You’ve thought about it, I’ve thought about it, my parents have asked me about it — is it time to buy a house? For generations, becoming a homeowner has not only been heralded as a money milestone but as a rite of passage for young adults. It’s also likely to be the largest purchase you’ll make in your lifetime, which is exactly why it’s not something to be taken lightly.
As it turns out, “I’m sick of renting” isn’t a good enough reason to want to buy a house. Beyond the cost of a mortgage, you’ll need to consider other expenses that come with homeownership, as well as contemplate the long-term viability of the abode you select as your own. For those reason, before you hit up that open house, here’s everything I’ve learned about house buying during my flirtations with home ownership as well as what you need to think about when determining if you really are ready.
Financing Options for Your First House
Before we get into all the extra costs that come with owning a home, let’s start with the basics: taking out a mortgage loan. As it turns out, there are tons of options to consider when looking at financing your potential new home. From your down payment to your last payment 30 years later, let’s take a look at some of your choices.
The 20% rule
Regardless of what type of mortgage you end up selecting (we’ll get there in a minute), the first step in buying a house is saving up for a down payment. But how much do you need? Most experts recommend that you put 20% of the purchase price, meaning that you’d need $40,000 on hand to purchase a $200,000 home.
There’s good reason for this 20% figure. First, ponying up a large chunk of cash up front will help lower your monthly payment. Furthermore, the less you need to finance, the less you’ll end up paying in interest. Lastly, by meeting the 20% requirement, you’ll avoid another added fee known as private mortgage insurance.
Private mortgage insurance
If you put less than 20% down on your home, you may be required to pay for private mortgage insurance (PMI). This fee can be as much as 1.5% of your loan amount, but will vary depending on the size our your down payment as well as on your credit. Typically your PMI will be billed into your monthly mortgage payment until you’ve paid off 22% of your total loan balance, at which point your PMI will be canceled.
It should be noted that there are some exceptions to the PMI rule. For example, some banks or credit unions will offer special mortgage products for first-time homebuyers, allowing them put as little as 3% down without paying a private mortgage insurance fee. However, these programs will often have a number of restrictions, so make sure you actually qualify before getting too excited.
Fixed rate vs. ARM
Speaking of different mortgage products, there are two major types of home loans out there: fixed rate and adjustable rate. As the names imply, a fixed rate mortgage means your interest rate and monthly payments will remain the same for the life of your loan. Meanwhile, adjustable rate mortgages (also known as ARM) have fluctuating rates based on certain indexes. As a result, your monthly payments are subject to change over time.
Further complicating the issue, there are several different types of ARM loans. For example, a 5/1 ARM means the rate will stay the same for five years before adjusting annually after that. Because of this, it can be difficult to calculate which option is truly best — especially since no one can really predict the future. That said, although ARM loans tend to have lower interest rates up front that may attract potential buyers, a good old-fashion fixed rate mortgage might be the better option in the end.
15 or 30 years?
Now that you’ve solved the fixed rate/adjustable rate dilemma, it’s time to decide on how long you’d like to be paying off your home. While the standard mortgage length is 30 years (360 months), many lenders offer 15-year (180 months) loans as well. Deciding which one is best for you will simply come down to your situation and how much you can afford per month.
Obviously, with the 30-year option being twice as long, your payments will be lower. Unfortunately, it also means you’ll be paying interest on your loan for twice as long. Thus, if you can afford it, a 15-year mortgage is usually a better option, as it will save you a ton of cash overall.
As mentioned, owning a home entails much more than just paying a mortgage. If you’re not prepared for these costs, a financial nightmare could be looming. Instead, be sure to read up on these costs so you know what you’re getting yourself into:
So, you’ve just purchased your first home and are an official property owner — congratulations! Now pay up.
Yes, depending on which state, county, and city you reside in, you could be looking at a hefty annual tax bill thanks to your new home. According to SmartAssett, the national average for property tax is around 1.2% of your home’s assessed value. However, that figure can vary greatly depending on where you live (Honolulu, HI? 0.291%. My first home of Clifton, New Jersey? 2.607%).
