Spring home buying season has arrived and with wages up, mortgage rates down and inventory slowly increasing, many first time buyers are ready to enter the market. Before you get sucked into the vortex of never-ending open houses (say goodbye to your weekends!), you need to guard against the emotional pull that real estate creates, especially for those who have never gone through the process before.
Falling hard for that “dream” house can lead anyone to pay up, but according to a NerdWallet survey, first time buyers are more susceptible: 56 percent of first-time buyers offered more than the asking price, more than the 35 percent of other homebuyers who did so. Maybe paying up led to the other glaring finding: 34 percent of first-time home buyers felt financially insecure after their purchase, versus 17 percent of buyers who had done it before.
I wonder how many of these first time buyers focused on the numbers before they started the process. I fear that some happily take however much money a lender will provide, and then back into the house price that they can afford. Just because a lender will fork over the dough, does not mean you should take it. As housing expert Ilyce Glink wisely notes, “there’s a difference between what lenders tell you is affordable and what will feel affordable to you.”
When you run your numbers, you will consider mortgage principal and interest, homeowners insurance, and taxes. But don’t stop there, add a line item for upkeep and maintenance. Depending on the age of the house and its condition, factor in one to three percent of the purchase price annually and then see how the numbers look.
While loads of lenders will tell you that you can buy a home with “just three percent down,” I prefer the conservative approach of a 20 percent down payment, which allows you to qualify for a conventional loan with the best rates. It will also prevent you from paying private mortgage insurance, which can vary from 0.3 -1.5 percent of the original loan amount, depending on your credit score and the size of your down payment.
That said, it is hard to accumulate 20 percent down, especially in pricey markets. If you are going to put down less, understand the rules for your particular mortgage and be clear that you need to monitor the value of your home and alert the lender if you have reached 80 percent equity so that you can get rid of that extra PMI payment. You should also research any local housing programs designed for first-time buyers.
Before you start the mortgage application process, pull your credit report at AnnualCreditReport.com and correct any mistakes that you find. This is an important step in getting pre-approved (which is much better than pre-qualified) for a mortgage. If the report looks good, it’s time to shop around, which according to the NerdWallet survey is another minefield for first-timers. Half of buyers applied to just one lender, which cost them about $430 in interest in the first year for a fixed-rate $260,000 mortgage.
Before you take the final plunge, consider whether buying a home might preclude you from addressing other important financial issues in your life, like paying down student loans or saving for retirement. And no, it is not OK to deplete your emergency reserves to make the purchase. The down payment fund is separate from the emergency fund, and you need to maintain both of these funds in boring checking, saving or money market accounts, not in any type of risky investment account that would subject you to market fluctuations.