LET’S ASSESS YOUR FINANCES
*Considerations Before You Buy
The first thing you'll need to determine is what your long-term goals are. Then, consider how home ownership fits in with those plans. Some folks are simply looking to transform all those "wasted" rent payments into mortgage payments that actually lead to owning something tangible—equity, baby! Others see homeownership as a sign of their independence and enjoy the idea of being their own landlord. Then, there's the issue of thinking of buying a home as an investment.
Narrowing down your big-picture homeownership goals will point you in the right direction. Here are 10 questions to ask yourself:
1.What Kind of Home Can You Actually Afford?
Before you start shopping, it's important to get an idea of how much a lender will actually be willing to lend you to purchase your first home. You may think you can afford a $300,000 place, but lenders may think you're only good for $200,000—depending on factors like how much other debt you have, your monthly income, and how long you've been at your current job.
On the other hand, sometimes a bank will give you a loan for a more expensive house than you really want to pay for. Just because a bank says it will lend you $300,000, doesn’t mean you should actually borrow that much. Many first-time homebuyers make this mistake and end up “house-poor”—meaning after they pay their monthly mortgage payment they have no funds left over for other costs, such as clothing, utilities, vacations, entertainment, or even food.
In deciding how big a loan to actually take, you'll want to look at the house's total cost, not just the monthly payment. Consider how high the property taxes are in your chosen neighborhood, how much homeowners insurancewill cost, how much you anticipate spending to maintain or improve the house, and how much your closing costs will be.
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2.Do You Have Serious Savings?
Even if you qualify for a sizeable mortgage, there will be a considerable upfront cash outlay that includes your down payment (3.5%–20% of the purchase price) and closing costs. When it comes to investing with an eye toward purchasing a home—a short-term goal—one of the biggest challenges is keeping savings in an accessible, relatively safe vehicle that still affords a return. If you have one year to three years to realize your goal, then a certificate of deposit (CD) may be a viable option. It’s not going to make you rich, but you aren’t going to lose money either.
The same idea can be applied to purchasing a short-term bond or a fixed income portfolio—it will give you some growth but also protect you from the tumultuous nature of the stock markets.
3.The Buying Process.
Now that you've decided to take the plunge, let's explore what you can expect from the home buying process itself. This is a chaotic time with offers and counteroffers flying furiously. But if you are prepared for the hassle (and the paperwork), you can get through the process with your sanity more-or-less intact. Here is the basic progression that you can expect:
4.Consider Your Financing Options and Secure Financing.
It'll behoove you to make sure your personal finances are in order. Generally, in order to qualify for a home loan, you have to have good credit, a history of paying your bills on time, and a maximum debt-to-income ratio of 43%.2
Consumer Financial Protection Bureau. "What Is a Debt-to-Income Ratio? Why Is the 43% Debt-to-Income Ratio Important?"
Lenders these days generally prefer to limit housing expenses (principal, interest, taxes, and homeowners' insurance) to about 28% of the borrowers' monthly gross income, though this figure can vary widely, depending on the local real estate market.3
Once you've settled on a lender and applied, the lender will verify all of the financial information provided (checking credit scores, verifying employment information, calculating debt-to-income ratios, etc.). The lender can preapprove the borrower for a certain amount. Be aware that even if you have been preapproved for a mortgage, your loan can fall through at the last minute if you do something to alter your credit score, like financing a car purchase.
5.Don’t be bound by loyalty to your current financial institution.
When seeking a pre-approval or searching for a mortgage: Shop around, even if you only qualify for one type of loan. Fees can be surprisingly varied, as can mortgage interest rates (which, of course, have a major impact on the total price you pay for your home).
Some authorities also recommend you have a backup lender. Qualifying for a loan isn’t a guarantee your loan will eventually be funded: Underwriting guidelines shift, lender risk-analysis changes, and investor markets can alter. There can be cases of clients signing loan and escrow documents, and then getting notified 24 to 48 hours before the closing that the lender froze funding on their loan program. Having a second lender that has already qualified you for a mortgage gives you an alternate way to keep the process on, or close to, schedule.
6.Special Terms for First-Time Homebuyers.
First-time homebuyers have a wide variety of options to help them get a residence, from state programs, to tax breaks, to federally-backed loans for those who don't have the standard 20% minimum down payment. Individuals in special identity categories, like Native Americans and veterans, may also qualify for special assistance. And while the definition of a first-time homebuyer seems self-evident, you might actually qualify as one even if you aren't a novice. Even the IRS gets into the act, letting you use an IRA (in a limited way) to finance a purchase.5 It definitely behooves you to check out the special benefits for first-time homebuyers.
7.Congratulations, New Homeowner.
You've signed the papers, paid the movers and the new place is starting to feel like home. Game over right? Not quite. Let's now examine some final tips to make life as a new homeowner more fun and secure.
With homeownership comes major unexpected expenses, like replacing the rain gutters or getting a new water heater. Start an emergency fund for your home so that you won't be caught off-guard when these costs inevitably arise.
9.Ignore the Housing Market
It doesn't matter what your home is worth at any given moment—except the moment when you sell it. Being able to choose when you sell your home, rather than being forced to sell it due to job relocation or financial distress, will be the biggest determinant of whether you will see a solid profit from your investment.
10.Don't Rely on Selling Your Home to Fund Your Retirement
Even though you own a home, you should still continue to save the maximum in your retirement savings accounts every year. Although it may seem hard to believe for anyone who has observed the fortunes some people made during the housing bubble, you won't necessarily make a killing when you sell your house.
If you want to look at your home as a source of wealth in retirement, consider that once you've paid off your mortgage, the money that you were spending on monthly payments can be used to fund some of your living and medical expenses in retirement.
The Bottom Line
This brief overview should help put you on the path toward filling in any gaps in your homebuying knowledge. Remember that the more you educate yourself about the process beforehand, the less stressful it will be, and the more likely you will be to get the house you want for a price you can afford.
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SHOW ME YOUR TAXES, I WILL SHOW YOU YOUR HOME*