This is one of the top questions I get from my clients. And I get it, we’re grown! I went through the home buying process myself not too long ago. When I ask why people are interested in buying a home, they often say something like, “I’m tired of throwing my money toward rent.” That’s real. I lived in an apartment in Houston for 7 years before starting the home-buying process. That said, just because you’re a certain age or because your friends on Facebook and Instagram are doing it — doesn’t mean you NEED to now as well. This is your process and like our students — we all need a little #differentiation.
As you may know, the answer to this question is “It depends.” There are so many factors and variables you need to consider. And we are human — oftentimes when we make buying decisions, there is a lot of emotion involved. One of my roles as your financial advisor is to help balance that out. Below, I’ve provided some thoughts from the personal finance side of things as well as some lessons I learned during my own process. Remember, there are “rules of thumb” and then there is life. I am by no means trying to oversimplify the home buying process to a list of rules — take my thoughts as benchmarks with the understanding that every situation is unique.
PERSONAL FINANCE IDEAS FOR SETTING YOURSELF UP FOR SUCCESS
I am not a realtor or lender — keep in mind that the thoughts below are from my perspective as your financial advisor.
- To rent or to buy? The decision isn’t always as simple as “I’d rather my rent money go towards a mortgage.” First, consider your current plans and financial circumstances. Transaction costs take time to recoup — if you plan on staying in the home for 5 years or more, consider buying. Next, is it financially feasible to purchase right now? Maybe. Maybe not.
- There is no substitute to setting a goal and making a plan. Not going to lie, I’ve made some impulse buying decision in my life – I’ll try to share a couple car buying stories in an upcoming blog. Yes, sometimes we just wake up and decide it is time for a new car or even a new house! Challenge yourself to be proactive and plan ahead as much as possible. You will save money and stress by doing so. Give yourself some time to save for the down payment that will prevent you from having to pay PMI or from taking from your own retirement nest egg. There is no shame in that game. We tell our students to set SMART goals all the time, don’t we? Set a goal to have saved $15,000 before you begin looking at homes, for example.
Set yourself up for success by knowing where you stand financially. For the examples below, let’s assume you and your spouse/partner make a combined $96,000/year or $8,000 per month (gross).
- When thinking about your future home, look for homes priced no more than 2-2.5x your annual salary (< $240,000). If you have significant debt, have other financial goals or your money is otherwise tied up, consider an amount below that.
- Your debt-to-income (DTI) ratio is a piece of what lenders look at when determining if you can take on a mortgage right now and if so, how much. Your debt payments (including your new mortgage, student debt, cars, credit cards, etc.) should not exceed 40% of your gross monthly income or $3,200. If your monthly debt exceeds that, you may need to pay some of it down before applying for a loan.
- Your monthly mortgage payment should not exceed 28% of your gross monthly income, < $2,240. BUT, depending on what your other expenses look like, this number should be lower. See the 20/50/30 Plan.
Using retirement accounts to help with a down payment. As a financial advisor, I would much rather see my clients save for a down payment and preserve their retirement accounts for the future, however, you should at least be aware of your options.
- Borrowing against your 401(k) or 403(b). Your plan may allow loans up to a certain amount — check with your plan provider for details. That said, it is important to know that if you do take a loan, you will be subject to loan fees, you will miss out on the growth of your nest egg, there is potential for taxes and penalties if you miss loan payments, or you may be required to repay the loan in full if you leave your employer.
- First-time buyers can withdraw up to $10,000 from a traditional IRA without paying a tax penalty, though you will have to pay income tax on the amount withdrawn. If both spouses do so, that amount could be double. If you have money in a Roth IRA, you can withdraw your contributions at any time, since it is after-tax money. In order to withdraw earnings, you must be age 59 1/2 or have had the account open for 5 years to not incur a penalty. Again, just because you could, does not mean you should.
WHAT I LEARNED
- Education is key. Some fellow educators recommended I take a home buying class before starting the process. I did and I will echo that to you. If you live in the Houston area — I did mine through Avenue CDC, where they will walk you through a full day of invaluable information. They are a non-profit and are committed to helping you go through a successful process. This blog post by no means is a substitute for a course like the one offered through ACDC.
- This is NOT HGTV. You likely will not meet your realtor over cocktails on the beach and will probably have to consider more than 3 options.
- Purchasing a new build versus purchasing an existing home. Although each have their pros and cons, something I learned was that it is more difficult to negotiate cost with the builder of a home than it is with an individual person selling.
- You don’t want to be “house poor.” House poor is a situation that describes a person who spends a large proportion of his or her total income on home ownership, including mortgage payments, property taxes, maintenance and utilities (Investopedia). Just because you’re approved for $X00,000 does not mean that is how much house you should buy. Your first home does not need to be your forever home. If you’ve read my other blogs, I talk a lot about values and that in order to live those values, you need to make decisions in other areas of your life. Owning a home, for me, is not my only value. I like to travel, for example — it is important that I am able to do so.
- Down payments and Private Mortgage Insurance (PMI).You may have heard the rule of thumb that you should put 20% down to avoid having to pay PMI. PMI exists to protect the lender if you are unable to make your payments. The more you put down, the less you owe on the home and the smaller your mortgage payments will be. That said, if 20% is not realistic for you, you should do what is with the understanding that you’ll have to pay for added insurance. Once you’ve built equity in 20% of your home, you can cancel your PMI (on Conventional loans).
- Your down payment does not equal your closing costs.This ties back to the point above. If all you plan for is your down payment, you will be sorely disappointed when you learn there are additional upfront costs. There are many great calculators out there I’m sure, this is just one I came across. Below is an example I ran on one of many available online calculators. I entered $250,000 as the target home price with 10% down. As you can see, in addition to the $25,000 down you will need, you will also need an estimated $7,360 for closing costs and fees, escrow and pre-paid expenses. You can use calculators like this to prepare and estimate; your realtor and lender should be able to work with you to understand your individual closing costs.