The biggest mistake people make when making the jump from renter to homeowner is underestimating the total cost of owning a home. Remember, as the homeowner, you are responsible for not only property taxes and homeowner’s insurance which tend to increase over the years, but also repair and maintenance, including lawn care, replacement of worn-out air-conditioning systems, roof repairs or replacements, electrical issues, and plumbing. Often, plumbing is overlooked in the initial inspection and what you cannot see can easily become a problem later. If your home is older, and you have galvanized plumbing, you may be looking at a “re-pipe” in the near future, which is not inexpensive.
In general, lenders follow the “28 percent rule,” meaning no more than 28 percent of your gross income should go to your mortgage. While that may be their rule, do the math yourself. Sit down and figure out all your monthly expenses coming out of your net monthly paycheck and include the new mortgage, a healthy contribution to your retirement savings plan, property taxes and homeowner’s insurance, and monthly upkeep required. Don’t make the mistake of being “house poor,” because you purchased a home that you really cannot afford to furnish and maintain while also keeping your lifestyle needs and responsibilities. For example, if you want to be able to have a little extra money left over each month from your paycheck to set aside for travelling home for the holidays, eating out, buying some new clothes, that gym membership, having some money for Christmas or birthday gifts, and saving enough money for retirement each month, factor all of these items into your budget before deciding how much house you can afford.
Don’t make the mistake of buying more than you can afford today, thinking that you will be getting a raise over the years, and you can make it work in the meantime. Be considering how long you will stay in the home, keeping in mind that you may not stay as long as you had originally planned and moving before 5-7 years of holding the house could likely end up in a net loss to you after factoring in closing costs. On average, people tend to move less frequently after age 30, and according to the National Association of Realtors, since 2008, people are staying in their homes about 9 years. While that may be true for the averages and you may expect to live in your home for at least a decade, eating peanut butter and jelly sandwiches for dinner every night for the better part of the next 5 to 10 years so that you can afford the home you just bought is not a good idea.
Before even considering purchasing a home, be sure you have an emergency savings fund of at least six months of what you spend on your household living expenses and very little or no credit card debt. Be sure that your cash flow situation allows you to continue to save for retirement and includes comprehensive insurance coverage, such as life insurance and disability insurance, which is necessary when taking on a huge commitment such as a home.
The key to saving enough money to buy your first home is to religiously pay yourself first from every paycheck, as though you are paying any other bill. The best way to do it is to use the automatic transfer feature available in your bank to move the money to a high yield savings account at the same time your paycheck arrives before you see the paycheck deposit. Then, when you have saved at least 20% of the purchase price which is typically the down payment needed to avoid PMI, you are ready to go. PMI is required for smaller down payments and is an added expense to you, increasing your mortgage payment. Also, while PMI can be removed by your lender later as the value of your home increases, it requires a bit of a hassle on your part to request that it be removed.
When you are ready to purchase your home, be sure to find a solid, reputable mortgage lender. While it is tempting to use the first lender you find, like the one referred to you by your realtor, you will want to shop around to make sure you are getting the very best deal. To compare offers, you may want to use a broker. Ask the broker to itemize for you what is negotiable and what is not, so that you can compare. Ask for an estimate so that you can use it as a bargaining chip for other lenders to lower the closing costs that are negotiable.
Once you have found the right home and are ready to move forward, be sure to have the home inspected carefully by an independent inspection company. I recommend that you use a company that does not come as a recommendation from your realtor, to ensure neutrality, as I have seen terrible situations with inspectors cutting corners to fast track the transaction for the realtor. If your home is older, while it may be tempting move forward quickly for the home you just fell in love with, arrange in-depth inspections such as a plumbing inspection and a separate foundation inspection from a structural engineering company so that you are very clear on the entire situation.
Last, consider using a real estate attorney to look carefully over the purchase contract and loan documents. To be safe, consider having your attorney review everything – even the brokerage agreement you are required to sign with your realtor.
For a collection of tips to read from Redfin designed especially for first-time homebuyers, visit Redfin Blog for First Time Homebuyers.
By carefully following these steps, you will set yourself up for a better outcome as a happy homeowner on the path to a successful financial future while avoiding unnecessary and painful learning experiences.
–Michelle Gessner, CFP®