listings to review; however, you can also find homes for sale online. If you find a home you like, ask your real estate agent to show it to you in person. Also, consider the following as you shop for a home:
- How quickly you want to find a home. This question’s answer determines how picky you can be in your home search and how aggressive your offers must be. You can look at more homes and make lowball offers if time is on your side. Otherwise, you may need to settle for a “good enough” home.
- What’s most important to you in a home. Before you start searching, make a list of your must-haves. You may not find one with everything you want unless you build a custom home. Your home search will be easier if you decide upfront your must-haves versus nice-to-haves.
- How to shop if you live far away from the area. You may live far away from the home you’re buying. It’s always wise to visit the home you’re buying in person. If you can’t do this, due diligence, such as hiring a licensed home inspector or other professionals to view it, is crucial.
Besides these considerations, you might need extra help because of a disability. Many resources are available to help people with disabilities buy a home. If you’re unsure where to get help, ask your lender and real estate agent. They may guide you to resources.
How to make an offer on a home
Once you’ve found a home you want to purchase, the next step is to make an offer to buy the home. You should only make an offer if you’re serious about buying the home. You’ll often need to include a deposit when you make the offer, which you could lose if you cancel for an unapproved reason.
The deposit size varies, but it could be as little as $1,000 or as much as 5% of the purchase price. The larger your deposit, the more seriously the seller may take your offer. Ensure the offer includes contingencies in case the purchase doesn’t go through.
The contingencies in the offer will vary, but common contingency clauses include:
- Home sale: If you haven’t sold your home, you may include a home sale contingency that allows you to back out the purchase if your home doesn’t sell within a specific period. Many sellers won’t agree to this contingency unless you already have a sales contract on your home.
- Inspection: An inspection contingency often allows you to cancel the contract for any reason during the specified inspection period (e.g., 10 days). After the inspection, you can do nothing or try to renegotiate the contract (e.g., ask the seller to pay for certain repairs). You may be tempted to waive an inspection in a competitive seller’s market. This can be risky, but if you choose to, ensure you have ample funds to pay for any unexpected costs.
- Appraisal: Offers often include an appraisal contingency allowing you to cancel the contract if a third-party appraisal comes back with a value less than the agreed-upon purchase price. You can also attempt to renegotiate the contract if the appraised value is lower than expected.
- Financing: If you’re funding the purchase with a mortgage, many contracts include a financing contingency that allows you to cancel if you can’t get a mortgage. Sellers often request a preapproval letter before agreeing to this type of contingency.
Include any documentation the seller might want to review with the offer. For instance, include your home’s sales contract if you’re requesting a home sale contingency and a preapproval letter if you’re requesting a financing contingency. You may also include proof of funds for cash offers.
Sellers are more likely to accept purchase offers they believe will go through. You can show you’re a solid buyer by making a well-documented offer, which includes how long the seller has to respond, with 24 hours being a common turnaround time.
Your real estate agent will handle the offer details, including drafting the offer and sending it to the seller’s agent. Before it’s sent, you’ll review and sign the offer in person or electronically, based on your preferences. An attorney may be able to assist if you don’t use a real estate agent.
Once the offer is made, the seller can reject it, accept it, or make a counteroffer. In case of a counteroffer, you can choose the same options. After you’re under contract, you can back out without penalty if the contingencies are met. The seller can also back out unless the contract disallows it.
How important is the down payment to your offer being accepted?
The size of the down payment you can make may not influence the likelihood of your offer being accepted unless the seller gets an offer from a better-qualified buyer. Sellers are more likely to accept offers they’re confident will go through.
If a seller gets two offers, one from a verified cash buyer and another from a buyer with a financing contingency, they’re more likely to accept the cash offer. The same is true for two offers with financing contingencies—they’re more likely to accept the offer from the buyer with more cash.
When you make an offer on a home, do your best to make it attractive to the seller. Even if you don’t have a large down payment, you can show the seller you’re serious by including a preapproval letter from your lender and offering an earnest-money deposit.
The larger the down payment you can make, the easier you’ll find the homebuying process. It will be easier to find a loan, and you’ll have more buying power and pay less in borrowing costs. So saving money for a down payment is wise if you plan to buy a home.
Do you need an appraisal?
You’ll need an appraisal if you use a mortgage to finance your home purchase. Your lender will order the appraisal once you’ve given it details about the home. Appraisals often cost between $200 and $600. You might have to pay this fee, or your lender might cover it.
Lenders use appraisals to confirm your home’s value and verify the down payment you must make. If the value is the same as or higher than the purchase price, the down payment will be based on the purchase price. Your down payment will be based on the appraised value if it’s lower.
If the appraised value is lower than the purchase price, you have several options:
- Back out of the purchase. If your contract has an appraisal contingency, you can back out of the purchase without penalty if the appraised value is lower than the purchase price.
- Renegotiate with the seller. Assuming you included an appraisal contingency in your offer, you may be able to renegotiate with the seller. They may be willing to reduce the price if they think future buyers will face this issue.
