Homes are the single-most significant purchase consumers make. Your knowledge and skill in making an excellent house purchase decision will contribute to helping you reach your other financial goals. This primer contains financial planning information to help prepare you for the buying process. This preparation phase is perhaps the most important phase of the home buying decision.
Step 1: Get Your Financial House in Order. Before you even think about the purchase of a home, look at your entire financial picture: your comprehensive financial plan. The purchase of a house affects not only the amount of money you currently have in savings and investments (if you use some of it as a down-payment), but the payments, maintenance, utilities, and costs to furnish and insure will affect your budget each month. Home buying decisions will affect your ability to reach your other financial goals, more than any other large purchase that you make.
Your decision process should begin by looking at your financial plan. If you don’t have a financial plan, consider an online eFinPLAN financial plan. Before embarking on the road to a big financial decision, it is key to get your financial house in order. The decision to purchase a home should not be made in a vacuum. It should take into consideration all of your financial goals and responsibilities. When you purchase the home, you should know how it will affect your other priorities. If the home will cost you, over time, less than you can afford, then you will be able to use those extra funds for other things, such as getting out of debt sooner or retiring before you thought that you could. It might mean that you are able to afford a vacation without using credit cards and going further into debt.
As with all financial decisions, this one should revolve around the written plans that you have made for your future. Check your budget to see if you will be able to see your gross and net income and to estimate how much you have left over to invest.
Step 2: Examine Financial Aspects of Home Purchases.The following is a list of the most common areas for consideration when purchasing your home. Make sure you discuss these with your Realtor or buyers agent. After all, it’s their job, so use all of their expertise.
- Insurance: Ask your insurance agent the approximate cost to insure the homes you are considering buying.
- Utilities: If you are renting now, your budget for utilities will likely go up. Your utility usage will depend on: the costs for utilities in your area, the size of the home, the age of the furnace, the type of heating, and the level of insulation in the home. Be conscious of these expenses while looking at homes, and if you find a home you like, the listing should provide the budgets for gas, electric, or heating oil.
- Payments: How much are you currently paying for your house or apartment? It is usually less than you will pay for a new house payment. Use internet loan calculators to determine approximate monthly mortgage payments. Avoid the temptation to spend more than you can really afford for a home, assuming that your income will increase over time. If you want to be in excellent financial condition, buy a home a few notches below your current income level. In most instances, the loan interest will be deductible; however, do not use this as an incentive to over buy.
- Inspection: Prior to buying a home, the buyer should hire an excellent home inspector to go over the home with a fine-toothed comb. Arrange to be there during the inspection.
- Maintenance: If this is your first home, talk to other homeowners, friends, and family to help you estimate the cost of maintaining the prospective home.
- Repairs: Estimate the cost for future repairs such as roof replacement, outdoor painting, concrete repair, basement repair or finishing, and major mechanical replacement. Work with friends, family, contractors, and the inspector to help you estimate future repair costs. You can plug these large expenses into your financial plan under the ‘large future purchase’ section to help you budget for these large future expenses.
- Real Estate Taxes: Make sure you know what real-estate tax costs will be in the areas that you are considering. They can vary quite a bit, they can go up very quickly, and they may make a big impact on your budget, so do your homework prior to making your final decision.
- Commuting Costs: If your commute will be longer as a result of moving, estimate the additional cost of fuel and maintenance for your car.
- Homeowners Association and Condominium Fees can be high in some areas. Make sure you know all the fees before buying.
- Real estate agents and buyer’s agent: Real estate agents represent the seller, not the buyer. Some people recommend hiring an agent who works for you, not the seller. However, I have had excellent experience working with a real estate agent for many years. Whomever you decide to work with, make sure you know all the services they will provide for you.
- Comparables: Get prices on other homes. Real estate agents call them “comps.” Knowing the price of other homes in a neighborhood will help you avoid paying too much. Remember the old real estate advice that it’s better to buy the least expensive home in a great neighborhood. Also consider whether any changes you want to make to the home would render it incomparable with the neighborhood.
Revisit Your Financial Plan: Use the data you’ve gathered to sit down and look at your financial plan to determine whether the mortgage payment (including the extra costs listed above) will positively or negatively affect your financial condition and any impact it might have on your other goals.
