June 30th, 2021 4:05 PM by Jackie A. Graves
The housing market has been on fire during the Covid-19 pandemic. People are looking to change locales, get more space, or just make some money owning real estate. Do not forget less than a decade ago; we were just coming out of the great recession and a major housing crisis. It is imperative that you put some thought behind where you want to live and how much house you can really afford. It may be tempting to rush and get in a bidding war during this crazy real estate market, but is this the best thing for your financial future? Or a huge real estate mistake?
Keep reading for eight questions you need to answer before buying a home today. I will leave the conversation about changing locales, or even neighborhoods, for another time. Mostly, this conversation around buying a home boils down to how much house you can afford and does it really make sense to spend the money.
1. What Is the Total Cost to Live in This Home?
The cost of ownership is not just your mortgage payment. There is homeowner’s insurance (I was just notified that mine is jumping 25% next year), property taxes, and maintenance. Don't forget utilities. You may also have to pay a gardener, pool person, HOA, private mortgage insurance (PMI), etc. I also don't think I've met anyone, who isn't downsizing, who hasn't had to buy some new furniture or décor for their new home.
2. Will You Still Have an Emergency Fund After the Down Payment?
First off, having a good down payment, as well as an emergency fund, signals that you are already making smart financial choices. It costs a lot of money to move into a new home beyond the cost associated with purchasing that new home. Many homebuyers face a budget crunch with overlapping rent and mortgage payments. This is on top of money for appraisals and home inspections (both a must for any homebuyer). You will then get the joy of paying to move all your possessions.
At the end of all this, make sure you still have an emergency fund. Your home purchase will likely come with a home warranty. But this warranty often does not cover everything. You will still get hit with service charges every time someone comes to fix or just look at your house's problems.
3. Can You Make the 20% Down Payment Threshold?
I recently asked in another Forbes post, "Is the 20% Down Payment Dead?" As a financial planner, there is a difference between being able to make the 20% down payment and choosing to make this large of a down payment. For potential homebuyers who have been able to save a good amount of money (i.e., a 20% down payment) likely have some room in their budgets to afford a new home. For those who have nothing saved, how will you cope when something breaks, or you don't get that bonus or raise?
Also, putting down the full 20% payment can eliminate the need for private mortgage insurance (PMI), which can make the monthly payments more affordable. By the way, this insurance protects the lender, not you. PMI will cost somewhere between 0.3% and 1.2% of the balance on your loan. So, assuming you are buying a $1 million home, you could spend more than $12,000, per year, on PMI. As the price of your home gets larger, so will the PMI premiums.
4. What Percentage of Your Income Goes to Housing?
If purchasing a home will push you to spend more than 30% of your income on housing, you might be looking at more house than you can afford. On the flip side, if the total cost of ownership is lower than 30% of your monthly income, you are probably in good shape to make the home purchase.
5. What Will You Be Giving Up to Buy This House?
The more of your money that goes towards housing means there is less money for other things you enjoy. What will you have to give up making this home purchase? Will you have to travel less? Cut back on your kids' activities? Reduce savings rate for retirement? Skip time with friends?
This will really depend on your priorities and financial goals. You may be willing to work a few more years to live in your dream home. One of my clients hates to travel, so we took that portion of her budget and put it towards building her dream home for retirement.
6. Will You Have Cash on Hand After Down Payment?
Over the years, I have spoken with many people who said they wouldn't need anything new after they moved. Let me just say that they all needed something. Some needed new furniture because what they had did not fit in the new place. Others had to replace lost or damaged items. Also, your new space deserves some new décor, bedding, etc. Even simple things like hanging things on the wall or installing your TVs can add up quickly. Will you have money for items like this after you move?
7. You Aren't Drowning in Debt
It is crazy to expect people to have all their debts paid off before buying a home. Let us be real; some people reading this will likely have student loan debt seemingly forever. Others will have a car note most of the time. If you have the payments under control, I do not think it is really that big of a deal to have some debt.
Credit card debt is different. If you are carrying debt on credit cards, it means you are likely spending more than you make; I would make every effort to get this debt paid before buying a home.
8. Consider Your Debt-to-Income Ratio
I just said in the last section that you do not need to pay off all your debts before buying a home. While it is still true, it does not mean your debts should not be considered when determining how much house you can afford. After all, these debts do come with payments that need to be made.
If your debt-to-income ratio is high, the size of mortgage you can qualify for might be limited. Generally, 43% is the highest ratio that can be approved for a mortgage. You can check this by adding up all your monthly debt payments and dividing that by your monthly income. This may be a tough pill to swallow for small-business owners, as the income a mortgage company will consider is smaller than what you feel your income is, assuming you are doing some tax planning along the way.
Purchasing a home is a major decision. Make sure you can truly afford the home so that if prices drop, you know you will not have to sell low. You do not want to be house poor for the next 30 years.
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