You've decided you want to buy your first home - congratulations! At first, you're full of excitement, but then you may be finding yourself thinking that you have no idea where to start. The questions start popping into your head. Before you know it, you may be completely overwhelmed! Stop, take a breath, and read on.
1. Where will you be in 5-10 years?
How long are you planning to stay in town? If you are somewhat of a nomad, buying a home may not be in your best interest. Depending on the terms of your mortgage and current rent prices, it can take at least 5-10 years for a mortgage to be more advantageous than renting. Take a moment to consider whether you're really ready to commit to your current city or if your career may require a change of locale.
2. Budget! Budget! Budget!
The first step in the home buying process is to have a firm grasp on your current financial situation. If you aren't aware of things like your cash flow and assets/liabilities, it is near impossible to determine how much house you can afford.
3. How big of a mortgage can I afford?
There's a difference between how much the mortgage company will lend you and how much you can comfortably afford. This difference can be to the tune of hundreds of thousands of dollars. This stage is where your budget comes in handy - knowing how much income you can allot towards housing is key. Spending more than 30% of your income on housing is defined as being "cost-burdened". More than 50%, you're "severely cost-burdened". Being cost-burdened means that you might have trouble affording non-discretionary expenses, such as food, prescriptions, or bills/utilities.
Another factor to consider is where you are in your career. If you're at the beginning of your career and can expect with decent certainty that your income will continue to increase in the next several years, that monthly mortgage payment will become less of an onerous expense. For example, a $1500/mth payment is 40% of a 45k salary. If your salary increases to 60k, that same payment is down to 30% of your income.
4. Be aware of all of the expenses that come with home ownership
Your mortgage payment is not the only expense! You'll be responsible for property taxes, homeowner's insurance, utilities, repairs, closing costs, and HOA dues (if applicable). If something in the house breaks or needs an upgrade, the buck stops with you, partner - there's no super to call up.
Closing costs - remember to ask about these ahead of time. According to Nerd Wallet, "Average closing costs for the buyer run between about 2% and 5% of the loan amount. That means, on a $300,000 home purchase, you would pay from $6,000 to $15,000 in closing costs"1. In addition to saving for your down payment, you also need to save up for anticipated closing costs. Forgetting about these costs can put quite a dent in your down payment.
5. DO save up for a down payment
We've all heard that we should be putting down 20% of the purchase price. In 2019, the average down payment was merely 12%. For first time home-buyers, it's even lower, coming in at around 6%.2 Now you may be thinking, why would I save 20% if I don't have to? There are several reasons why having a larger down payment is advantageous. A bigger down payment now means a smaller monthly payment for the duration of your loan. Additionally, buyers putting down less than 20% often have to pay for mortgage insurance.
A home purchase shouldn't be a spur of the moment decision. Taking the time to save up adequately over a period of years pays off in the long run.
6. You can't afford to change everything you want
As we're touring homes, sometimes we begin to have HGTV flashbacks and start planning all of the changes we'd like to make to the property. Realize that all your grand ideas are most likely not fiscally feasible. I would be wary of your dreams of buying a home that needs a bit of work and changing it into your ideal home. The cost of home improvements is measured in thousands, not hundreds.
7. Possible overlap of paying rent and mortgage
I envy anyone who manages to perfectly align the end of their lease with the closing of their new home. Consider that you may have some overlap where you're paying both rent and mortgage in the same month. You could also end up needing to pay for interim housing if there is a gap between the two. Remember to factor in this possibility when budgeting for your home purchase.
8. Fixed v. Balloon v. Variable Mortgages
There are a couple different types of mortgages available. A fixed rate mortgage guarantees the same monthly payment for the life of the loan due to the unchanging interest rate. This type of mortgage is the most common due to the stability it provides and is suitable for most homebuyers. A balloon mortgage has a set payment for a set amount of years and then the balance of the mortgage is due all at one time. A variable rate mortgage means that the interest rate is subject to change. This means your payment amount is not guaranteed. These are also known as adjustable rate mortgages, or ARMs. There is more uncertainty/risk involved with an ARM. Talk with your mortgage lender to determine what's right for you.
9. Rental properties only sound easy
A common thing to hear after the purchase of a new home is "you can always rent it out!". Managing a rental property may be more work than you think. There's a reason why property management companies exist - it's a whole job!
10. Titling of the home
Are you buying the home with a spouse or significant other? New Mexico is a community property state. This means that if you buy a house while married, your spouse automatically has a 50% right to the asset. It's important to think about how best to title a property if you are buying it with someone who is not your spouse. The title states who owns the asset. How much is each party contributing to the down payment? To the mortgage payment each month? Titling the property to both of you will split the asset down the middle in the eyes of the law. If you're contributing the entirety of a substantial down payment, you may want to consider titling the property solely to yourself.
11. Don't make any changes without consulting your mortgage lender
This one's pretty self-explanatory. If you're planning on buying a home imminently, DO NOT do anything with your finances! For example, don't open any new lines of credit or fund new investments. The best plan of action is no action. Making changes can have adverse effects on your loan approval. Consult your lender prior to making any changes.
12. First home doesn't mean forever home
Your first home doesn't need to have all the bells and whistles. It doesn't need to have four bedrooms to house your future kids. You don't have to keep this home forever! You may always consider moving in the future to accommodate a growing family or changing needs.
13. Build your team of trusted professionals
The home buying process involves three professionals: your mortgage lender, your realtor, and your financial advisor. Encourage communication between them! And communicate with them! They are there to help you. After a mortgage lender explains what loan amount you're pre-approved for, your financial advisor can help you determine what purchase price is in your best interest. Your financial advisor should be familiar with your entire financial picture and thus will be able to guide you through this process. A home purchase is a significant purchase that affects your financial plan and future, so it's a good idea to keep your advisor appraised of any updates.
This is meant for educational purposes only. It should not be considered individualized advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions.