Buying a house may be one of the biggest decisions you ever make in your life. Not only is it a promise to yourself to settle down – or start a giant remodeling project in the hopes of making a small fortune on a renovation – but it is a giant financial commitment that can be the greatest thing you’ve ever done, or break your bank in the future. If you’re getting ready to buy a home, or thinking about starting your search, there are a few things to know. The home-buying process can be infuriating, complex, even dizzying, but a little research and a lot of helpful tips can prove to your great advantage and make the process go a little smoother.
Calculate a Budget
Buying a home is an expensive undertaking. It’s important before you dive too deep into the process to understand what your immediate, short-term, and long-term costs will be. To do this, it’s necessary to know what you can afford to spend. While advice varies from expert to expert, remember not to stretch yourself too thin – don’t spend more than three times your annual household salary on a new home. To this end, it’s important to consider what you make now, if you plan to keep your second/third job if you have multiple, and if you plan to start a family and have one partner stay at home. Additionally, if you’re moving to a new city or state, it’s important to scout out job opportunities so you know what your potential salary range would be for calculating your house payment.
When determining what you can afford, the most important factor is knowing how much of your income you actually bring home. When you accept a job offer or rattle off your pay per hour to an impressed (or not) group of friends, with exceptions for 1099 taxpayers, the quote given is your gross pay – the amount paid out before deductions are removed. Such deductions can include taxes, health insurance or HSA payments, and retirement contributions. When considering buying a home, you want to base your decision on your net pay, or how much actually hits your bank account on payday.
In addition to your down payment (more on that below), there are many immediate and long-term costs associated with buying a home, including:
- Closing Costs. These are variable per situation but can total up to $10,000.
- Home Inspections. If the seller or realty company hasn’t already paid for a home inspection, that responsibility falls to you. Depending on the size of the home, you can expect to pay around $300.
- Moving Expenses. Moving is not a cheap process. I myself moved with my family almost 2,000 miles last year, and the cost of renting the moving truck alone totaled upwards of $2,500. Moving expenses to be prepared for include:
- Cost of movers and/or truck
- Gas, meals, and hotel rooms, if moving long distances
- New tags for your vehicle(s)
- New identification or driver’s license(s)
- Cost of breaking rental leases if moving mid-lease
- *Mortgage payments. If you’re looking at buying a home, this is likely the cost you’re most concerned with – for good reason. Mortgages can eat up a substantial amount of your monthly income, and missing payments can result in penalties or the bank repossessing your home. The kicker is that, especially at first, most of that mortgage payment is actually going toward the interest on your loan, not toward paying off the home itself – it’s not uncommon to pay almost double the cost of your home in total due to interest on your loan. Your mortgage payment may also include necessities such as:
- *Homeowner’s insurance
- *Property taxes
- *Private mortgage insurance (PMI)
- Upkeep. Though hopefully these costs come way down the road, sometimes upkeep is the first thing that happens when you move into a new place. It’s advised to budget 1-2% of your home’s value each year to put toward upkeep, such as a new water heater, roof repair, or A/C issues, among a myriad of other potential problems.
- Emergency Savings. Though it may seem to be a difficult endeavor, it’s recommended to have six months’ worth of emergency savings in the bank before you shell out for a new house. These can cover anything from home repairs to costs of job loss to emergency events such as hospitalizations.
Your Down Payment
The price of your down payment will vary based on the size of the house and type of mortgage you secure. The size of your down payment can also influence the price range of homes available to you, and even change the true cost of your loan in the long run. The more money you’re able to put down up front, the smaller the principle of your loan will be. Even if you can’t make the traditional 20% down, it’s recommended not to buy a house unless you can put down a 10% minimum.
To calculate a maximum reasonable estimate of a 20% down payment, multiply your take-home pay by three, then multiply that number by 0.2. This will give you a goal to save toward.
For instance, let’s say your household brings home $5,000 monthly:
$5,000 x 12 months = $60,000 take-home yearly.
$60,000 x 3 (expert recommendation) = $180,000 to spend on a new home
$180,000 x 0.2 (20%) = $36,000 needed for a down payment
Some considerations to make saving up for your down payment include:
- Reduce your expenses. If you don’t need a new home immediately, cut corners on your expenses wherever you can. This can be accomplished through methods such as ceasing your weekly dinners out, downsizing to a smaller apartment, giving up that flashy new car and its expensive monthly payment, and being smarter with your utilities.
- Increase your income. If you’re in a position to take on a second job or some freelance work on the side, this can be a valuable addition to your savings, not to mention your life experience.
- Shoot for 20%. Hopefully, you’ve determined the maximum budget for buying a house. If possible, aim to save 20% of that value in a separate account to spend on your down payment. This will give you the best chance at acquiring a decent mortgage rate – and keep you from paying PMI.
