• First-time home buyers face a steep learning curve, needing to get a handle on mortgages, budgeting and other intricacies.
• Tips include cleaning up your credit score before applying for a mortgage, and striving to keep prospective housing costs to no more than 20% of income.
• Overestimate what you think your post-purchase expenses, such a furniture, will be.

First-time home buyers have a steep learning curve, from understanding true affordability and how to qualify for a mortgage to managing their cash flow after their purchase.

"When buying your first home, you need to consider that what a lender will let you borrow is not necessarily the same amount as what you can reasonably afford," said certified financial planner Eric Roberge, founder of Beyond Your Hammock in Boston.

While most banks will let you take out a loan with a payment around 30% of your income, Roberge advises clients to keep their annual housing costs (mortgage payments along with property taxes, homeowner's insurance and annual maintenance) to 20% of their gross income.

"In today's environment, they're buying the payment, not the purchase price," said CJ Harrison, CFP, vice president of DecisionPoint Financial in Mesa, Arizona. "But they need to keep in mind that these are super inflated home prices.

"I ask these clients, 'Can you stomach financially a catastrophic decline in your home's value?'"

To bring his clients down to earth, Brian Mercado, a CFP with JSF Financial in Los Angeles, has them do an exercise.

"I tell them that, while they are house-hunting, they should try to live as if they were already making that larger payment," he said. "It's a stress test on their cash flow."

While buyers get used to the new budget, Mercado invests the excess monthly savings so it can be added to the down payment.

You don't want to outgrow your new house, said Stephanie Campos, CFP, owner of Campos Financial in Miami. She asks clients questions such as "Will this house meet your needs for more than five to 10 years?" and "Are the mortgage and closing costs worth it, if you need to buy another place in a few years?"

Tips for mortgages

Before applying for mortgages, it's essential to clean up your credit score if necessary, according to Campos.

"The advertised teaser rates are only for excellent credit and [in general, bank rates are a moving target dependent on the risk appetite of the lender," she said.

Campos advises home-seekers with credit scores under 600 to look into mortgages back by the Federal Home Authority. These are geared toward first-time homebuyers who have difficulty saving up the 20% down needed to avoid private mortgage insurance, she said. FHA loans may require as little as 3.5% down but come with slightly higher rates and certain payment and income requirements.

A way for buyers to avoid having to get private mortgage insurance, or PMI, Mercado said, is to take out two separate loans — i.e., a mortgage for 80% of the needed amount, and a home equity line of credit for the balance.

Mercado also suggests buyers request multiple pre-qualification letters from lenders in different amounts for different negotiation strategies. For example:

• If you don't want to tip off the seller that you can pay more, use a letter that shows only the amount you need for the purchase.
• If you are in a bidding war, use a letter with an amount that shows the seller that you can go higher.

Buyers should have a few on hand, in case they need to make an immediate offer, Mercado said.

Mortgages are one of the "most competitive arenas out there," said Harrison, "so get the cost breakdowns and show them to other lenders."

He tells buyers to get quotes from at least three mortgage sources and request a fee worksheet, which is preliminary and does not require a credit check, and/or a loan estimate, which is binding and requires a credit check.

After you buy

Overestimate what you think your post-purchase expenses will be, Harrison said, as furniture, yard maintenance and repair costs are high due to demand resulting from the hot housing market.

"Be patient before you start spending money after your purchase," he said. "Pace yourself and preserve your emergency fund — and budget for future purchases instead of spending all your cash."