Honey, I’m Home: How buyers can navigate a competitive housing market with confidence

Americans are eager to own homes, and it’s no surprise why: despite this year’s rallies in stocks, gold, and crypto, Americans still firmly believe that real estate is the best long-term investment. The bottom line is that homes tend to go up in value. Real estate is widely seen as a reliable asset and a strong way to build equity, offering the opportunity to grow wealth once buyers are through the door.

But many buyers are having difficulty getting a foot in the door due to the nationwide housing shortage. However, there are several strategic steps buyers can take to gain a competitive edge. For instance, the seasonal effect of the summertime on the market is a lever that can be pulled in either direction, whether a buyer wants more home options (through the summer months), or less competition (over the winter season). 

With a high demand for homes and a limited supply, it’s vital that prospective buyers get acquainted with the market. As with any major financial decision, a bit of preparation can set you up for success. For buyers, getting a grip on their local markets, financial considerations, and quirks of the mortgage market is the best way to maximize chances of securing a dream first or second home — as well as the options that having home equity gives you further down the line.

First-time buyers: What are the core financial considerations?

Pre-approval 

So you’ve decided to go for it and start looking at homes. But there’s a few steps you’ll want to take before you fall in love with the beautiful townhouse in a  great school district— and on the mortgage front, it’s time to get pre-approved.

There’s a couple of documents you may have heard of in the pre-approval process: a prequalification letter, and a preapproval letter. While the first is an informal estimate of the size of loan you can get, a pre-approval letter is the golden ticket. The pre-approval letter is signed off by your lender with a statement of how much they’re willing to loan you. It’s based on a deeper scope of your financial information including W-2s, bank statements, and credit score.

On both the seller’s and buyer’s end, it’s ideal to get pre-approved. As the buyer, you get a precise idea of your budget; for the seller, an offer backed by a pre-approved loan is obviously preferable and gives you an edge over the other prospective buyers who don’t have pre-approvals.

Calculate Your DTI

Another factor in figuring out what you can afford comes down to your DTI, or debt-to-income ratio. Lenders use this to gauge the amount of debt you have as a proportion of your income, which factors in everything from rent to student loan payments to minimum credit card payments. A high DTI might translate as a higher-interest mortgage offer.

Applicants that have a DTI ratio of <50% are preferred by lenders. So for instance, if your monthly household income is $5000 and your monthly debt (inclusive of rent) to be paid is $2000, your DTI is 0.40, and you’d likely qualify. 

Loan Options

Most prospective home buyers will be familiar with conventional mortgage loans, although down payments differ from case to case. 2022 NAR data pins the average down payment on a first home at 6-7% — rising to 17% for a second home — but conventional loans start from 3% down. 

If credit debt is an obstacle, first-time home buyers also have the option of an FHA loan. These government-backed loans offer more flexible credit score requirements than the conventional loans you’d get from lenders, offering down payments from 3.5%. That said, with a credit score below 580, a 10% down payment is usually necessary.

Two other notable mortgage types include USDA loans, which are applicable for homes in qualified rural or suburban areas, as well as VA loans for veterans or active duty members of the armed forces. These both offer 0% down payment loans to those eligible. 

For an accurate and personalized picture of what you can afford, Rocket Mortgage’s purchase calculators are a great place to start. Figure out your budget, your monthly mortgage repayments, your down payment savings goal, or start simple by comparing the cost of renting vs buying. There’s a calculator for all those things, and more.

Considerations for repeat and second-home buyers

If you’re a repeat buyer, the financials of a home buy could look a little different. A second mortgage usually has a higher eligibility threshold than a first, so while the same considerations apply, there are few notable differences.

Down payment and interest. For repeat or second-home buyers, your down payment is likely to be a higher percentage of your home. Per NAR’s 2022 data, 17% was the average down payment for repeat buyers. If you’re using a conventional loan for a second home, most lenders require at least 10% down payment too — and you won’t be able to use a government-backed FHA option.

