Buying a house is a BIG deal! When purchased at the right time and within your financial ability, a house can be great for your family. In this episode we break down the house buying process so you can be totally prepared for buying your first or next house.
Should you buy a house?
- Buying a house is a big deal!
- It’s a lot of work and not always a good investment. Before you take the leap it’s best to understand what you’re getting into because it’s a big commitment.
- Where are you in your financial journey?
- Do you have a written budget in place, so you know what’s coming in and going out?
- Do you have 3-6 month emergency fund?
- Have you paid off the majority of your debt? (student loans, credit cards, car loans)
- Do you have a down payment saved on top of your emergency fund?
- Do you have money saved for furniture or any needed maintenance?
- Are you ready for closing costs?
Why do you want to buy a house? Is now the best time to buy your first house?
- Don’t buy because someone told you you should or because someone told you paying rent is “throwing money away.”
- Don’t buy because all your friends are doing it.
- Don’t buy because the interest rates are low or because it’s a buyers market.
- Buy because you’re settling down and need a place to live for a minimum of 5 years.
- Buy because a house would better meet your family’s needs.
- Buy because you’re financially ready.
Great credit - You might get approved for a mortgage with a score in the 600s but, a score of 720 or higher will get you the best rates and save you, quite literally, tens of thousands of dollars over your lifetime.
Cash down payment - Although you can purchase a home with as little as 3.5% down payment (FHA loan) , we don’t recommend it. Put at least 20 percent down to avoid being upside down on your loan and to avoid private mortgage insurance (PMI).
Cash on hand - Aside from the down payment, banks want to see that buying a home isn’t going to drain your account. And it’s good form to have an emergency fund leftover after all the closing costs and moving expenses are paid.
Solid employment - Next to your credit score, this is most important. The longer you’ve been at your job, the better. If you’re self-employed, prepare for a minor battle to get approved for your mortgage: Most lenders will want to see at least two years of tax returns and will figure your income as an average over the last two years, which could potentially reduce the amount of financing for which you can qualify.
Getting Financially Prepared
Step 1: Determine how much house you can afford
- Keep your total housing cost at around 30% of your net income. Check out the spending guidelines to get more accurate.
- Will you live in it at least 5 years? If not, renting will be cheaper. Use a rent vs buy calculator to determine if it makes financial sense to buy.
- Don’t think of your home as an investment. An investment puts money into your pocket, while a liability takes money out of your pocket. A house costs money to buy and to maintain (taxes, insurance, maintenance and upgrades). It will likely go up in value, but so will your expenses as it raises in value.
Step 2: Get your finances in order to prepare for the mortgage application
- Check your credit score. Credit Karma or your bank. If you’re under 720 work on improving the score (about 6 months) before taking on a mortgage.
- Save for the down payment and closing costs. No less than 10% down payment (20% preferred). Closing costs can range between 2% and 5% of house price.
- Gather your documents
- Pay stubs / W2’s.
- Bank statements.
- Self-employed - tax returns for the last 2 years.
Step 3: Shop for a mortgage
Get pre-approved. Mortgage pre-approval is free and you have no obligation to purchase. It helps to present you as a serious, qualified buyer when buying a house.
- There are fixed-rates and adjustable rates (ARMs).
- You can take out a mortgage for 30 years or as little as five years (interest rates are typically higher the longer the term of the loan).
- We recommend a fixed-rate 15yr mortgage if you can afford it.
- It’s good to become familiar with how mortgage rates work and the different kinds of loans that are available.
- Run some scenarios through a mortgage calculator to see how different terms and rates will affect your monthly payment.
- To make matters worse, mortgage lenders charge fees that aren’t necessarily reflected in the interest rate. There can be fees for appraising the home, checking your credit, and preparing documentation.
- With some loans you have the option to pay “points” at closing that will reduce your interest rate. Points are essentially prepaid interest. This can be a tricky decision, but it can make sense if 1) you can afford to put down the extra cash and 2) expect to carry the mortgage for many, many years.
- Private mortgage insurance (PMI)
- If you put less than 20 percent down, your lender will charge you a monthly premium for what’s called private mortgage insurance (PMI). PMI protects the bank in the event you default on your loan and the value of your home declines significantly.
- PMI varies from .3% - 1.2% of the loan amount per, paid annually. Typically it is around .5%, which is about $50 per month per $100,000 borrowed.
- $200,000 = about $100 a month = $1200 a year
Don’t Forget Closing Costs
- Closing costs vary, somewhere between 2-4%, average 2.5% of total purchase price:
- $100,000 is about $2,500
- $200,000 is about $5,000
- $300,000 is about $7,500
- $400,000 is about $10,000
Where to get mortgage rates and pre-approval
- Shop around. Start online or find a mortgage broker. You can compare rates with any number of leading online mortgage lenders or find a local mortgage broker who will shop your application to multiple lenders on your behalf.
- Many real estate agents have relationships with lenders and they can help you find a good lender if you want the transaction to be face to face.
- Using an online lender like LendingTree.com or Bankrate.com can help you quickly get four or five competing mortgage rates from different banks.
- These rates will be more accurate than the ones you see in advertisements and websites because banks provide real rates based upon your credit profile and the location and value of the home you want to buy.