We all want to own a home. But before you turn your dreams into reality, you must take a careful, objective look at your finances. Ask yourself: Can I really afford a home?
Here is the reality. Very few first-time home buyers have the cash reserves to purchase a home outright. You will have to take on a long-term mortgage. This means that you are accepting debt that in most cases exceeds $100,000. Are you ready to take on that commitment?
Most experts agree that your mortgage payment should be no larger than one-third of your income. This will change depending on your existing debt (student loans, credit cards, car loans). Take the time to examine your expenses. How much can you realistically afford to pay each month? Can you make cuts to your current expenses?
A standard down payment is typically 20%, but this amount can vary. By investing this much upfront, you can avoid mortgage insurance and will lower your monthly payments. You can be approved for a home loan without a large down payment, but you should get into the habit of saving your money to put toward your first home.
When you invest in your first home, you are not paying just for the mortgage. There are many added expenses that need to be factored into your new budget. This will include the following:
This last one is hard to plan for; we never know when an emergency will arise. In general, you should have three months of income saved in an emergency fund for any unforeseen disasters.
One of the most attractive aspects of home ownership is overseeing your own home: You get to decide how to design the home, when and where to paint, whether you want to tear out the carpets or add a new roof. You no longer need to seek approval from a landlord or property manager.
This is also one of the hardest transitions to make. When the kitchen sink pipes burst, or the roof leaks, or you suddenly need to replace old fixtures, you are now responsible. You will need to hire your own plumber or roofer (or do the work yourself).
These unknowns must be included in your emergency fund before you purchase your first home. It is not the most exciting thing to save for, but it will keep you out of financial trouble down the road.
Let’s say you have completed all the previous steps. You have the down payment saved. You created a working budget that includes your anticipated mortgage along with taxes, insurance, and an emergency fund. Time to go buy a home, right? Not yet.
Most sellers will not entertain an offer until you have been pre-approved by a lender. Before you make any offers – and really before you start a serious home search – you need to know how much the bank is willing to give you. Loan officers will review your financial record – W-2s, credit history, student loans – to determine what you can afford. They most often offer 15-year and 30-year mortgages. These come with either fixed or adjustable interest rates.
The safest route is a 30-year, fixed rate mortgage. You will make steady monthly payments and if your credit score is excellent, you will have a lower interest rate. An adjustable rate can be tricky only because it can fluctuate over time.
If you are prepared to pay a certain monthly amount but the rates change, you may find yourself over budget. It is worth noting that many banks will offer a loan amount that exceeds your set budget. You might plan to pay $200,000 for a home, but receive a loan offer of $300,000. Do not take on a loan that exceeds your budget. Just because you are eligible for a large loan does not mean you should take it. If you do this, you risk becoming house poor – spending your income on monthly mortgage payments and not building your savings or using money toward repairs, maintenance, and other necessities.
Buying a home is one of the biggest purchases you will make. It can be an emotional process but that doesn't mean you should make an emotional purchases. Here are a few common mistakes you should be aware of:
1. Waiting for the Perfect Deal
The market always goes up and down so it's easy to believe you will find a better deal. Yes, the market could drop but you're still never certain if it will. The best thing you can do is research and not get hung up on finding better deals forever.
2. Love at First Sight
In real estate you should never believe in love at first sight. Even if you do love the first home you see, look at 5 more homes just to make sure it's true love.
3. Looking for Perfection
This is similar to waiting for perfect deal because you might never find it. Have an open mind because it is unlikely you will find a home that crosses everything off your list. Make sure you don't overpay for perfection as well!
4. Not Thinking About the Future
People are investing to live in a neighbourhood but don't often think about the future of that area. Will there be construction there in 5 years? A highway behind your house? Are house prices declining in the area? You have to think about these things so you eliminate unpleasant surprises in the future.
A house is a big purchase so don't let small mistakes cost you lots of money. Here are some tips and principals you can apply to the purchase of your home:
Budget for added expenses
Get a guarantor if you're struggling to find a mortgage
Don't take the biggest loan the bank offers. Stay within your budget.
You never know where the market will be tomorrow
Get info from the sellers. How long has it been on the market? How are the neighbours? What renovations have been done? Talk to the neighbours yourself. Ask about the area and you could get to see what they are like. Consider resale potential in the future.
The more information you can gather, the more wise decision you will make.