A home can be a wise purchase, but don't get in over your head. Too many people jump into buying a house without giving it enough thought, simply because it seems like the next "thing to do" on their life checklist.
Unfortunately, many of these people become "house poor." Don't be like them.
Instead, ask yourself the following critical questions to make sure that you're not just buying your dream home -- you're also making a financially-savvy choice.
#1: Should You Buy, Rent or Rent-to-Own?
First of all, should you buy a home? Or are you better off renting? There's a pervasive myth that people who rent are "throwing money away," but that's a gross oversimplification.
Take a good look at your one-, five- and ten-year plans. Ask yourself how long you plan on staying in your area. After all the transactional costs that come with home buying (closing costs, realtor commissions, inspections and appraisals), it might be cheaper for you to rent, if you think you may be moving soon.
If you're not sure, you can always rent-to-own. This is officially called a "lease purchase," or a lease with the option to buy down the road. (To use a stock market or business analogy, it's like having a "call option" or a "first right of refusal" on the property.)
Here's how it works: You and your landlord sign a lease-purchase agreement prior to move-in. The agreement specifies that you have a limited time period (usually 2-3 years) in which you can exercise your "call option" to buy the house at a specific price. If you choose to buy the house, your rent payments (retroactively) will get applied towards your home purchase, as if they had been mortgage payments. But if you don't buy the house, they'll remain as rent payments.
Lease-purchase options are generally used in conjunction with owner financing. This comes at a price: Owners generally charge a higher interest rate than banks or credit unions.
If you're certain you want to buy, try a traditional route. But if you're on the fence, or if you can't qualify for traditional financing, consider a rent-to-own option.
#2: How Much of a Down Payment Can You Afford?
Making a significant down payment can eliminate your private mortgage insurance(PMI), which is tacked on to each mortgage payment you make.
PMI is a lender's way of protecting themselves in case you default on your mortgage. This mandatory insurance can cost an extra $40-$50/month for every $100,000 you borrow.
If you're able to put down 20 percent or more of the purchase price of the home, you'll avoid this extra fee.
#3: Do You Know How Much You'll REALLY Be Paying?
Your principal and interest aren't the only numbers you need to estimate when buying a home. You want to get a grasp on other ongoing costs like real estate taxes and homeowner's insurance. Different areas have different tax rates, so take that into consideration when looking at neighborhoods.
Bear in mind the county can always raise taxes, and your insurer can always raise rates, so you don't want to be too close to the brink when it comes to how much you can afford. Leave yourself a little "wiggle room" for future increases and stay away from those homes that are in the tip-top of your budget.
#4: Can You Afford the Upkeep?
Even brand-new homes need repairs and maintenance. If you get a reputable home inspection, you should hopefully avoid buying a money pit, but you'll still have to deal with occasional repairs and the everyday upkeep of lawn maintenance, snow removal, gutter cleaning, tree-pruning, HVAC tune-ups and even the higher utility costs that come from moving from an apartment to a house.
In addition to calculating how much you can afford each month for a mortgage, take into account both regular maintenance and unexpected emergencies. As any homeowner will tell you, there always seems to be something that needs to be done when you have your own house. Plan for more expenses than you expect!
How much? One very broad rule of thumb is to set aside one percent of the purchase price of the house annually for maintenance costs. If your house costs $300,000, for example, set aside $3,000 per year, or $250 per month. You won't literally spend this every month -- some months, you'll spend $0, and other months, you'll spend $12,000 replacing the roof.
#5: How Soon Will You Sell?
When you buy a home, you'll need to pay for a huge heap of closing costs. These include real estate agent commissions, title insurance, attorney fees, recording fees, surveys, excise tax, points to the lender, inspection fees, warranties -- the list feels interminable.
In theory, closing costs are negotiable. You can ask the seller to cover some of these expenses. But "negotiable" is not a guarantee of anything. The seller might reject your offer. Or they might counter with a purchase price that's higher than they otherwise would have granted. One way or another, those closing costs will get paid.
If you're planning on selling your home and moving within the near-term, you might want to avoid purchasing a house. After accounting for all of the closing costs, plus repairs, maintenance and the amortized mortgage, you might not end up in a better position than you would have been if you were renting.
In the End
Purchasing a home can be a savvy financial move, as long as you manage it well. Make sure to ask yourself the above questions before signing on the dotted line, and your dream home can bring you joy for many years to come.
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