Homeownership is a big deal. Finding a house to call your home, moving in, fixing it up, decorating it, making it your own, then building years and years of memories in it is one of the more rewarding things we experience in life.
Today, we look at the financial aspect of the home-buying conversation. Many of our younger clients come to us with questions about what it will take to purchase a home and seek guidance on how to do be smart about it.
This blog post is a gathering of the minds of sorts. We posed the question to several of our advisors to help guide first time home buyers through the process. Financially, there are many things to consider as buying a home is one of the biggest investments of your life. Therefore, it is imperative to get this right for you and your family.
What is a comfortable mortgage payment for my income?
Nick Rose, Lakewood: When applying for a mortgage, the lender will typically want to see a debt-to-income ratio (total debt payments divided by your gross income) below 36% (43% is the max for a qualified mortgage) in order to approve a loan. Furthermore, most lenders don’t want your mortgage payment to be more than 28% of your total gross income.
So, when planning for a monthly mortgage payment, we have 2 goals:
First – ensure you will qualify for a loan based on the lenders debt-to-income ratios.
Second – Have enough flexibility in your monthly mortgage payments to save toward other future goals (i.e. college funding, retirement, etc.)
As a result, a good target for your monthly payment toward a mortgage
would fall between 20%-25% of your total gross household income from all
Realistically, how much should I have in savings to start the process?
Scott Marks, Scottsdale: Ideally, before buying a home you would have enough in savings to cover 20% of the purchase price as a down payment. This is the magic number, as a 20% down payment allows you to avoid private mortgage insurance (PMI). PMI is a way for lenders to reduce their risk exposure on a loan with minimal equity. The PMI payments are generally paid for by the borrower (you).
If a 20% down payment isn’t realistic, aim for at least 10%. It is important to lenders that the borrower have some skin in the game, so the more you can put towards the down payment the more likely you are to get favorable lending terms.
What kind of expenses will I encounter through the home-buying process?
Emily Biehler, Lakewood: We know to save for the down payment when buying a home, but there are some other expenses to consider as well.
First, you’ll typically need to be prepared to put some earnest money up front when your offer is accepted. The home seller requests this, and it can count towards your down payment at closing.
Next, there could be an appraisal or inspection fee charged before you get to closing. Then, there are the infamous closing costs that could include loan origination fees, document fees, title insurance, recording fees, survey fees, real estate agent commissions, and wire transfer fees. These fees are all in addition to your down payment and range from about 2% to 5% of the purchase price of your home.
Lastly, you may want to set some extra money aside for the moving expense and purchasing some new supplies or furnishings for your new home.
Should I buy a home warranty?
Jason Runung, Lone Tree: This will depend on the age of your home.
- Homes that have been built in the last ten years
I would not advise purchasing the warranty as the individual manufacturers of various appliances tend to maintain warranties on said appliances in a way that effectively covers the homeowner for that period of time.
- Homes built between ten and twenty years ago
Extensive communication with the home inspector is going to be the best course of action. They will be able to determine the age of all appliances and can also share information regarding which appliances they have tended to observe as having issues. Ultimately, this election would be more at your discretion as a homeowner and would take into account how you feel about risk. With home warranty costs typically ranging between $300 and $600, or $25 to $50 per month, this may be worth the expense, especially as a home is between fifteen and twenty years old.
- Homes over twenty years old
A home warranty would definitely be recommended. Most homes built in the late nineties tend to still have the original appliances, water heaters, and furnaces that were originally installed in the home and twenty years is the most you can reasonably expect these devices to work properly.
That all being said, doing the research and making sure that your home inspector provides an in-depth review of the age of the appliances in the house and their condition is the best way to help protect your new purchase.
Anything else I should consider financially?
Nate Archuleta, Colorado Springs: When getting to know new clients I often ask what was the best or worst financial decision they have made. Quite often, it’s a home purchase and its pretty evenly split between good and bad. Buying a home is colossal commitment, so take time to consider how this step fits into your overall journey towards financial freedom.
As you would with any major undertaking, keep in mind the big picture and then break it down into smaller pieces. Evaluate your 5, 10 and 15 year financial landscapes; think through the things that could change in life and how that might affect your financial contentment. Do you have a stable financial foundation; might that change unexpectedly? Is this a short-term purchase or a long term purchase? Could you be relocating, upsizing, or downsizing? Think about what is best for your long-term goals, not just your short-term needs; they depend on one another.
Consider shopping for a mortgage first. Mortgage’s most often fall into 15 and 30-year payment periods; the longer the payments, the more interest you will pay. A 30-year mortgage for $250,000 at 4% has total payments of $429,673 ($179,673 in interest or 72% of your $250,000 purchase)! Find the payment and loan terms that fit comfortably into your budget and be cautious about adjustable rate mortgages and balloon mortgages. Things can get uncomfortable in hurry.
Allow yourself some extra savings to make the new house a home too. You might be surprised at how much just purchasing window treatments will cost! Be aware that there are also a lot of expenses associated with owning a home. Landscaping, maintenance, repairs and maybe eventually upgrades. After a few years you may find yourself hating that wall-to-wall carpet or longing for a double shower instead of a tub.
Taking the step into home ownership is a grand adventure and big step in building independence and net worth. Buying a home will affect the landscape of your financial future, so consider discussing with someone who is looking out for your best interests. Areas of your financial plan will need revisiting after this life change, such as emergency funds, insurance coverage, and estate plans.
We hope this has been a beneficial discussion as you pursue your home ownership journey, feel free to ask any questions in the comments and we’ll do our best to answer!