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’s also a giant financial commitment that has potential to 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 before you get started. The home-buying process can be infuriating, complex, or even dizzying. However, a little research and a lot of helpful tips can prove a great advantage. The more you know jumping in, the smoother the process will be.
Before we continue, Financial Professional wants to remind you that this article is meant to serve as an informational starting point. Any and all financial decisions should be made depending on your personal situation and possibly with the aid of a licensed financial professional. Happy hunting!
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Before You House Hunt: Calculate a Budget
Buying a home is an expensive undertaking, but if you know the costs beforehand, you can start saving early. It’s important before you dive too deep to understand what your immediate, short-term, and long-term costs will be. However, before you make that leap, it’s necessary to know what you can afford a spend. This is where calculating a budget comes in.
Ask Yourself Some Questions
While advice varies from expert to expert, the overarching theme is it’s crucial to not stretch yourself too thin. As a rule, advisors agree that you shouldn’t spend more than three times your annual household salary when buying a new home. In addition to your current earnings, you’ll also want to have a rough idea of your financial future in the next three to five years. Ask yourself these important questions:
- Do you plan to keep second or third jobs, if you have multiple now?
- Is it feasible to assume you will be in the same or a higher income bracket in the next three to five years?
- Do you plan to start a family?
- If you do want a family soon, will one partner stay at home with your child?
- Are you moving to a new city or state with higher wages or cost of living?
This last question is especially important if you don’t have a job lined up yet. If you do plan to move, it’s critical to scout out job opportunities now so you know what your potential salary range would be. This will help you more accurately determine your affordable house payment.
How Much Do You Really Make?
When calculating what you can afford, the most important factor is how much of your income you bring home. Typically, when you accept a job offer on a price or rattle off your pay per hour to an impressed (or not…) group of friends, the quote given is your gross pay. This is the amount you receive after deductions have been taken. Such deductions can include taxes, health insurance or HSA payments, and retirement contributions. When considering buying a home, it’s important to know that you want to base your decision on your net pay, or how much actually hits your bank account on payday.
Know the Costs of Buying Your Home
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, but can total up to $10,000.
- Moving Expenses. To put it bluntly, moving is not a cheap process. Expenses include:
- Movers or truck
- Gas, meals, and hotel rooms
- 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 buying a home, this is likely the cost you know off the top of your head – for good reason. Mortgages eat a substantial amount of your 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 – it’s not uncommon to pay almost double the cost of your home due to interest.
- Upkeep. Though hopefully these costs come way down the road, sometimes upkeep is the first cost you incur in a new place. It’s advised to budget 1-2% of your home’s value each year toward upkeep, such as a new water heater, roof repair, or A/C issues.
- Emergency Savings. Though it may seem 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.
The Down Payment on Your House
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. It’s important to remember that 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, experts recommend not to buy a house unless you can put down a 10% minimum.
Calculating Your Down Payment
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
While this may seem like an impossible goal, remember that you are going to pay much, much more over the life of your mortgage. The more you pay now, the less you pay later (especially when accounting for interest!).
Saving For Your New Home
Now that you know how to calculate your down payment for buying a home, it’s time to take a hard look at your financial situation. It’s not enough to have the number – you actually have to save toward that amount. This can be stressful when you take into account all of the other expenses eating into your paycheck on a regular basis.
Therefore, it’s very probable that you’re going to have to make some changes in your life to meet your new goals. While that may seem like a daunting preposition, never fear – I’ve put together a quick list of places to start.
1. Cut the Fat
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.
2. 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.
3. 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.
The Agent, the Lender, the Bear…oh!
Now that you know what to be prepared for before you go house-hunting, it’s time to look at the myriad of other aspects involved with buying a home. That brings us to…
The Real Estate Agent
Choosing a real estate agent can be very beneficial in your hunt for the best deal on your next home, but only if you pick the right one. Though it’s tempting to forgo the agent to save on costs, a good one will have access to the MLS – multiple listing service – and thereby be able to show you houses you couldn’t find on your own.