- Maintain your emergency savings. Your emergency savings and your down payment are not the same. Keep them separate, and don’t dig into your emergency savings to make your down payment unless a true emergency arises.
- The Rent Rule. Have you ever heard the advice on buying a new car, to put aside your estimated monthly payment now to build a savings and get a lower loan later? Buying a house can work the same way. Though it’s often not possible to set aside the full cost of a monthly mortgage payment if you’re renting, it’s still possible to save more. One piece of advice is to take your estimated monthly mortgage payment, subtract your current rent payment, and set aside the difference in a savings account. This can go into emergency savings, your down payment savings, or even go to covering the costs surrounding buying a house such as moving costs and any required repairs.
It’s Almost Time…
The Agent, the Loan, the Bear…oh!
Choosing a real estate agent can be very beneficial for you in finding your next home at the best deal, but only if you pick the right one. Though you might be tempted to forgo an agent to save on costs, a good real estate agent will have access to the MLS – multiple listing service – and show you homes you wouldn’t be able to find on your own. They also know what to look for in a home to suit specific needs, can negotiate better deals, and will know what your contract actually says. And, though it may sound a little cheap, your real estate agent should offer to drive you to all the homes, which can save you a tank of gas a day when you get into the heat of the hunt.
For a little added reassurance that you are making the right choice, you can choose to go with a buyer’s agent. A buyer’s agent is a real estate agent responsible solely for assisting buyers in finding their homes – meaning they never list homes themselves. Selecting a buyer’s agent gives you the peace of mind you are not walking into someone else’s hidden agenda to bilk your cash for their gain on a worthless or overpriced property. If you aren’t sure whether your agent is a buyer’s agent or not – or if you don’t trust their word – you can:
- Ask them if they’re a buyer’s agent outright
- Look them up online
- Search the contract for mention of the words “buyer’s agent” or a buyer’s agent agreement
To start your search for a real estate agent, it’s best to go to the experts – mortgage brokers. They deal with real estate agents every day, and may have suggestions for agents, agencies, or what to look for in your search. You can also snoop around online. When you have your list of names, search the web to see if they have any reviews, and call and interview your favorites. Ask questions with the thoroughness and zeal you would your child’s potential babysitter. A good agent will happily answer your questions. The best ones won’t charge you a cent, as they split the seller’s commission.
In the reverse, when you’re ready to start your search for a lending institution, call up local real estate brokerages to request any recommendations they have for mortgage lenders. As before, look up any available reviews online and call your selections for an interview personally. This will give you an idea of what rates you’ll get and who you want to do a deal with. In addition, be appropriately wary of suggestions made by your agent, as they may have a deal with some lenders to get the most money out of their client – you.
In addition to interviewing lenders, it’s a good idea to (preferably before the interview) have a basic idea of your options. If you hold a special status, such as veteran, soon-to-be graduate with a mountain of student loan debt, or rural borrower, you may qualify for less common or more specialized options. Research and get familiar with your options online including:
- Conventional loans
- FHA (Federal Housing Administration) loans
- Less common loans for special statuses
Among your options and qualifications, choose the lowest interest rate you can find. Though fractions of a percent may not seem to be a big difference, over the traditional 30-year timeframe, those fractions of a percent can add up.
On a loan of $200,000, a 4.0% rate comes to $343,739; on the same loan, 4.25% bumps that up to $354,197. The difference? $10,458 over the same 30 years.
Once you’ve decided on a lender and a loan, heed this pro tip: don’t open a new line of credit. No store credit cards, no personal loans, no new cars. Your lender will view a new line of credit as a red flag, even if it comes through the day before signing and all parties have already committed.
Another thing to consider is getting a note of pre-approval from your lender before you start visiting homes in person. This is both a reminder to you of how much your lender is willing to lend (remember, you don’t have to borrow that top limit, it’s merely a maximum), as well as physical proof to a potential seller that you are both serious in intent and financial footing.
The Mortgage Itself
Ah, your mortgage. The financial bane of your existence. The giant weight hanging over your head. The unsightly chunk forcibly dragged out of your checking account every month. And entirely necessary to buy a house for 99.9% of the population (just spit-balling here). As a mortgage is a gigantic loan with a lot of interest tacked on and many complex, potentially adjustable parts, and each mortgage can be tailored to every situation, it’s important to know what your options are and what the breakdown of your mortgage actually means. So, without further ado, let us dive in.
- Term. A mortgage’s term is the amount of time required to pay back both the loan and its interest. Most United States mortgages run on 30-year terms, but if you can afford the higher payments of a 15-year loan, you’ll save yourself a lot of interest.
