A first-time buyer's guide with the arithmetic left in

Buying a first home is mostly a sequencing problem. Almost every expensive mistake in the process comes from doing step four before step two — usually from falling for a house before knowing what the payment on it does to the household. Here is the order, with the arithmetic left in.

Step 1: find your ceiling, and find out what sets it

Lenders test you with two debt-to-income ratios: housing costs over gross income (the front-end ratio, classically 28%), and all debt payments over gross income (the back-end ratio, classically 36%). Both are computed before tax. The lower of the two budgets is your ceiling.

Which one binds is the useful information. Take a household on $118,000 a year — $9,833.33 a month gross — with $40,000 down and $640 a month of other debt, looking at a 30-year loan at a placeholder 6.5%:

• Front-end budget: 28% of $9,833.33 = $2,753.33.
• Back-end budget: 36% of $9,833.33, less $640 = $2,900.00.

The front-end test is tighter, so the ceiling is a $366,506 price. Paying off the car would not raise it by a dollar. Raise the other debt to $940 a month and the back-end budget falls to $2,600, the back-end test takes over, and the ceiling drops to $346,962 — at which point clearing $500 a month of debt is worth $19,544 of house, more than half a point of interest rate would be.

The affordability calculator names the binding constraint in a sentence. Read that sentence before you read the number.

Step 2: count all the cash, not just the down payment

The down payment is the number people save for. It is not the number they need.

• Closing costs, commonly 2–5% of the price. On a $310,000 purchase, $6,200 to $15,500. Lender fees, title insurance, appraisal, recording, and prepaid taxes and insurance into escrow.
• Earnest money, typically 1–3%, paid when the offer is accepted. It is credited at closing, but it leaves your account months earlier.
• The inspection, a few hundred dollars, paid on the day and not refundable if you walk away — which is the point of it.
• A reserve. Some loan programmes require one. Every household needs one anyway.

Step 3: choose the programme by its mortgage insurance

For a first purchase with less than 20% down, the mortgage insurance is usually the largest long-run difference between programmes, and its rules differ more than its rates.

• Conventional with less than 20% down carries PMI, which under the Homeowners Protection Act of 1998 must be cancelled on request when the scheduled balance reaches 80% of the original value and automatically at 78%. It ends.
• FHA carries an up-front premium of 1.75% of the base loan plus an annual premium whose duration is fixed at origination by HUD Mortgagee Letter 2013-04: the full term above 90% LTV, eleven years at or below. On a 3.5%-down purchase it never comes off. It does not stop at 80% — that is the conventional rule and applying it to an FHA loan understates the cost badly.
• VA has no monthly mortgage insurance at all, only a one-time funding fee.
• USDA has both a one-time guarantee fee and an annual fee that runs for the life of the loan.

On a $310,000 house, an FHA loan with 3.5% down pays $32,850 of annual MIP over thirty years plus $5,235 up front, while a conventional loan with 5% down pays $17,650 of PMI and is done in month 124. The FHA MIP calculator prints the duration rule beside the figure, and the full comparison is in its own article.

Step 4: get pre-approved, then stop looking above it

A pre-approval means a lender has read your documents and formed a view. It is what makes an offer credible in a competitive market and it is what stops you touring houses you cannot buy.

You will need, roughly: two years of W-2s or tax returns, thirty days of pay stubs, two months of statements for every account you are drawing on, photo ID, and an explanation of any large recent deposit. If you are self-employed, two years of returns and probably a profit-and-loss statement.

Two rules while a file is open: do not open new credit, and do not move money between accounts without being able to document where it came from. Both create work; the second creates delay.

Step 5: the offer, the inspection, the appraisal

Once an offer is accepted, three clocks run at once and only one of them is yours.

• The inspection is your check on the house’s condition and your last clean exit.
• The appraisal is the lender’s check on the collateral. If it comes in below the contract price, the lender lends against the lower figure and the gap becomes cash you must find, price you must renegotiate, or a deal you must walk away from.
• Title confirms the seller can actually sell it.

The appraiser and the title company work to their own calendars. That is precisely why no honest lender promises a closing date, and why nothing on this site does.

Step 6: read the Closing Disclosure against the Loan Estimate

You get the Closing Disclosure at least three business days before closing, by regulation. Put it next to the Loan Estimate you were given and compare line by line. Some figures are allowed to move and some are not. Ask about every one that changed. This is the last moment at which asking is cheap.

The question underneath all of it: should you buy at all?

Buying is not automatically better than renting, and the honest version of the comparison is sensitive to inputs in a way that slogans are not.

Take a $385,000 house with 12% down at a placeholder 6.5%, tax at 1.25%, insurance at $1,800, maintenance at 1% of value, $5,400 of buying costs and 6% to sell, against renting at $1,950 a month growing 3% a year, with both households investing whatever they save at 5%:

• After 7 years, the renter is ahead by roughly $43,000.
• After 10 years, still ahead by about $40,000.
• Buying does not overtake renting until around month 234 — nineteen and a half years.

Now change one input. If the comparable rent is $2,400 rather than $1,950, buying overtakes renting at month 74 — a little over six years — and is ahead by about $40,000 at ten years. And if home appreciation is set to zero at that same $2,400 rent, buying does not overtake renting inside ten years at all.

That volatility is the finding. The answer is not “buying wins” or “renting wins”; it is that the answer is decided by the rent you are actually comparing against and by an appreciation rate nobody knows. Run it on your own numbers, and set appreciation to zero once to see how much of the case rests on it.

The short version

1. Find the ceiling and find out which ratio set it.
2. Count all the cash, not just the down payment.
3. Choose the programme on its mortgage insurance rules, not its down payment.
4. Get pre-approved, then shop below it.
5. Expect the appraisal to be the thing that goes wrong.
6. Read the Closing Disclosure line by line.
7. Buy a payment you would still be comfortable with in a bad month — work backwards from that payment rather than forwards from a maximum.