Purchasing a house is the single largest investment most of us will make in our lifetime. The decision to make the transition from renter (or freeloader) to homeowner is not one to be taken lightly. To help with the journey to home ownership, here are a few tips for first time home buyers.
1. Get pre-approved for a mortgage before house-hunting
Most financial institutions will pre-approve you for a mortgage based on your income, debt load and amount of savings. Knowing how much money a lender is willing to provide will give you an idea of how much house you can afford. And when you find your dream home, you can make an offer that is not conditional on financing which can be an advantage during negotiations. A pre-approval will also lock in the current interest rate for a predetermined period of time (usually about 3 months) which can save you some money if mortgage rates go up. And if rates go down, you will qualify for the lower rate.
2. Don’t trust the bank’s numbers
Just because the bank is willing to lend you, say, $250,000 doesn’t mean you should borrow that amount, as tempting as that may be. Banks are only concerned with their level of risk, not with any lifestyle sacrifices you may have to make to repay their loan. Before you max out, consider the following questions that many first time home buyers ignore:
- How much money is in your budget for furniture, paint and decor? Sooner or later you will want to put your own personal stamp on your house and chances are that over the life of a twenty-five year mortgage you will want to redecorate a few times. Keep in mind that a large house will cost more to furnish and decorate than a small house.
- How much do you spend on travel? How much do you want to spend on travel in your future?
- Do you have hobbies? Do they have any associated expenses?
- What about your social life? Do you like to dine out? Attend concerts or sporting events? How much are you willing to sacrifice for your house?
- Do you have a large family? How much do you spend on gifts for Christmas or birthdays?
- Do you have children? Even if the answer is no, you may have children someday. Therefore you need to consider the costs associated with their education and activities (not to mention food and clothing).
- How old is your personal vehicle? It is safe to assume that you will have to replace your car(s) at least once or twice before your mortgage is paid off.
- What are your transportation expenses (public transit, fuel)? These expenses vary depending on where you buy your house.
- How stable is your job? How employable are you? What will happen if you change jobs? Will you still be able to afford your mortgage if you experience a reduction in your income?
- Will you be able to afford future repairs and maintenance on your house? Roofs, furnaces and air conditioners don’t last forever. Neither do appliances like fridges and stoves and washers and dryers. If your furnace breaks down in the middle of winter, will you be able to afford to have it fixed? The accepted rule of thumb is to budget 1-2% of your home’s value per year for repairs and maintenance, so allow $2500-5000 per year for a $250,000 house.
After the bank runs the numbers to determine how large of a loan you qualify for, you should run your own numbers to determine how comfortable you are with the payments. It is easy to make sacrifices in the short term, but a mortgage is a long-term commitment.
Also, keep in mind that in addition to the purchase price of the house you will have legal expenses to pay out for things like title and other document searches, land transfer taxes (or similar fees), and municipal taxes. Contact a local real estate lawyer to find out how much you can expect to pay. There are also expenses associated with utilities such as connection charges and new account deposits for which you will need to budget. You want to have a decent cushion of funds in your bank account to cover these expenses.
3. Don’t forget about the other amounts in your mortgage payment
Your mortgage payments are not limited to just the amount of money you borrowed. The lender will try to sell you mortgage life insurance and sickness and accident insurance. These are optional. You are often better off to buy a term life insurance policy on your own, since the amount of that coverage will not decrease during the term. A mortgage life insurance policy will only cover the balance of your mortgage so the amount of coverage decreases with each mortgage payment while the premiums remain the same. Sickness and accident insurance will cover your payments if you are unable to work. Read the terms of the coverage carefully to decide if this product is right for you.
You may also have the option of paying your municipal property taxes with your mortgage payments. Rather than paying your taxes directly to your municipality, you can have your mortgage lender handle the payments for you. The tax component is added to your regular mortgage payments and held in an account until payment is required, which can greatly simplify your budget.
If your down payment is less than a certain amount, you will have to pay for mortgage loan insurance. The amount of this insurance is usually rolled into the mortgage.
4. “Forever House” or Property Ladder
It can be very tempting to buy the biggest and best house you can afford with the idea that you can grow into the house and never have to worry about moving again. However, you should consider the advantages of climbing the property ladder. Buying a less expensive house with a shorter loan amortization will help you build equity faster. Equity also increases and decreases with the value of the house, something to consider after the crash of 2008-9.
250,000 Mortgage. 25 years at 5%.
- Payments: $17,537.76 per year
- After 5 years: Mortgage balance: $221,450
- Equity: $28,550
150,000 mortgage 25 years at 5%
- Payments 10,522 per year (save 7,000 per year, or $35,000 in 5 years)
- After 5 years: balance $132,869
- Equity: $17,131
- Equity + Cash= $52,131
Now let’s take the payments on the $250,000 mortgage and apply them to the $150,000 mortgage. Your equity after five years would be more than $52,000. If you stay in that house, you will be mortgage-free in less than 12 years. During that time, you may decide that you would rather be debt-free than live in a bigger house….
5. See the potential
The perfect house is elusive unless you have a house built to your exact specifications. But shortcomings can be overcome. Let’s say, for example, that your budget is $250,000 and you really want a two car garage. You might find your ideal house for $220,000, but without garage. If you can have a garage built for $30,000 you will still be within your budget.
6. Don’t be distracted by shiny objects
Just as you should look beyond what is in front of you to see the future potential of a house, you should not allow yourself to be distracted by fancy extras. Which would you rather have, updated wiring and plumbing, or a rocking hot tub? While not as sexy as the hot tub, the wiring and plumbing are worth more. Put another way, you can put lipstick on a pig, but it’s still a pig. Don’t be fooled by the lipstick. You can always buy a hot tub later, if that’s something you really want.
7. Do the math and be realistic
Okay. You have found a house that meets most of your criteria, but it needs some work. Can you afford to do the work or have the work done? What does that do to your bottom line? It’s easy to look at a house and imagine certain upgrades and renovations, but you have to realistically budget for those things. The costs can quickly add up and your dream can turn into a nightmare. While renovations may add value to your house when they are complete, your house could lose a lot of value while renovations are in progress. You don’t want to run out of money or, even worse, be in a position where you have to sell your house in the middle of renovating.
8. Ownership may not be right for you
Despite what your friends, family and bank tell you, there is no rule anywhere that says you have to buy a house. Houses are a lot of work and a lot of expense. While it may be nice to call a place your own, it is far from worry-free. Paying rent and letting a landlord handle the major maintenance and repairs may better suit your lifestyle.
You may also be interested in Episode 27 of the Thumb and Hammer Home Improvement Podcast: Lies, Deception and Home ownership