- Make a larger down payment. The best action may be to make a larger down payment. If the appraised value is marginally smaller than the purchase price, it might not be worth renegotiating or restarting your search.
- Find another lender. Your lender might back out of the loan if the appraisal is too low. If you still want to buy the home, you may need to find another lender. If you can’t close in time, you might need to ask the seller to extend the contract.
It often benefits you if the appraised value is higher than the purchase price. The seller may not know the appraised value because appraisals are often ordered for the lender and you. In most cases, nothing precludes sellers from backing out of contracts, so this is a risk.
In certain instances, you might get an appraisal for a reason other than a loan. For example, if you’re a cash buyer, you might get an appraisal to confirm the home’s value for your purposes. You and the seller might also get an appraisal to set the price in rare instances.
Should you decide to get an appraisal for a reason other than getting a loan, you’ll need to work out who will pay for and order the appraisal as part of the contract negotiation process.
An appraisal may take a couple of weeks or up to a month. This can depend on how busy the market is, the size of your loan, and the home’s characteristics. Busier markets and more complicated homes and transactions may have longer appraisal times.
Do you need a home inspection?
In most cases, the decision to get a home inspection is up to you, the buyer. Most lenders don’t require home inspections because their analysis of the home’s condition is based on the appraisal. Even so, getting a home inspection is often a good idea, particularly with older homes.
You can expect a home inspection to cost between $300 and $1,000, depending on the home’s location, size, and features. In many cases, buyers cover the home inspection costs, but you can ask the seller to pay for it when you negotiate the purchase contract.
Depending on the home’s nature and your expertise, you might decide you don’t want to get a home inspection. For example, you might decide against an inspection if the home is new. If you’re a construction expert, you might inspect the house independently.
Besides determining whether a home inspection is needed, you’ll need to decide what to check. Most home inspections include a visual survey of the structure, exterior, roof, appliances, windows, doors, heating and cooling system, and plumbing. You might also need a:
- Termite inspection: This inspection includes evaluating whether termites or similar pests infest the home. Certain loans (e.g., VA loans) may require you to get a termite inspection as a closing condition.
- Radon inspection: If you’re concerned about the potential radon levels in your home, a radon test can verify the exposure level. See your radon zone by checking with the EPA.
- Mold inspection: If you see mold or notice dampness in the home, a mold inspection can help ensure no problems or identify the extent of the issue. Home inspectors may also recommend this if they see evidence of an issue.
- Foundation inspection: Home inspectors will visually inspect the home’s foundation, but if they notice a potential issue, they might recommend you have a structural engineer complete a foundation inspection.
If issues arise during the inspection, you have several options, assuming your offer has a home inspection contingency. You can do nothing, you can try to renegotiate with the seller, or you may be able to cancel the contract. What you choose to do will depend on the severity of the issues.
Sometimes, the items the inspector identifies are minor, so you might decide it’s not worth the hassle of renegotiating the contract. If the repairs are costly, you might see whether the seller will pay for them or lower the purchase price.
Depending on what the home inspection finds, you might decide to cancel the contract. If you think the repairs will be too expensive or there are major structural issues, you might save trouble and money in the long run by canceling the contract.
When to get insurance quotes
If you’re getting a mortgage, you must carry property insurance. You’ll provide your lender with proof of insurance as a condition of the loan approval. It’s wise to get a quote early in the process to know how much it will cost and to give you time to shop around.
Lenders will evaluate whether your home is in a flood zone early in the process. If your home is in a flood zone, you’ll need to purchase flood insurance, which can be expensive. Depending on the cost, you might decide a different home is better.
Depending on how your contract is worded and the contingencies, you may be able to back out because insurance is too expensive during the inspection period. Talk about this with your real estate agent, and get insurance quotes early so you can back out of the contract if needed.
Even if you’re not getting a loan, property insurance is wise. Homes are often one of our most significant purchases, so protecting this valuable asset makes sense. If you don’t have property insurance, you’re not protected if something that’s covered happens, such as a house fire.
What happens when I close on a mortgage?
When you close a purchase transaction, the home’s ownership transfers to you. If you’re using the proceeds from a mortgage to purchase a home, the mortgage will close simultaneously with the purchase transaction. Your lender will send the loan funds to the seller at closing.
If you’re using a title company to close the transaction, it will handle all the closing details. This includes collecting the money you need for your down payment, closing costs, mortgage proceeds, and distributing the funds. It will also handle all the paperwork.
You’ll often go to the title company on closing day or several days ahead to sign the paperwork and give the funds you must pay via a cashier’s check or wire transfer. Once everything is processed, the title company will give you paperwork copies and the keys to your new home.
Certain states use attorneys instead of title companies, but the process is similar. Potential problems could include issues with the paperwork that needs to be fixed or you not meeting the closing requirements. Review what’s required before closing to minimize issues.