Since we were the first among most of our friends to buy a home, we’ve gotten lots of questions about the best way to go about it, save money, and avoid the pitfalls. So we’re here to give you the layman’s guide to buying a home, with tried and true tips straight from the real estate trenches! Even though the homebuyer’s tax credit has come and gone, it’s still a great time to be looking at a new home. Historically low rates are available (under 5% still a possibility), and although you may have to jump through a few extra hoops with paperwork, lenders have loosened their purse strings again. If you’re willing to employ a little forethought and patience, you can have your dream house and keep it a happy home.
With that in mind, we present Dreaming the Possible – Top 10 Tips for New Homebuyers. Some of these we hit, some we missed and learned after the fact (I marked them accordingly). If you do nothing else, these steps will ensure you get a smart deal. Picking the right house is up to you.
- Take a Deep Breath: HIT! First things first, keep calm. Patience is your number one ally. We started shopping in late 2009. We got our house for about 20% under its value (30% under the original asking price), mostly by refusing to rush even with the homebuyer tax credit deadline looming (but we did get it!) Sleep on any decision. It’s still a buyer’s market, and there will always be other places to love if it comes to it.
- Clean Your Plate: HIT! This is a radical concept that goes against everything the modern American consumer practices, but if you have any existing debt (credit card balances, student loan payments, payments on furniture or electronics, car payments, old lines of credit, etc) you aren’t ready to buy a house. Stop scoffing (or swearing) and get this: Adding a mortgage onto a pile of other payments is too much debt and stress on your budget. No whining – If you have big debt, you can’t afford not to do this. If it’s little, you’ll have it cleaned up in no time so get to it. This does require maturity so if your bratty inner child screaming “I want it NOW!” rules your finances, you may be so used to being in a hole the light hurts your eyes. But as an adult, you have to accept that you can’t have everything at once. If your budget is stretched to accommodate a bunch of debt payments you have no flexibility and no financial power. Any unexpected emergencies or changes in income could sink you. Even if they don’t, that looming stress is an anchor you don’t need. In order:
1) Get focused and clean up your other debt first.
2) Save your down payment (more on this later).
3) Then, and only then, go house hunting!
- If it’s Fixed Don’t Break It: HIT! Assuming you aren’t paying cash (100% down payment anyone?) make sure to take a fixed rate mortgage only. ARMs and balloon mortgages are dangerou, with rates and payments that can go up dramatically. These loans are exactly what caused the housing bubble to burst (and the irresponsible lenders who approved them, and the greedy buyers who accepted them, but I digress…) I don’t care if you’re planning to move in 4 years, this is too much risk. If one of these is all you can qualify for, just accept you aren’t ready to buy yet. Keep saving and you’ll get there before you know it. Also, and this is usually standard for fixed rate these days, make sure that there is no prepayment penalty (essential for making extra payments – see #7 below).
- Shop Locally: MISS! Whether you’ve been preapproved for a mortgage already or not, check with a local bank or credit union. You might not get a better rate than a mortgage broker, but you’ll get to work with a local lender and actually meet the people who will hold your housing destiny. Some small lenders have a policy of not selling mortgages. Many larger lenders do this – ours changed hands twice before we even made our first payment! – making following the paper trail a dizzying and impersonal process. Plus a local lender keeps your money in your community, a nice karmic bonus.
- Double Down: HIT! Once you qualify for a fixed rate mortgage, ignore your agent’s 10% down recommendation. His job is to have you get the biggest mortgage you can. Putting at least 20% down will lower your payments, ensure less risk, and is required to avoid private mortgage insurance (PMI). PMI means you pay to ensure your lender. Yeah, it’s as crazy as it sounds and it’s money down the drain. Save 20% first and avoid it altogether.
- Do the Math: HIT! Calculate a monthly payment of no more than 30% of your net (after taxes) household (combined) income. This is crucial! If it’s over this amount, negotiate harder or find another house. “But 30% is so low! I can’t get a big expensive house this way!” Maybe not, but it ensures you get a house you can actually afford. Paying no more than 30% of your net household income means the payment will be manageable for your budget. It frees up more money for extra payments or savings goals, and gives you a good margin of safety should your income change.
- 15 Will Get You $170,000: MISS! If your budget allows it, I recommend a 15-year fixed rate mortgage (still following the 30% guideline above). You’ll get a higher monthly payment, but also a much lower rate. The low rate and shorter timeline are a powerful one-two punch of savings and you’ll pay vastly less in interest over the life of the mortgage. Example: Let’s assume a 5% rate on a $200,000 mortgage. Even at the same rate, a 15-year fixed loan will save you $170,000 in interest compared to a 30-year.
- Pour it On! HIT! If you don’t have car payments, credit card payments, or student loans to repay, (and you should if you’re beyond #1) extra mortgage payments will save you serious money. I know what you math nerds are saying; mathematically you can earn higher interest on an investment than what your mortgage rate costs you, but it’s not apples to apples. The interest charges on your mortgage apply to the total amount immediately. Slowly trickling money into a mutual fund over years won’t have the same impact. More importantly, if you miss a few contributions to your IRA, no one is going to take your house away from you. Free that money up and invest it each month debt-free and you’ve got some power.
Want to get truly extreme? Here’s a real-life example: By making extra mortgage payments each month, we’ll retire our 30-year fixed mortgage (at 4.9%) in 5 years. Total interest paid: $15,000. If we went the full term of the loan, the interest would be nearly $120,000!
- Like a Good Neighbor: HIT! Look around the area once you’re getting close to buying a place. What’s in the neighborhood? What are other houses nearby selling for? What’s the demographic (young families, professionals, retired couples, crack heads…) and does it appeal to you? Are there good local resources for shopping, food, parks and rec, and entertainment? Research the local school system. For us, a great library branch and outdoor performing area a mile away was a huge appeal.
- Check Under the Hood: HIT! Your inspection will ensure everything is in working order, but find out the age and condition of the Big Three: furnace, roof, and electrical system. These can easily add $5k to $20k to your costs in the first few years if there are any major problems. Roof newer than 10 years, the others newer than 4 years is good.
The bottom line is that your house is your home, and a peaceful home is a happy home. Figure out your values, what’s important to your life, and live by them. If you buy a lavish, expensive house but you’re making the payments by the skin of your teeth, you and your family will be living on the edge, constantly stressed and afraid. Is that living in line with your values? For us (no surprise), peace and financial freedom are our goals. We bought less house than we could afford, and made the decision to finish in our ‘starter’ home. There’s tremendous value (personal and monetary) by figuring out where you want to be, what you want to live in, and then staying there. There’s nothing wrong with wanting get nicer homes over time as finances allow, there are even some tax advantages if you’re lucky and smart enough to make money on each upward sale, but one bad deal and you’ll lose out on the appreciation and equity in your home, not to mention the personal upheaval each time. Think about what really matters in the long run when deciding what features make your ‘must-have’ list.
Final note, buying a home is an incredibly fun and exciting journey and even more enjoyable if you get to share it with a great partner! A good friend of mine once said; “the most important financial decision you’ll ever make is who you marry.” Sharing core values for family and finances has been a huge source of peace for Courtney and me, even tho we are different in myriad small ways. That’s just the fun stuff!