To be fair, there are also a number of tax benefits that homeowners enjoy as well. Still, that doesn’t mean you can simply ignore the price of property tax when you’re determining if you can really afford to buy a house.
Another must-have for any homeowner is insurance. Not only will such a policy cover damage that may affect your home and the possessions inside of it but also covers any liabilities you may have resulting from injuries or other incidents on your property. Like with auto insurance or renters insurance (you do have renters insurance, don’t you?), homeowners insurance policies can vary depending on a great many factors. That’s why it’s best to get a quote from a provider in your area so you have a good idea of how much this will run you.
You’ll also want be sure to pay close attention to what is and, perhaps more importantly, what is not covered in your policy. Depending on the risks that Mother Nature poses to your neck of the woods, you may want to invest in additional coverage such as earthquake insurance or flood insurance as well. Of course, these too come at a cost that you’ll need to account for in your calculations.
Even with insurance, you’ll certainly have your fair share of out-of-pocket upkeep costs. From cleaning your rain gutters and doing yard work to fixing pesky plumbing problems, it seems there’s always something that needs to be done (and often paid for) around the house. Even if you’re handy and can take care of some of these chores and repairs by yourself, you may still need to purchase various supplies and tools. Because of this, it’s a good idea to have money set aside in a “rainy day fund” to cover some of these needs.
I’m sure you’re probably shocked to learn that refrigerators, washing machines, and water heaters aren’t actually built to last forever. If that reality isn’t harsh enough for you, just wait until all of them decide to break around the same time. Once again, this is where that rainy day fund is really a must — unless you like melted food, dirty clothes, and cold showers, of course
Incidentally, your appliances don’t just cost you money when they break; even when they’re working, you’re still spending thanks to electric bills and other utilities. This probably isn’t terribly surprising because even most renters are still responsible for paying utilities. However, have you considered how much more it takes to heat and cool a full-sized house compared to a tiny apartment? Furthermore, just like your current utility bill likely varies from month to month based on the season, the same is sure to be true of your home, except on a larger scale. (Yes, this is why your father always yelled at you for leaving the lights on.)
Rarely will you find a home for sale where every fixture, swatch of carpet, and spot of paint is to your exact style and taste. Of course, some are pickier than others and may want to redo larger aspects of the bathrooms or kitchen. As anyone who’s watched enough HGTV should know, that could mean a full-on remodeling project.
If you know you’re going to want to remodel a home anyway, you may be tempted to purchase a less expensive home and fix it up — just like Chip and Joanne or the Property Brothers, right?! While that does make good financial sense on the surface, be aware that a lot can go wrong during the remodeling process that could end up blowing your budget. So, before you bite off more than you can chew, be sure you know what you’re getting yourself into and commission a thorough home inspection beforehand to reduce the chance of costly surprises.
Now that you have an idea of what types of mortgage options there are and some of the other expenses required for owning a home, it’s time to explore other factors that could impact your decision to (or not to) buy. Like in so many other areas of life, when it comes to buying a house, timing is everything. With that in mind, here’s why you might not want to buy right this second:
When deciding if you want to buy a home, here’s one big question to ask yourself: how’s your credit? Just like when buying a car or other big-ticket item, the worse your credit is, the higher your interest rate will likely be. Considering the price tag that comes with buying a house, every small percentage point could mean thousands of dollars. Thus, if your credit isn’t in great shape, you may want to hold off until you can repair it.
If you don’t know what your credit currently looks like, the first thing you’ll want to do is try a free monitoring site like Credit Karma (which I reviewed in-depth here). Long story short, these sites will give you a ballpark figure of what kind of shape your scores are in, although they might not be exactly what mortgage lenders will see, as they use slightly different credit models. While you can review your credit report on Credit Karma, you can also download your official report for free once a year by visiting AnnualCreditReport.com. Be sure to review it thoroughly and report any errors that could be unfairly hurting your credit.