Real estate agents also know what to look for in a home to suit specific needs, can negotiate better deals, and will be able to interpret your contract. And, though this might sound cheap, your agent should offer to drive you to each home, which can save you a tank of gas per day.
For a little added reassurance you are getting the best deal, you can choose a buyer’s agent instead. This is a type of real estate agent responsible solely for assisting buyers in finding their homes – they never list homes themselves. Selecting a buyer’s agent can give you peace of mind you’re not walking into someone else’s hidden agenda to bilk your cash for their gain.
If you aren’t sure if your agent is a buyer’s agent or not, you can:
- Ask them outright
- Look them up online
- Search the contract for the words “buyer’s agent” or a buyer’s agent agreement
How to Find a Real Estate Agent
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. 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.
The Lending Institution
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 your agent makes, as they may have a deal with some lenders to get the most money out of their client – you.
How to Choose the Right Loan
In addition to interviewing lenders, it’s a good idea to (preferably before the interview) have a basic idea of the types of mortgage loans available. 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.
Once you know what home buying loans you qualify for, 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, they can really add up.
For instance, on a loan of $200,000, a 4.0% rate comes to $343,739.
On the same loan, a 4.25% interest rate bumps your final cost up to $354,197.
The difference? $10,458 over the same 30 years.
After You Secure Your Loan…
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 on Your House (I Mentioned a Bear, Right?)
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.
Your Mortgage’s Term
A mortgage’s term is the amount of time you have 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.
The 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.
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.
Your Principle (Not That 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 you should avoid PMI at all costs).
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.
Hidden Costs of Home Ownership
When buying a home, it’s important to know that your mortgage and associated fees aren’t the end of your financial investment. There are several other pieces to keep in mind, such as repairs, renovations, and basic upkeep. Unless you buy a house knowing there are repairs to make, you are most likely to encounter such expenses unexpectedly. This is where your emergency fund comes in handy.
Unfortunately, these are still not the end of your home ownership costs.
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.
An important rule to know when buying a home is that 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.
When you’re in the process of buying a home, one cost to know is the price of closing the deal. As closing costs are not part of the sale price, and therefore 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.
Time to Buy! … Not Yet?
Okay! You know what a mortgage is, why you’re paying what you’re paying and what exactly you’re paying for, and what you can afford. Hopefully, 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.
Inspecting Your Home
When searching for your perfect palace, it’s important to not get bogged down in the cosmetics. Bad colors can be painted over, inconvenient walls knocked down, and out-of-date trim and cabinetry touched up with new stain. Even a shabby carpet can be replaced with hardwood floors for a pittance.
However, there are some issues that can’t easily – or cheaply – be solved. These are the ones you should ask about when touring the house and again during inspection.
- Roof. If the roof 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 on top of the cost of buying a home, it’s important to know what you’re getting into structurally.
- Windows. Windows are the least heat-efficient part of any wall. 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 other appliances, such as the stove, dishwasher, and even the water heater, ask about any damage, recent repairs or replacements, and warranties.
Have Someone Else Inspect Your Home Too
Note that your private home inspection and questioning of the realtor may not cover everything. When buying any building, especially a family home, it’s highly recommended you get an official inspection. 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 a house. Your inspector should have certain certifications and qualifications (typically state-dependent).
When inspector-shopping, you should also consider tests for radon, mold, pests, and lead. Any of these in a home is a red flag and pose 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 or provide a list concerns if you’re not present. The biggest upside of going with the inspector is asking questions they arise. You should also note that a good inspector will know what questions to answer before you get a chance to ask.
Another thing to know is that some states require the inspection before buying your home, 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.
Inspect the Surrounding Area
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 live in the area for years or even decades, you want to know you’re satisfied with the area 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
Look to the Future
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?
- Is there an office space (if you work from home)?
- Do you want to start a family in the next few years, or 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 Negotiate for Your Home
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.
Time 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 for negotiation purposes. 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.
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.
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 are negotiable. Know where you stand going in, so you’re prepared for where you stand coming out.