What you should know about buying a home

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AJ: When Kirby and I began looking for our first home almost 5 years ago the only thing we knew for sure was our price range. We looked at more than 70 homes of every possible variety before closing on our current home. We placed offers on two other homes that we loved that fell through for various reasons which taught us the value of doing our research. Zillow.com is a great resource for ensuring you know the value of homes in an entire area, not just in a small neighborhood. It also provides details on when homes were previously sold and for how much (which should be taken with a grain of salt), all of which serves as additional information to compare to a seller’s disclosure.

It’s important to stay focused on what it is you’re truly in the market for. We were looking for our starter home, not our forever home or our dream home. Commit to your non-negotiables before you even begin looking, and do enough research to ensure you’re buying the right property for your stage in life and your budget.

KJ: We purchased our first home a little over four years ago, and at the time, we said it was our “3-5 year house.” Now that the time has passed, we have continued to evaluate how long we might realistically stay in our home. Given that the longer you are in a home, the more your mortgage payment applies toward the principal balance, it can make sense to extend how long you stay in your home if your circumstances (job location, addition of a family member) haven’t changed, so you can continue to build up more savings in your house. Especially with volatile home prices these past four years, you have to really think long and hard about how long you plan to stay put.

I don’t consider our house an investment. It certainly doesn’t generate revenue (that is unless we later decide to rent it out, and at that point it becomes an investment property)…in fact…I actually have to pay to be in the home, and I am entirely banking on the fact that someone later down the road will pay more for the home than I did (including any money we have put into it). So if it truly were an investment, it would be speculative at best. Sure you can build up equity in the home, but as most homeowners saw in 2008, that equity can dry up almost instantly. A home is a ‘use asset.’ We live in it, we grow in it, and we will always have to live somewhere, so we don’t plan on accessing the equity in our home except to roll it into our next home purchase looking for the day where we can be mortgage free.

Step one of buying a home is knowing how much of a house you can afford. While buying a home is not for everyone, there are certainly some benefits that are worth considering, and some good rules of thumb to follow.

Evaluate what you can afford:

1) Most people should plan for a home’s purchase price to be less than 2.5 times your salary. If your family’s income is $50,000, then you could consider shopping for a home worth around $125,000. If your income is $100,000, consider homes less than $250,000.

2) Various studies have shown that individuals who save aggressively and are rapidly working toward becoming financially secure spend only 1.5 times their salary.

3) The mortgage companies will let you purchase a home so long as your debt-to-income for house payments (principal, interest, taxes, homeowners association dues, and insurance) is less than 28%. In essence, if your family’s income is $50,000, then the MAXIMUM you should spend on those items each year is $14,000. This is an underwriting standard and should be considered the absolute maximum amount of house you should purchase, so steer clear of any home that comes close to this number.

Other considerations:

1) The average homeowner’s monthly payment should end up being around 1% of the value of the home (principal, interest, taxes, and insurance). You could see great differences between states (since some states have hefty real estate taxes and other states generate their revenue elsewhere). Also, interest rates are at historical lows, so this figure is actually on the high side now.

2) Put 20% down on the home (if you are able) since this will allow you to avoid PMI (private mortgage insurance). If you are just starting out or just flat don’t have this size of a downpayment, you will still need about 3-10% depending on the mortgage company. It may not make sense to put more down (even if you are able) since a mortgage is a fixed expense and interest rates are low, so you may be better off long-term investing the funds and putting the money to work.

3) A homeowner should plan to spend about 1% of the value of the home on repairs and updates each year. The law of averages skews this a little since newer homes typically have much fewer repairs while a 60 year-old home could have substantial repairs and maintenance from painting, updating, dated appliances, etc.

4) How long you plan to live in a home is another important factor. If you are planning on being in the home for any period less than 3-5 years, it is probably not worth the closing costs (buy and sell side) to purchase a home. The longer you plan to live in the same area, the more it makes sense financially to purchase than to rent. You get the federal income tax benefits of deducting interest, real estate taxes, etc. that makes it beneficial to own a home, plus you start building an asset through the value of your home as you pay down your mortgage.

If you are in the market for a home, Zillow.com and Trulia.com are some great resources to see what is available and what the going rate is. They also have some great historical information on houses too (previous sale or listing prices).

Update: Check out: Housekeeping.org for a wealth of information on loan pre-approval, improving your credit score, selecting the right realtor, and making on offer on a home.

Remember, the less you spend on a home, the more discretionary income you will have to put toward that emergency fund, retirement, a nice vacation, or food!

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5 thoughts on “What you should know about buying a home

  1. Sound advice! Buying above your affordable means decreases enjoyment too! Evaluating what you really will use in your daily lifestyle in the square footage you require will help in setting up the criteria you are even looking at when shopping for a home. We found this out when we downsized 6 years ago and have been so pleased!

  2. A quick addition to #2 regarding the 20% down payment. If you are unable, and sense I personally hate PMI (because it is dead money-no tax benefit, no payment benefit) look into getting a 1st and 2nd and do a simultaneous close. Depending on the bank, typical options include 80-10-10, 80-15-5, and some 80-17-3 (but these are rare). The ratios are first mortgage-second mortgage-down payment. This will maintain that all payments are mortgage payments and not premium payments to your bank’s insurance company. In short depending on how you file your taxes, you won’t be losing itemization benefits of the mortgage insurance as opposed to the non tax beneficial PMI premium payment

    • Interesting point, Chad. I think that it’s best to try and avoid PMI, but I’m not sure that the 80-10-10 method (or other ones mentioned) is really much of a better option to get a loan. They aren’t nearly as frequent anymore (compared to 5-7 years ago), and the interest rates on the second loans are usually quite a bit higher than the base loan interest rate on the primary loan. As such, any ‘savings’ you get from not paying PMI would likely be offset by the higher interest rate.

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