- Interest rate. The interest on a 30-year mortgage can almost double the cost of your home, as your interest is compounded. Compound interest is calculated monthly on your current principal owed.
- Principal. Your principle is the amount of the loan itself. On a home loan, your principle is the cost of your home minus the down payment. If you have put less than 20% down, you will also be responsible for private mortgage insurance (PMI), which is less insurance for you and more a fee charged by the lender in case you default on your loan. In essence, if you don’t put 20% down, you’ll pay an extra two hundred dollars a month or more that doesn’t go to paying your loan and has no benefit to you whatsoever. (If it wasn’t clear, this is a bad idea and should be avoided if at all possible).
Experts recommend that you spend 25% of your net pay (what you take home after taxes and insurance) on your housing, be it rent or a mortgage. For instance, if your household brings home $4,000 per month after taxes, it’s recommended you take on a mortgage of no more than $1,000 per month.
Keep in mind that while experts recommend 25%, some unscrupulous lenders will happily push you to take on more than you can reasonably handle. This means more money in interest for them, as well as that pesky little PMI fee. In addition, if taking on a loan you can’t afford means you lose they house, they get to repossess the building and make money on selling it themselves.
Adjustable vs Fixed Rates
There are two options for the interest on your mortgage: a fixed-rate loan and an adjustable-rate loan.
- Fixed rate. In a fixed-rate loan, the percent of interest you pay will remain constant. If you sign a lending agreement at 4.0% interest, your interest will remain 4.0% regardless of market fluctuations.
- Adjustable rate. In an adjustable-rate loan, the percent of interest you pay will fluctuate with the market values. Very rarely will you get a better deal over time on an adjustable rate loan.
Hidden Costs of Ownership
When you buy a home, your mortgage and its associated fees aren’t the end of your financial investments. There are several things to keep in mind, such as the spring-to-mind repairs, renovations, and basic upkeep. Unless you buy a house knowing there are repairs to be made, you are most likely to encounter these unexpectedly, which is where your emergency fund comes in handy. Unfortunately, these are still not the end of your home ownership costs.
Property Taxes. Every jurisdiction, state, county, and local, has its own property tax rates, which can be added to your monthly mortgage payment. During your home search, the listings you come across should have an estimated annual tax rate printed somewhere. That number is subject to change based on the housing market but will generally remain close to the current rate unless something drastic happens. If you take that annual tax rate and divide it by 12, you will have a rough idea of how much money will be added to your monthly mortgage payment.
Home Insurance. An important rule to consider when buying a home? If you can’t afford the extra $100-$200 per month on homeowner’s insurance to accompany your mortgage payment, you shouldn’t be buying a house. Even though homeowner’s insurance isn’t legally required when buying most mortgages, having a policy may be the only thing that saves you from structural and financial ruin in case of disaster.
Closing Costs. When you’re in the process of purchasing a home, one potentially unexpected cost is the cost of closing the deal on your home. As closing costs are not part of the sale price, and therefore are not coverable by your mortgage payment, they can actually prevent you buying a home you otherwise thought you could afford. Closing costs are often required to be paid in cash and can range from 2% to 5% of the price of the house. As indicated by the plural on “costs,” there are a wide range of fees this price covers, including but not limited to:
- Application fees (negotiable with the lender)
- Lawyer’s fees
- Inspection costs
- Homeowner’s insurance – the first year’s worth is commonly paid upon closing the deal
- Origination fee
- Recording fees
- Transfer fees (on the home’s title)
- Underwriting fee
Though closing costs may catch you off-guard, you can at least take comfort in knowing that (hopefully!) the seller is responsible for paying the real estate agent out of their own pocket.
Let’s Get Going!
Okay! You know what a mortgage is, why you’re paying what you’re paying and what exactly you’re paying for, and you know what you can afford now and in the future. You have your down payment, or the start of one. You have your real estate agent’s number in your phone, your pre-approval letter in your hand, and a burning desire to live in a new land (or at least neighborhood) in your heart. It’s time to go! … shopping.
Inspect Your Home
When searching for your perfect palace, it’s important to not get bogged down in the cosmetics of every house you meet. Bad colors can be painted over, inconvenient walls can be knocked down, and out-of-date trim and cabinetry can be touched up with some new stain. Even a shabby carpet can be replaced with hardwood floors for a pittance compared to the price of the house. However, there are some issues that can’t easily – or cheaply – be solved and should be asked about either and/or when touring the house and when the structure is being inspected.
- Roof. If the roof of any house is old, creaky, or leaky, chances are it will need repair or replacement soon. As a new roof can run into the tens of thousands of dollars, it’s important to know what you’re getting into structurally.