Step 3: Choose between New Build or Existing Homes. Many home buyers choose new homes because the price may be close to an existing home and because older homes require more maintenance. However, if you purchase a new home, it may not have the features that existing homes may have, such as added patios or decks, installed draperies or blinds, security systems, lawn sprinkler systems, seasoned landscaping, finished basement, and simple things like hooks and shelves. These extras can make an existing home a great buy, especially if you are just starting out or if money is tight. Building a new home can be a hassle (especially if you are inexperienced with the many questions you need to ask) and the wait to build can be long.
In addition, some buyers choose new homes because of financing options, without fully understanding all of the details, and then they find themselves in a situation where the mortgage payment increases more quickly than they planned. Any changes or upgrades to a new home floor plan will raise your costs dramatically. Existing homes sometimes have more character as well as established neighborhoods and schools; however, they may need more repairs or have undesirable floor plans. Many home buyers choose new homes because they dislike making repairs of any kind, then find themselves installing blinds or shelves each weekend. We have loved living in an older home and in a home we built. Both have required different kinds of projects and expenses. Think through your decision, perhaps journaling the pros and cons of different homes or builders you visit to help you decide between a new or an existing home.
Step 4: Financing Your Home. There are two types of conventional mortgage rates: fixed and variable. If you choose a variable rate, make sure you know all the variables and conditions. If you have a variable rate loan and interest rates go up, you can usually convert to a fixed rate loan. However, if you convert when interest rates are rising, your rate will be higher than what it would have been if you had started with a fixed rate loan. Discuss your options with your banker and your Realtor.
There are also other types of financing plans, such as interest only loans, which are appealing to many people because it may help them afford the payments on a much larger house. It is also appealing to people who are only planning to live in a house for a few years. Interest only loans are popular when homes are appreciating rapidly, as they were up until recently. In many parts of the country, home values are not appreciating as much or depreciating significantly, therefore interest only loans should be approached cautiously.
Most people choose a 15- or 30-year mortgage. Monthly payments will be higher for a 15-year loan, but you will be able to pay it off obviously sooner than a 30-year mortgage and you’ll save a lot in interest. The interest rates and expense for 30-year mortgages is higher in the long run, but these loans are usually more affordable in the monthly budget and generally allow you to take an extra 15 years of interest deductions, assuming you do not pay off the loan early. Discuss your individual situation with your banker and your tax adviser.
Step 5: Closing
- Home Purchase Negotiation and Closing is very important. Your Realtor can help you with this. When interviewing potential Realtors, discuss their depth of knowledge and experience in this area.
- Always use an attorney to review the documents you are signing, especially at closing. There are just too many things to sign, and it helps to have someone else paying attention to what you’re signing when you consider the risk of agreeing to something—in writing!—unaware. Before closing, send all the documents to the attorney for prior review, or ask your attorney to attend the closing with you.
- Do not be ‘House Poor’. As a rule of thumb, your home budget (including mortgage, escrow, condo or homeowner’s association fees, etc.) should not exceed one fourth of your monthly budgeted expenses. Bigger houses are more expensive to furnish, maintain, landscape, and heat and cool, taking a bigger bite out of your overall budget. Many people may encourage you to buy as much home as you can afford now or will soon be able to afford. Perhaps they have reminded you that you have a successful job, and besides you can always cut back on eating out or going on vacations. The approximate mortgage amount you have been given will make things tight, but you really love that house. Now stop and take a deep breath. Is this mortgage amount within the comfortable range you have determined after reviewing your financial plan? If you own a home that cost less than what you can afford, then your financial life will be much less stressful. You will be able to work toward the goals you have established in your financial plan. Often, the greatest source of financial setback, causing people to use up their savings and go into debt, is unexpected expenses. Living below your means with a comfortable mortgage payment will help you plan for your future and the unexpected setbacks of life.
Summary: We have provided information about home buying and other areas that will affect your financial condition. These informational articles, along with your financial plan, are designed to help you take control of your financial future. This general informational material is designed as a list of reminders for homeowners and as an informational tool for first-time home buyers. Making a great home purchase decision that falls in line with your financial plan takes time, energy, self-education, and a great deal of patience. Since homes are the largest purchase for most consumers, it is an especially important financial decision. It is our hope that you will end up in a comfortable home with a painless payment, surrounded by great neighbors and friends.