For first-time home buyers, the process of shopping for a home can be overwhelming. It's not just the search for a house that is daunting, but also the anxiety that comes with deciding how much home to purchase. It's normal to wonder if you're ready to take on a new expense, or if you've done the best job preparing yourself for the shift from renter to owner. So what questions should house hunters ask themselves to be sure they're making the right move? What areas of your life should you inspect to feel confident before applying for financing? Let's walk through 7 questions that can help you decide whether you're ready to pull the trigger:
1. Am I Being Realistic About Pre-Approval?
There is a difference between being pre-qualified for a home loan and pre-approved for a home loan. To pre-qualify, lenders will ask you preliminary questions, such as your household income and job status, in order to give you an estimate of how much home you might be able to afford. The pre-approval process is much more involved. You will have to provide tax returns, pay stubs, bank statements and more in order for a bank to state in writing that they will indeed loan you a certain amount of money. A potential home-buyer who has already been pre-approved could have a leg up on competing buyers. As a matter of fact, some sellers will reject applications that aren't cash offers or pre-approved. But just because you're pre-approved for a certain sized home loan doesn't mean you must borrow the whole amount. A lender's concern is whether they can get THEIR money back, not your financial well-being in general. If you can pay them back every month but don't have any money left to save for your other goals, they will still be perfectly satisfied. It's up to you to determine whether your payment is too much, even if the bank has offered you the loan. Make sure that you write down all of your financial goals, and that the mortgage amount you request doesn't put you in a position where your other priorities have to be pushed to the side.
2. Will I Have Any Savings Left After I Make My Down Payment?
There is no worse feeling than finally getting into your dream home and realizing ... you're broke. To avoid this fate, make sure that when shopping for homes, you stay in a range that will allow you to keep at least three months' expenses saved even after paying your down payment and closing costs. It's common for you to not have to pay your mortgage the first month after closing, and I would advise you to save this money as well. Coming into a new home with a cushion in your savings account will make sure you have money to pay for any unexpected expenses. You never want to live paycheck to paycheck as a homeowner, and savings is the key to making sure that is never your plight!
3. ... AND Pay To Move and Furnish My House?
Guess what? Furniture costs a TON of money - Surprise! If you are a thrift store aficionado who finds furniture for pennies, feel free to laugh at all of us who haven't figured out your secrets. But for the common person, filling your new house with furniture and furnishings can be an expense that adds up quickly. Even if you're moving a good amount of your old stuff into your new place, you want to make sure you've estimated the costs of moving when you prepare to buy a home. Write down a list of pieces you would like to buy and shop around beforehand to get an idea on pricing. Call local moving companies to compare rates, and add these budget items to your down payment and closing costs when doing your calculations. If you plan on borrowing the money for the furniture, ask if the furniture store offers 0% interest for a set amount of time. If you can't afford to pay off the balance in full before interest starts accruing, consider dialing back your furniture goals and resolve to add pieces as you can afford them.
4. Can I Afford My (Entire) Payment?
We've all been there; you Google 'mortgage payment calculator', run some numbers, and somehow it looks like you can afford to live in a million dollar home for the same price as your rent right now. It's tempting to look at that number and head straight to Zillow, and then you realize that not all mortgage calculators estimate your ENTIRE payment. A mortgage can be made up of the following components: 1.) Principal, the actual amount you've borrowed, 2.) Interest, 3.) Escrow, an account which holds the money needed to pay your property taxes and homeowners insurance, and in some cases, 4.) P.M.I., private mortgage insurance. Many online calculators only show you the payment for the principal and interest, meaning the remaining components, which can be a substantial part of your payment, are left out of the equation. To get the best idea of your actual payment, find a calculator that incorporates not just the amount of the loan and your interest rate, but also your homeowners insurance and the estimated property taxes for the area in which you will live. Now that you have a closer estimate of the true cost of your mortgage, plug it into your budget so you're working with more concrete numbers as you search for a home.
5. Can I Manage The Repairs and Upkeep?
Are you buying a fixer-upper, or have a few modifications you'd like to make to your new home? If so, identifying a responsible way to pay for those improvements before buying your home is key. If you know your house needs $10,000 in work, you should be able to pay for it outright or find a financing source with favorable terms. Examples of these financing sources could be a home-equity line of credit or a low-interest personal loan. A credit card is NOT an ideal way to pay for home repairs, as the high interest can cause your debts to spiral out of control. The same consideration for home improvements should be given to the costs of keeping up your home. Are you moving into a neighborhood where you're required to keep your lawn a certain length? Are you buying an older home that is likely to need regular repairs? Try and estimate these costs so that you're not caught off guard when the time comes for repairs. And trust me, when owning a home, those times WILL come!
6. Am I Maximizing My Other Investments?
Have you ever heard someone say that they are "house poor"? It's a term that describes a person who spends an inordinate amount of money on home ownership, to the point they are unable to save elsewhere. It is a situation to avoid at all costs, because being house poor means your house HAS to be a good investment. Why? Because if you are "house poor" and it doesn't turn out to be a good investment, you also haven't been able to establish your other investments! If you're considering buying a home, ask yourself the following: will I still be able to save after I buy this house? Can I afford to put money into other ventures? If you work for an employer that offers a matching contribution to your retirement account, make sure that you'll still be able to contribute the maximum that they will match. If you can't afford to both buy the home and take advantage of the free money that's offered to you, consider shopping for a more cost-effective home or even delaying your purchase until you can contribute to all areas of your financial life.
7. Do I Have The Right Insurance?
There are some insurances that you're legally required to own, such as car insurance. If you do get a home loan, homeowners insurance is required to protect your lender against loss. Other insurances, such as life insurance and disability insurances, are optional. However, as a homeowner they are even more vital, because they protect you and your family's ability to pay the mortgage in the event of catastrophe. As a homeowner, life insurance can allow you family to pay off the house if you die: it is a selfless purchase. Disability insurance protects you by replacing a portion of your income if you can't work due to illness or injury. Oftentimes these insurances are offered to you by your employer, otherwise known as group insurance. However, many group plans have limitations that stop short of your true needs. Group life insurance, for example, typically isn't portable, meaning you only have the coverage while you're working for your current company. If you were to die in-between jobs, there would be no benefit to your family. Group disability insurance, a portion of which is typically paid for by your employer, has benefits that are potentially subject to income tax, and often do not offer protection for bonuses and overtime pay. For these and other reasons, it's wise to consider all options by looking into individual coverage outside of your job, as well. Doing so will give you better comfort knowing that you've transferred the financial risk of your death or disability from yourself and onto the shoulders of the insurance company.
8. Is My Consumer Debt Under Control?
In our video series on Student Loans we touched on the term debt to income ratio, which mortgage lenders use to determine if you can manage your debts. Because lenders won't offer you a mortgage if your debt to income ratio is too high, there is SOME barrier that makes sure your debt payments are under control AT THE TIME OF THE APPLICATION. But you are the only one who truly knows if you have your expenses under control. Are you able to meet your needs each month without using a credit card? And if you do use a credit card, maybe for work or because you have a variable income, are you able to pay off the balance in full each month before accruing interest? The costs of owning a home can make borrowers more likely to utilize consumer debt for home expenses than renters. Heading into a new home without having a handle on your expenses is a recipe for disaster. If you manage your consumer debt well, you're in a great and enviable position. However, if you're interested in buying but are having trouble with your expenses, put in place a plan of action to both address and eliminate your consumer debt before applying for a home loan.