Eligibility. When it comes to secondary homes, lenders usually have tighter credit score, debt-to-income ratio (DTI) and cash reserve requirements for financing. A credit score of 700 or above is usually the cut-off point for securing a mortgage on a second home. The required range for debt-to-income ratio is also narrower for a second mortgage, with experts recommending a DTI of 43% or less (compared to 50% for first-time buyers).

Leveraging equity in your home

As a prospective buyer, understanding how home equity growth might affect your financial position is also a key consideration. Broadly speaking, if you pay off your mortgage monthly and the price of your home appreciates, you’ll gain equity — but equity growth will be slower in the initial stages of the amortization period as you pay more towards your mortgage’s interest than principal. 

That said, if equity growth is important for your finances, there are ways you can accelerate your position as a homeowner. Namely, you can pay off more than your minimum monthly payment so that you’re paying towards the principal balance. You could also consider renovating your home to increase its value. 

The way you leverage equity you’ve gained in your home is a personal decision as much as a financial one. Depending on your objectives, you might opt for a cash-out refinance, a home equity loan, or a home equity line of credit (HELOC) to either pay off other debts or generate cashflow. Mortgage refinances and home equity loans usually offer more competitive interest rates than credit cards, auto loans and personal loans. Prospective buyers with any of these kinds of high-interest debts should know that they can put home equity to work to offset some of that interest.

Home equity loans can also be utilized for remodeling, which is a way to leverage home equity that reinvests back into the property’s value. This can potentially add to the value appreciation your home is likely to gain over time. Plus, the interest on home equity loans used for renovations may be deductible from your income tax return.

Another equity consideration for prospective buyers relates to private mortgage insurance (PMI). Most conventional loans will require this for down payments under 20%. It isn’t automatically removed until the homeowner reaches 22% equity — but you can request that your lender cancel this at 20% instead. This is an additional reason to prioritize accelerating equity growth early in the amortization period and being proactive about the financial leverage that home equity can bring.

Home finances, figured

Prospective buyers are facing some fierce competition — but there are smart ways to gain a competitive edge, whether it’s a first-time home buy or leveraging equity further down the line. Understanding the financial requirements and implications of home ownership is the foundation of a smart investment… as well as a lender who can help you get what you need. 

Rocket Mortgage is on hand to make sure that happens. As America’s largest mortgage lender with 90% of clients willing to recommend them, Rocket is an invaluable partner in thousands of home buys. Whether you want to purchase a new home or refinance, they’ve got experts on hand 24/7 to fuel you with confidence throughout the process — and they’ll still be there for you as you repay.

Rocket knows it’s a tough climate… which is why they’re offering Sherwood readers lender credit of $1,000 when they lock in a loan using this link. If 2024 is your year, let Rocket show you what’s possible. Start an application today.

Advertiser’s Disclosure: 
¹Home equity loans will add to a lender’s overall debt burden and may entail a greater risk of losing the home, paying more interest over the life of the debt consolidated into the loan, and greater difficulty qualifying for a cash-out refinance in the future.

²Based on a Rocket Mortgage market research questionnaire of clients whose loans closed in 2022.

³Clients will receive a lender credit of $1,000 when they lock a loan on or after October 20th, 2023, utilizing the Sherwood readers application link. Offer cannot be retroactively applied to previously closed/locked loans. Offer does not apply to new loans submitted through non-retail loan originators, including brokers. Additional restrictions apply. Rocket Mortgage reserves the right to cancel/modify this offer/terms/conditions at any time. Acceptance of this offer constitutes acceptance of these terms and conditions. Offer is nontransferable. This is not a commitment to lend. Offer not valid with any additional discounts or promotions.

⁴The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as financial advice. Borrowers should undertake their own due diligence and carefully evaluate forecasts and factors before entering into a mortgage contract. 

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