A Guide To Affordable Home Purchase
BudgetWhat can you realistically afford? First things first, determine your budget. Aim for houses priced at approximately 3-times your annual income. Committing to monthly payments that exceed 28% of your gross earnings each month could soon put you underwater. You might want to plan on an even lower percentage if you have other costly items on your list of bills. It's useful to have a figure in mind for what you'd like to pay, and one for what would be your absolute maximum if you find something you want. Do not exceed that latter figure under any circumstances. Too much is too much.
Once you've figured out your budget, you need to build up a cash reserve. It's a good idea to be able to put a minimum down payment of 20% on a home purchase. If you can't, you might be stuck with having to fork out money for private mortgage insurance, and will almost certainly pay a higher interest rate on your loan than you would with a higher down payment. On top of that 20% down payment, the closing fees usually rack up to about 3%.
On top of that 23%, you need enough in that cash reserve to cover the cost of moving, home improvements, interior decorating, and any other unforeseen costs that might surprise you. You don't want a plumbing issue to turn your bathroom into an indoor swimming pool without having the funds to repair such potential problems. Moving is not cheap: there will always be things you need to do, and some of them will be unexpected. Be ready.
Don't deplete your regular savings on the inevitable extra costs. Create the additional cash reserve first. Anticipate the worst-case financial scenario and prepare a cash fund to cover it, independent of the funds you've saved for the home purchase.
Start saving. If you're not sure where to start, seek professional help. In this case, that would be a financial professional. Financial counseling is widely available through many venues and is worth the time it takes. The more you know, the better.
Choose Your MortgageMortgage shopping may not sound like fun, but it's the backbone of your quest and will have an enormous impact on your long-term financial responsibilities. Get energized and get into it. Find a mortgage lender with a good reputation. You're going to have a bunch of questions, so only deal with a mortgage lender who answers all of them to your satisfaction.
There are plenty of different options to consider, but it's advisable to stick with either a fixed-rate mortgage or an adjustable-rate mortgage. With a fixed-rate mortgage, the interest rate will remain the same for the entire term of the loan. With an adjustable rate mortgage, the rate will fluctuate according to any changes in the market. One is set in stone for the future, while the other is a wild card.
You're far better off choosing a steady, fixed-rate mortgage. Even if an adjustable-rate mortgage seems to have a lower interest rate in the initial, fixed-rate period, these rates tend to increase substantially after that period is up. They are only a good option if you plan to live in that home no longer than the initial, fixed rate period portion.
Loan TermsA 30-year mortgage is a safe bet. You may be able to afford shorter term, but it's important not to stretch your finances too thin. Building home equity is an excellent way to grow your wealth, but as we all know, the market can rise or decline over time. Even if you think you could pay it off in half the time, take out a 30-year mortgage and feel free to make accelerated monthly payments for twice the set amount. You'll be paying off your mortgage faster, but if the market tanks, or if you run into financial burdens, this strategy will still leave you able to fall back on the initial monthly payment. The interest rate is the same either way but paying the loan off earlier lets you save on all those interest payments you don't have to make.
Apply for Pre-ApprovalJust like the title says, apply for a pre-approval. The lender will review your credit report, bank statements, W2s, and other financial information before pre-approval. A successful pre-approval gets you the "qualified buyer" stamp of approval, proving to any seller that you're a legitimate option. Another little bonus pre-approval is if and when you make your offer, your finances have already been reviewed, meaning all that's left for the bank to do is appraise the home!
Think you can only run into sharks on the used car lot? Think again! Your bank may approve you for a loan - bigger than the one you originally planned. Don't swallow this bait-and-switch scheme. Stick to your original plan.
To Be, or Not To Be?If you think you're going to roll out the door on a house-hunting trip and find something comparable to King Arthur's castle for the exact amount you budgeted, think again. We all know that nothing is that easy, so don't narrow your selection too much. Remember, in time you can make it your perfect home! Think about what features are important to you now, and in the future. How many bedrooms and bathrooms? How accessible is the area to where you frequently go, what's your drive time to work, and how are the schools? Remember, you can upgrade the house, but not its location and the right house in the wrong place is still wrong. You will have to go to and from work every day, so think twice and then twice more before choosing a home that imposes a difficult commute. Think about your needs and prioritize them: what's essential and what allows some flexibility.