Armed with the knowledge of what your credit scores are, you can then look for ways to improve them. Depending on how bad your credit is, this might be a hard road. As a result, delaying your home buying dreams may, unfortunately, be the best option.
Does it meet all your needs?
Before you sign on the dotted line and buy a home, you’ll want to make sure it really fits all of your needs. This might seem obvious, but somehow practicality can often be lost as buyers are dazzled by shiny new homes. Futhermore, don’t just consider the needs you have today but also those you might have in the coming years. One popular example of this is young couples looking to start a family — are you sacrificing the space you’ll need tomorrow because of your budget today? If so, that could cause real trouble down the road.
Clearly you don’t need to live in the same home forever, but there is a good rule of thumb: the five-year rule. Basically, this philosophy states that you should own a home for at least five years before moving. So, like a potential employer might ask you in an interview, where do you see yourself in five years? If you can’t answer that or the answer involves living somewhere else, it might be best to pass on buying a home for now.
The rent or buy calculator
Still not sure what makes the best financial sense for you? This rent or buy calculator can help you out in a big way. Basically, it incorporates a number of the factors we’ve discussed and provides you with a purely numerical look at whether it’s best to rent or buy. If my yammering on about costs isn’t doing the trick for you, perhaps looking at the actual numbers will help you make your final decision.
So you still have your heart set on buying a home and you just need a couple more things to fall into place for you, eh? The good news is there are ways to save and make your dream home affordable after all. Here are a few things you can do to help cut the costs of homeownership:
Do the full 20%
As we’ve discussed, there’s a good reason why a 20% down payment has become a standard in home buying. Sticking to this will not only save you money on PMI payments but will also cut down on the total interest you pay over the life of your loan. Plus, being able to save up a nice chunk of cash like this will teach you some great habits that will certainly come in handy throughout your financial life.
Protip: listing prices are just a starting point. That’s why, before you officially buy your first home, you make an offer. While there is risk in lowballing a seller and insulting them with your price, there is often room for negotiation. If you’re not sure what’s fair, you can always ask your agent as they’ll have a much better sense for what homes in your area go for and what’s customary in terms of sticking to list price.
Another thing to remember is during the negotiating process is that money doesn’t suddenly change its value just because you’re talking about a lot of it. Sure the difference between $195,000 and $200,000 might seem petty in this instance, but how would you react if you gained an extra five grand in any other situation? Now, I’m not suggesting you go back and forth with a seller over a few dollars, but also don’t lose site of what these figures actually mean.
While I did warn against taking on too big of a project earlier, there are certainly some things you can do to fix up your house yourself and avoid paying someone else. You’d be amazed at all of the resources you can find on YouTube and other sites that will help walk you through tasks you never knew you could do. Personally, I once changed out and installed my own garbage disposal thanks to a YouTube video and I’ve never been more proud of myself (not to mention the cash I must have saved).
The best way to avoid costly repairs and other expenses is to prevent them ahead of time. There are a number of small changes you can make and tasks you can perform — ranging from replacing air filters to adding insulation — that will help ensure that your home and appliances are running efficiently. While none of these will guarantee that you won’t run into issues, they’ll certainly help.
Rent a room
Lastly, if you really want to buy a home but want a little bit more financial stability, you might consider renting out one of your extra rooms. Obviously living with a stranger (especially when your several years removed from college) might not be for everyone, but it could prove lucrative.
Of course, if you’re relying on always having the room rented in order to survive, that’s not going to end well. Instead, you should be sure you can afford your mortgage payment and other essentials regardless of whether the room is occupied. Then, any time you do have a tenant, the money you make will be pure gravy.
Home buying is a big deal. While the prospect of owning instead of renting may be as consistently alluring to you as it is to me, unknown costs and unanswered questions can get in the way of making what is ultimately the best financial decisions and turn your money milestone into a massive mistake. So the question remains — are you really ready to buy your first house?