August 30th, 2018 By Daniel Fisher in Blog.
Step 1: Compare the pros and cons of renting and buying.
Sure, renting has its advantages: convenience, flexibility and maybe lower cost. But sometimes buying a home can be the smarter option, especially if you dislike having a landlord and sharing walls with neighbors and want to build your financial net worth.
o Start by seeing what homes are available and get an idea of home prices in your area.
o Then use our Rent vs. Buy Calculator to compare the costs of renting and buying.
o Even if buying a home costs more, consider the benefits of tax breaks, appreciation, the chance to build wealth and the ability to borrow against the equity in your home. Plus, you’ll never have to worry about annual rent increases and fees.
o Read more about the pros and cons of homeownership.
Step 2: Create a “Home Wish List.”
Write down everything you want and need in a home. Use this as a framework for what houses to look at; you may find that now is not the time for you to buy.
o Consider your family, career and interests, and come up with the type of house that fits your lifestyle. Find out how to create your vision of home.
o Ask questions like these:
Where will you be in 5-10 years?
Do you have kids or plan to have them?
Does your job require you to move around a lot?
Do you have time to maintain a home and yard?
Do you want to live near work?
Do you want to live near shops, restaurants and nightlife?
How much living space do you need?
o Study your list. Refer to it when you tour houses, or you may decide to hold off on buying. For example, because of the costs of buying a home, it doesn’t make financial sense to buy if you expect to move within five years.
Step 3: Calculate a monthly mortgage payment you can afford.
Just because a lender is willing to lend you the world doesn’t mean you should take it. Know what you can manage. Don’t over-extend yourself.
o Gather and tally your fixed monthly responsibilities (utilities, credit cards, cell phone, groceries, etc) and subtract that amount from your monthly income. This is roughly what you have left for a mortgage payment.
o Calculate your debt-to-income ratio — your amount of monthly bills compared to your average monthly income. Mortgage lenders look at this ratio when qualifying you for a loan. If your debt is more than 20 percent of your net monthly income, pay down some bills.
o Understand what a mortgage payment covers. Just remember PITI: principal, interest, taxes and insurance. Use FrontDoor’s Mortgage Calculator to figure out your monthly payment and total interest.
o If your down payment is less than 20 percent of the total loan, you may also need to pay for private mortgage insurance, or PMI.
o Examine your spending habits and try to stretch your monthly mortgage amount by cutting back on non-fixed expenses like entertainment and eating out. You should also build in a buffer in case you lose your job or unexpected expenses arise.
o Consider these rules of thumb about how much house to buy:
The purchase price should be no more than 2.5 times your gross annual income.
Your mortgage payment should be less than 28 percent of your gross monthly income.
Step 4: Create a budget for monthly homeowner expenses.
The cost of owning a home is not just the purchase price. This list shows some of the other expenses you can expect each month.
Step 5: Check your credit report and improve your credit score.
Lenders use your credit history and rating to get a picture of your credit worthiness, gauge the risk involved in giving you a loan, and determine what interest rate to offer you. A good credit score (best possible is 850, median is 723) will help you get a better interest rate and lower your monthly mortgage payment, so it’s in your interest to get your score as high as possible.
o Go to AnnualCreditReport.com and get a free copy of your credit report from each of the three credit-reporting companies: Experian, Equifax and TransUnion. The Fair Credit Reporting Act entitles you to one free credit report each year.
o Go to MyFico.com and buy a report with your credit score.
o Study your report and make sure everything is accurate. Notify the reporting agency of errors related to late payments, credit limits, collections or any negative items. Negative items older than seven years (10 in the case of bankruptcy) should have been removed from your report.
o If you have bad credit, consider getting yourself in a better financial position before buying a house. Bad credit can make you a miserable mortgage payer. It’s better to wait and get a mortgage with better terms than to buy now and end up with house payments you can’t make and ending up in foreclosure.
o Give your credit report a makeover and start with these basics:
Pay bills down and on time.
Don’t max out credit cards.
Pay more than the minimum on your credit cards each month.
Don’t open new credit-card accounts.
Keep credit card balances at 30 percent of the credit limits.
o Read more tips to increase your credit score.
Step 6: Research the market where you want to buy.
Is it a buyer’s or a seller’s market? If homes in your city are sitting unsold and prices are leveling out, you’re in a much better bargaining position than if you live in a hot market where houses are snapped up even before they’re publicly listed for sale. Less competition also means you’re more likely to get the house you want for the price you want. Are you prepared financially and emotionally to get involved in a bidding war over the home of your dreams?
o Drive around neighborhoods you like, note the number of “for sale” and “open house” signs, pick up flyers and study listings online. How long have the houses been on the market? How “motivated” are sellers? Are sellers cutting prices?
o Where are mortgage interest rates and where will they go? Today, rates are still at historic lows in the 6 percent range. Compare that to 1985, when homeowners paid a whopping 11.85 percent.
o See how you can make the most of a buyer’s market and find out which U.S. markets are ripe for first-time homebuyers.
Step 7: Figure out how you will get a down payment and pay closing costs.
While you can finance most of your home purchase, you’ll still need to fork up a significant amount of cash for the down payment and other expenses at closing, the meeting in which you and the seller sign a pile of documents to legally transfer ownership of the home to you.
o Lenders ideally want you to put down 20 percent when buying a home, but you can find mortgage programs that require as little as 3 percent down or even nothing down.
o The Federal Housing Administration (FHA) has a loan program that requires as little as 3 percent down. Find out if you qualify for federal homebuying programs.
o Contact your state’s housing finance agency.
o Get a down payment gift.
o Tap your IRA. Tax laws allow first-time buyers to use up to $10,000 in IRA funds as a down payment without incurring the 10 percent penalty for early withdrawal. According to the IRS, a first-time buyer is someone who has not owned a principal residence during the past two years prior to the purchase of the new home.
o Borrow from your company’s 401(k) plan. You’ll have to pay back any money you take out with interest.
Step 8: Start off small.
Your first home doesn’t have to be the home of your dreams. If you can’t afford a big house, buy a fixer-upper or a house in an up-and-coming neighborhood. They require a lot more sweat equity than a “move-in ready” home, but you can end up with a great home for half the cost.
o Get help fixing up your “handyman special.” Look into rehabilitation and home improvement programs like the Department of Housing and Urban Development’s (HUD) 203(k) Rehab Program
o Look for bargains on the outskirts of downtown and other popular neighborhoods. Declining neighborhoods could easily become up-and-coming ones when they’re categorized as revitalization or “empowerment” zones. Contact federal, state and local agencies that offer subsidies or other incentives if you buy in such zones.
Step 9: Consider sharing ownership of a house.
You can buy a bigger house if you pool your resources with other cash-strapped homebuyers. Research co-ownership options, such as a “tenancy-in-common” or “joint tenancy”. If you don’t feel comfortable dealing with strangers, buy with a family member or friend.
Step 10: Know your rights as a homebuyer and borrower.
Be aware of housing discrimination and predatory lending during the homebuying process. You have the right to buy any home you can afford in any neighborhood. You also have the right to fair lending. Under the Fair Housing Act, it is illegal to discriminate based on race, color, national origin, religion, sex, familial status or handicap.