If you're planning to buy your first house, take these steps to nail down the basics before talking to a lender or real estate agent:

• Review your credit report.
  
  
• Organize your financial information, including current earnings, income tax returns, employment history, current liabilities and bank accounts.
  
  
• Secure pre-approval for a mortgage.
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• Scope out prospective neighborhoods.

"Many first-time home buyers overestimate what they can afford," says Mauro Appezzato, chief executive officer at America's Lending Partners, an Internet mortgage company based in Sacramento , Calif. "The key is to stay within your budget. Buyers sometimes forget that a real estate agent earns a bigger commission by selling them more house than they can really afford."

A good starting point: plan to spend about 30% of your gross monthly income on the mortgage payment, assuming that debt, including car and student loans and credit card payments, are less than about 8% of your gross monthly income. Some push the limit to 35% or even 40% of gross monthly income.

If there are problems with your credit, now's the time to clean them up and set the record straight. (See: "How To Read a Credit Report" and "What Is a FICO Score and How Does It Affect You?") 

After taking these steps, ask yourself five basic questions that will help determine what you can afford and how much you'll pay for the mortgage:


1) How long do you plan to live in the house?

In general, a fixed-rated loan is better if you plan to keep the house for the long-term and interest rates are low. An adjustable-rate mortgage can make sense if interest rates are high and if you plan to move in a few years. Typically, ARMs re-set once a year after an initial period that can range from a few months to several years. The new interest rate is pegged to a market index, including recent action by the Federal Reserve.


2) Do you want to pay discount points?

Points work like this: Pay the lender upfront or pay more over time in the future. You can pay extra at closing and lower your interest rate. This is often called "buying down" your interest rate and will vary from lender to lender.

"You don't want to put all your cash toward the down payment and points," Appezzato says. "There are always some unexpected expenses in owning a house and you want to have a reserve to cover them. It doesn't make sense to exhaust your cash on a 6% mortgage and then blow out your credit cards at 20% or higher to make home repairs."

Estimate how long you plan to stay in the house before deciding to pay points at closing. Calculate how much the additional payment for points will lower the monthly mortgage payment and balance this against the money you have on hand to swing the deal. Next, pencil out how long it will take for payments with lower interest rate to equal the cost of making an additional lump sum payment up front. If you calculate that it will take about five years to break even and if you plan to stay in the house for 10 years or more, paying points looks like a smart move.


3) What does the mortgage payment include?

There are four basic elements in your monthly mortgage payment: Principal, interest, taxes and insurance.

The principal is the balance outstanding on the loan. Early in the payment cycle, most of the monthly payment will go to interest, or the cost of borrowing money from the bank. Taxes include levies imposed by local government, including money to support schools, fire and police. Insurance protects the lender from losses caused by fire or severe weather.


4) Will you need to buy Private Mortgage Insurance?

If the mortgage totals 80% or more of the value of the house, expect to pay extra for Private Mortgage Insurance. The coverage is a way for the lender to recover its investment if you default on the loan.

Few first-time buyers have the money for a large down payment, so it's probably wise to include the cost of private mortgage insurance when calculating the cost of buying a house.


5) What does your gut say?

After you've penciled everything out, you'll find there's also an emotional aspect to buying a house. Don't ignore it - follow your gut. If something doesn't feel right, fix it or move on. Your first house won't be your last unless you get in over your head. If that happens, you run the risk of losing your house, your credit rating - and your dreams.