Buying a Home 101 Series – Week 1
In my weekly home buying series, you’ll learn how to find a home that is the right fit for your lifestyle, needs and, most importantly, your budget. It takes you through every single step and shows you how to avoid buyer’s remorse. Your first home is most likely the stepping stone for your next home so you want to do it right and set yourself up financially to move up to your next home.
When it comes to getting a mortgage to buy your first home, many buyers decide on the price point of the house they want to buy before talking to a lender.
They’ll say something like — “We are going to buy a home for $500,000” — and then they head out to open houses in that price range.
Even though that’s how it seems like it should be done and how many people do it, that’s not at all the way to start your home-buying experience.
In fact, if you go about financing your first home this way, you’ll not only have a miserable experience, but it also could cause you to buy the wrong home!
Follow these Four Steps —
You’ll be all set and on the right path if you follow the 4 steps below. And keep reading since you don’t want to miss the BONUS section — with even more tips on getting the right mortgage for your budget.
This is the most important decision you’ll make when it comes to buying your first home. Everything else will fall into place once you make this decision.
Decide this before you talk with any lenders, before you start searching for homes online, and before you start going to open houses.
The reason is twofold.
This often comes as a surprise, since most people feel like they won’t be approved for enough. But that’s typically not the case; it’s actually the opposite! Most people are approved to spend way more than they want to shell out every month for a home.
That’s why I always start the conversation with my clients not by asking them what they want to be approved to buy, but rather asking them what they feel comfortable paying per month for their new home (inclusive of condo fees, if any, taxes and insurance).
We can then work backward to determine the correlating sales price and tell you if you would be approved for that amount.
We will need one other piece of information from you in order to provide a price point, which we will discuss when talking about cash for your transaction (see #3 below).
Conservative advice is to spend about 30 percent of your income on housing. In areas that have high costs of living such as New York, San Francisco and the DC area, that number can creep up to 40 percent and still be okay. Ask yourself if what you want to spend per month is in that range. If it is, you are A-okay.
You should also be looking at your monthly budget so you can compare future home expenses to your current rent expenses. That will help you determine an affordable mortgage payment.
Again, focus on your monthly mortgage payment rather than fixating on one big sales number or price range. It’s easier to comprehend since most of us budget for monthly expenses already, and will help you take into account any HOA fees, etc.
In addition to what you want to spend per month, you need to know how much cash you want to spend on your purchase. As we mentioned above, this is the second piece of information needed in order to determine your price point.
Yes, you are going to need cash for your down payment but another cost up front that most people don’t take into account is closing costs.
Decide upfront how much cash you can put towards your home purchase. Do you have enough saved? Will it include a gift from family? A loan from your 401k?
Some things to keep in mind when you are thinking about how much cash you want to allocate to your home purchase:
You may be able to spend a little less cash to hit one of the points that lenders like to see. For example, if you have around 10% to put down, then putting 12% down won’t change your interest rate or really help anything from a loan standpoint. So you could save that extra 2% for moving expenses since it will do you more good as cash in hand than cash in your home.
You are all set to meet with a lender. You should now understand the two things that will help them determine your price range:
You can always make adjustments later on and see how that will change the price point, but start with some figures you are comfortable with in terms of monthly payment and cash for your purchase.
BONUS SECTION – More Information on Getting the Right Mortgage
When it comes to adjustments once you receive your price point from your lender, keep these tips in mind:
These are additional guidelines that you can use to help determine your mortgage payments. Remember, you still want to have some cash left over and not be wiped clean each month.
You should think of the loan summary and price points your lender gives you as rough drafts until you find an option that suites your specific finances and situation.
The loan your friend gets is not the one you should necessarily get. These days, when it comes to financing your first home, there are SO MANY loan options available that you really need to focus on what’s best for your particular financial situation and goals.
Remember, a credit score has nothing to do with your income or investments. It’s based on how you’ve handled your credit card payments and other loan payments, like your car or student loans. It also takes into account if you’ve declared bankruptcy, have a tax lien, or you’re being sought by a collection agency.
If you need to improve your rate, you may need to delay getting your home until it’s higher but speak to someone first to determine if needed.
Consider your current and future finances and also where you will be in 5 or more years. There are several loan products that may be better for you than a “go-to” 30-year fixed loan.
If you don’t plan on owning for more than 5 or 6 years, you might want to consider an adjustable-rate mortgage (ARM). Today’s versions are much more straight-forward, conservative, and safer for homeowners than the ones in the past. These loans typically offer a substantially lower interest rate, saving you thousands of dollars while you live there.
Your lender may tell you that if you pay one point, your interest rate will be lower than if you pay zero points. And even lower, if you pay 2 points.
A point is equal to 1% of your mortgage amount (or $1,000 for every $100,000). So points are basically an “upfront payment of interest” at closing for usually 30-year fixed loans. Rather than pay it over the life of your loan, you can pay a large chunk when you get the loan.
As a buyer, you will need to weigh the pros and cons in getting the lower rate and paying for points upfront.
You’re off to a great start now that you know the best way to go about financing your first home. Stay tuned for next weeks article to stay knowledgeable and ahead of the home buying race!