- Windows. Windows are the least heat-efficient part of any wall, as they offer very little substance between the temperature outside and the temperature inside. If the windows are old, leaking, or otherwise inefficient, not only will you pay to replace them, but in the meantime, you’ll be paying the unnecessary increase in utilities.
- Foundation. The foundation of any home should be unshakable and undamaged, and anything otherwise will easily run into the thousands of dollars in labors and materials – if you’re lucky. Ask about any foundational issues or recent repairs upfront.
- Appliances. If moveable appliances such as the refrigerator and washer-dryer units are being left, inspect their quality. As for the other appliances, such as the stove, dishwasher, and even the water heater, ask about any damage, recent repairs or replacements, and included warranties.
Have Someone Else Inspect Your Home Too
Note that your private home inspection and questioning of the realtor and/or homeowner may not cover everything you need to know. When buying any building, especially a family home, it is highly recommended that you get an official inspection from a qualified inspector. In other words, just because you “know a guy” doesn’t mean that “guy” (or girl, or trained seal…Office fans, anyone?) is qualified to inspect an entire house. Your inspector should have certain certifications and qualifications depending on your state.
When inspector-shopping, you should also consider concerns such as tests for radon, mold, pests, and lead. Any of these in a home is a red flag and can be a serious problem both health-wise and in the pocketbook. While an inspector who goes to this level of detail can be significantly more expensive, it’s still cheaper than replacing an entire moldy bathroom.
You should accompany the home inspector to the site for the inspection if at all possible or provide a list of areas of concern if you cannot be present. The biggest upside of going with the inspector is being able to ask questions as concerns or curiosities arise, as well as the follow-ups to those questions. It should be noted also that a good inspector will know what questions to answer before you get a chance to ask.
Another thing to note is that some states require the inspection before purchase, and some after. In the event the inspection is required after purchase, the contract should be contingent upon a successful inspection. If the inspection turns up any unsavory findings, you should be able to back out of the sale with zero penalties.
What Do You Want?
In addition to knowing the intimate details of your potential new home, it’s also important to know details about the neighborhood or suburb. As buying a home means you’ll likely be living in the area for years or even decades, you want to make sure the area is one you are satisfied with overall. If you’re down to your last two or three choices, it’s worth driving through each at various times of day to see if there is an unreasonable amount of traffic, dogs barking, a lot of noisy children, etc. Other things to consider when examining the neighborhood include:
- Driving or walking distance to both work and the nearest hospital
- Access to stores, restaurants, and desired entertainment
- Proximity to the closest school district, either in favor for or against (against all the way, anyone else? No? Oh…)
- The crime rate, which can be found online or inquired about with the realtor
Knowing what you desire about your home and neighborhood now is important – but so too is looking toward the future. Buying a house is a long-term commitment, so thinking about your long-term plans may have a significant impact on your decision if you’ve otherwise been considering the immediate reality.
- Do you plan to stay in the area long, or do you move around for work? Do you need extra space to store tools carried to the job? Do you need an office space to work from home?
- Do you want to start a family in the next few years? Do you have young children sharing a room now who will need their own space in five years? Are the area’s schools satisfactory for your needs and the needs of your children?
- Do you plan to rescue animals? Is there a yard or field big enough? Will you need to fence off a space, or is there already a fence up?
- Is the extra cost of upkeep and insurance on that pool reaaaally worth it?
Time to Make an Offer
A reliable buyer’s agent should help you negotiate the price of your intended home. However, with or without a buyer’s agent, ultimately what you offer on a home is up to you. There are a few things to consider when putting together your negotiation toolkit:
- How long has the house been on the market? If your desired home has sat stagnant on the market for several months or even years, or if the seller is asking too much based on house and neighborhood specs, its acceptable to offer less than you are willing to pay to negotiate up to your target price. However, it’s important to have a sense of the seller if you intend to lowball too low: some sellers won’t consider a lowball as worth it, and therefore won’t engage in the negotiation process. There goes your house.
- Are there any needed repairs? If the house requires repairs, or if you intend to replace otherwise-working but entirely too-old appliances, mention this when presenting your offer. The seller may be willing to negotiate the price based on how much you’ll throw into the house after purchase.
- Are there expensive upgrades? If you want to make expensive changes such as completely replacing the cabinetry, updating the kitchen top to bottom, redoing the bathroom, or even installing new windows or solar panels, ask the seller to consider funding the project in return for you adding that cost to the price of the house. This will let you pay off your upgrades through your mortgage instead of out of your pocket immediately.
- Everything is negotiable. The price of the house, closing costs, realtor’s fees, inspection fees (sometimes), even your mortgage rate can be negotiated. Know where you stand going in, so you’re prepared for where you stand coming out.