What Should I Consider When Buying a Home - Part I
Buying a house is much more than just a principal and interest payment to the bank. With interest rates on the rise, still being in a somewhat hot real estate market (at least in Texas), and inflation eating away at your dollars, you should really consider all financial aspects of buying a house. A wrong move on this transaction could cost you significantly, so plan it out! Also, remember a bank wants to lend you money and as much as you’re willing to take and they believe you’ll pay back! Be mindful of the amounts you’re approved for vs what you can actually afford. In Part I of this article, I will discuss budget/cash flow issues to work through as well as mortgage related issues. Part II will discuss closing, tax, estate and other issues to keep in mind.
Budget/Cash Flow Issues
Have you calculated the full costs to own and maintain your home?
Calculate the full payment. Mortgage payment (principle and interest), property tax, homeowners insurance, HOA dues, and private mortgage insurance if your down payment is less than 20% (aka PMI, if applicable). Search for a calculator that incorporates all of these characteristics to see the full monthly payment.
Cost of utilities - Ask for the last 12 months of utility bills from the current owner as a better guide. Don’t just assume your utility bills will be the same. For example, if you’re buying a home with vaulted ceilings it may cost more to heat and cool. Or perhaps there are two air units to consider for electricity costs. Or you’re switching from all electric appliances to some with natural gas.
Costs to maintain property - Are you paying a yard service to mow, do you have a sprinkler system that needs maintenance, is there a need for a new roof? Get quotes for all of these things and add them to your budget.
Costs of commuting, child care, private education (if needed) - Map out the new routes and understand the impact of fuel and tolls. Determine if the school district is acceptable for you, or if you need to consider private school costs. Additionally, it’s a good idea to actually make the drives a few times from the potential new home to get a feel for traffic.
Are you making improvements (renovation or additions)?
Ask your contractor to view the home with you and give you an estimate of the costs for any renovations or additions. Consider how you are going to fund this (from savings or including it in the loan). Recalculate new down payments, monthly payments, and insurance costs with any improvements.
Will the purchase impact your ability to save for other goals (such as retirement)?
Don’t sacrifice your future for the desires you have today. You don’t want to approach retirement and find out you have to work longer because you really wanted that one house that was a bit too expensive in your 30’s. Prioritize goals and weigh tradeoffs. A good financial planner is perfect to help with this!
Do you have a spouse/partner and do you currently or plan to live on one income?
Does the new home cost fit within your budget? The answer needs to be yes even if both spouses work! If one spouse wants to stay home in the future, don’t get trapped in a scenario where you can’t take care of your family the way you want because of a house payment. I’ve seen this too many times and it puts a strain on the relationship.
Will you be living in this home for less than 5 years?
You may not pay much on the buying side of the transaction in terms of fees, but typically sellers pick up a large portion of the price to sell. Realtor commissions alone are usually 6%, other closing costs at about 1%, you might have to repair something, and then add in moving and rental expenses for the in-between-times. Get some help to try to calculate your break even cost and consider renting if it doesn’t fit into your timeline.
Mortgage Related Issues
Are you getting a Variable vs Fixed Rate mortgage?
I’m going to be hard pressed to find a scenario where a variable rate (one that changes at set intervals) is good for most people, especially in a rising interest rate environment. If you’re set on looking at a variable, know the highs and lows of the interest rates and how often they can adjust.
Will you get an FHA, Conventional, or VA mortgage?
FHA (Federal Housing Authority) is an agency that helps lend when your credit score is on the lower side (in the 500’s). They require lower down payments (between 3.5% and 10%), mortgage insurance is required (protects FHA if you default on the loan) and the amount of debt you carry can be higher.
Conventional is a “standard” mortgage where your credit typically needs to be above 620. You can put as little as 3% down but you’ll be subject to mortgage insurance. Try to put at least 20% down to avoid mortgage insurance.
VA - If you served in the military, you can consider a Veterans Administration (VA) loan. Credit scores needed vary based on whoever is issuing the loan. One of the big draws for some is that VA loans don’t require a down payment. That doesn’t mean it’s free! There are still costs associated with getting the loan and often they can be more expensive than your conventional mortgage. If you’re a veteran, do your research and compare total costs on this one!
Compare interest rates.
If you Googled “what are mortgage rates today”, that’s just an average across the U.S. Also, just because one bank gave you a quote doesn't mean that’s the rate across all banks. Be sure to do all your rate shopping within a 30 day window as your credit score should be viewed as one “hard” hit (too many “hits”/inquiries on your credit in a short amount of time can cause the score to decrease. Luckily, the credit bureaus give you this window to shop for your home).
Compare your PITI to your gross income.
No, it’s nothing to feel sorry about, PITI stands for principal, interest, taxes and insurance. Think of this as the full payment of the house that the bank expects you to cover. Once you have that number, enter into the calculator and divide by your monthly gross income (before all of your taxes, retirement, and benefits come out). If it’s more than 28%, you may have trouble with lenders approving you for the loan.
Are you retired and considering a mortgage?
Be ready to show your investment portfolio, pension, and social security statements to the lender. They will want to make sure the money you get from all those sources can cover the payment.
Do you have any other long term debts that kick your debt to income ratio above 35%?
Similar to PITI above, when you add in all of your other debt payments on a monthly basis and divide by your gross income, that number should not be above 35%. This is a line in the sand that many lenders take to make sure you don’t have too many debt payments for the amount of money you bring in.
Do you have a low credit score or poor credit history?
Review your credit report to ensure no inaccuracies. You’re allowed to pull a free copy each year from each provider (Equifax, Transunion, Experian). Know that you could be charged a higher interest rate or denied a loan if it’s too low or you have past issues with debt payments. If this is you, you can improve your credit score by paying bills on time and paying down debt.
Do you anticipate making large purchases, opening new credit cards, closing credit cards leading up to purchase of your home?
Consult your lender before you do any of this so it doesn’t impact your credit score during the buying process or jeopardize your loan situation.
If you want help working through your next home purchase from an independent person, click the schedule appointment button at the top of the page!
