Are you looking to become a first-time home buyer?
Owning your own home is a key part of the American Dream, and therefore a goal for many people. Having your own little piece of land, no matter how small, makes you feel safe and happy. It’s your place to lay your head down and take comfort.
Unfortunately, your own little piece of land can be pretty expensive — seemingly out of reach for too many homeowner wannabes. While it’s exciting to qualify for a mortgage and move into a new place, owing a half-million dollars can be kind of sobering. And scraping together the down payment can be a real challenge.
How can you do it? We have a few tips for first-time home buyers.
1. Figure out how much house you can afford.
This is a multistep process that includes tallying your income and monthly expenses, including any debt you might have. The Motley Fool has how to figure out how much house you can afford boiled down to six simple steps.
- Once you get a number, you’ll see how much of a mortgage payment you can realistically make each month. As a first-time home buyer, when you try to get pre-qualified for a loan, the bank will make this calculation for you.
- In my experience, the bank is willing to give you way more than you should take. Check out this home affordability calculator – it can give you an idea of what I mean. After I plugged in some numbers, it told me I could afford to spend 36 percent of my income on housing.
- The Department of Housing and Urban Development says: “Families who pay more than 30 percent of their income for housing are considered cost burdened and may have difficulty affording necessities such as food, clothing, transportation and medical care.”
- Median household income varies widely by state, so let’s just use $50K a year as an example. The calculator says with that income, you could afford a mortgage of $1,500 a month.
- But what are you paying now? If $1,500 a month seems astronomical to you, it probably is. Don’t just take what they’re giving. Take what you think you can afford is a great tip for a first time home buyer. The bank accounts for debt, but it doesn’t account for what happens if you lose your job and have to take one that pays less, or your car gets totaled and you need to buy another one.
- Don’t get into a situation where you can make your mortgage payment each month only if everything else goes right.
2. Borrow from your 401(k).
There are arguments for and against this strategy, but sometimes it’s the only way to get a home.
- In most cases, first time home buyers need a down payment. When do you not need one? When you get a Veterans Administration loan or a USDA loan. USDA loans are given to low-income buyers who want to purchase a home in a rural area. Some of the requirements include income eligibility levels, buyers must have U.S. citizenship or qualified alien, and buyers must agree to use the home as the primary residence.
- If you don’t fulfill the requirements for either a VA or a USDA loan, you will need a down payment. If you don’t put down at least 20 percent of the purchase price, you will need to pay private mortgage insurance until you have 20 percent of the house paid for. This insurance protects the lender if you are unable to make payments.
- The average home sold in the U.S. is a little under $200,000. If you put $10,000 down — or 5 percent — you’d have to pay $91 a month in PMI for nearly 10 years. That’s almost $11,000.
- You can avoid that by putting down 20 percent, or $40,000. Lots of first-time home buyers don’t have $40,000 laying around, so if you can’t borrow it from your family, you might want to look to your 401(k).
- The good part about borrowing from yourself is that even though you pay interest, you pay it back to yourself. The bad part is that your $40,000 won’t be fueling the growth of your retirement nest egg. But your home will appreciate in value and you won’t be flushing away a grand or more each month on rent.
3. Plan ahead for those pesky expenses related to closing.
- It can be hard to save up the money to put a down payment on a house when you’re a first-time home buyer. Borrowing the money helps, but it comes with a cost.
- For instance, you know how much your mortgage payment will be, but if you borrow from your 401(k), you have to remember that you’ll be paying on that loan every month too. It’s nice that the money is going into your account, but you still have to make the monthly payments.
- Further, you will have to pay the dreaded closing costs. What are these? They are not the same in every transaction. Most lenders will require an appraisal to be sure that you are not paying more than the house is worth. Angie’s List puts this cost at between $300 and $400.
- You will also likely have to pay a mortgage application fee. Banks.com says up to $500 is common for this fee. Depending on what state you are looking to buy in and what lender you are using, you could face a host of other fees as well, including origination fees, title and escrow fees and the cost of a home inspection.
- In some states, a home inspection is mandated. But even if it isn’t, you should still get one unless you feel qualified to vouch for the working condition of all the home’s systems and parts. HomeAdvisor puts the average price for a home inspection at $325.
- Another valuable tip for first time home buyers? Read your home inspection contract carefully. Many home inspections do not include tests for radon, lead paint, asbestos, air quality or other concerns. Termite inspections are required in some states, but not all home inspectors are certified to do termite inspections, so that might be a separate expense.
- All in all, closing costs can be several thousand dollars.
4. Don’t buy furnishings right away.
- It can be exciting to pick out furnishings for your new home. But they can be expensive. Especially if you’re moving from a small apartment, you may not have enough furniture to fill your new home, or the pieces might look silly in the space.
- Some first-time home buyers go shopping after their offer has been accepted because they are so excited to move forward. This is a critical mistake for two reasons. One is that mortgage preapproval is not a guarantee. The bank will check your credit a second time before finalizing the loan, and if you just bought $5,000 worth of new furniture and appliances, it could skew your debt-to-income ratio and cause the sale to fall through.
- But even if your loan proceeds without impediment, having another large purchase to pay for in addition to your mortgage, insurance, taxes and closing costs could push your budget over the limit.
- Keep this in mind also if you’re buying a fixer-upper or a house that needs work. You cannot roll the cost of the work into the mortgage; you have to fund the rehab yourself. The money for the renovations, as well as the labor involved, could get problematic, especially if the house isn’t even livable.
- If you’re planning costly renovations, be sure that you can either afford to pay for them or you can wait to make them.
We want you, as first-time home buyers, to go into the process well-informed and prepared. Foreclosure activity hovers between 60,000 and 80,000 per month, and many of these are due to first-time home buyers purchasing properties they couldn’t afford.
Owning your own home should be a joy. It should be liberating. But too often a first time home buyer’s castle becomes his or her prison. As with all major purchases, being cautious can help protect you from getting into a financial bind.