Home ownership is the second biggest financial commitment most people ever make – the biggest being children. Home ownership has great benefits as well as heavy responsibilities. Following are items to consider when taking the plunge into home ownership.
Plan to Stay Put
Home ownership is probably not the best option for you if you can’t commit to remaining in one place for 3 to 4 years. Given the transaction costs, you may end up losing money if you sell a home within a few years. And, if you happen to make money on the deal, you’ll pay capital gains taxes if you’re in the house less than two years.
Clean up Your Credit
Take steps to ensure your credit history is as clean as possible. Prior to house hunting, get copies of your credit report and make sure the facts are correct. Contact Experian, Equifax or TransUnion to receive a copy of your credit report. Fix any issues you discover by contacting the agencies directly (this can take up to 3 months to resolve). Be prepared to explain any past issues to a loan officer.
Find a Home You Can Afford
As a general rule of thumb, look for homes where the asking price is no more than two-and-one-half times your annual salary. Find online tools and calculators at CNNMoney.com or Quicken.com for a better understanding of your income, debts and expenses for determining what you can afford.
Don’t Worry About the 20 Percent Rule
If you qualify, there are public and private lenders who offer low-interest mortgages that require down payments as low as 3 percent of the purchase price. For more information, check out FannieMae.com or Freddiemac.com. Note: For down payments under 20 percent, you will probably be required to pay for private mortgage insurance (PMI). PMI protects the bank in case you fail to make payments. It generally adds 0.5 percent of the loan amount to your mortgage payments for one year.
If you’d rather pay the 20 percent, you have some options. First-time homebuyers can withdraw up to $10,000 from an Individual Retirement Account (IRA) without a penalty (though you must pay taxes on the amount withdrawn). You can also receive a cash gift up to $12,000 per year from each of your parents (without incurring a gift tax). Another method is to withdraw money from a 401k or similar retirement plan for a personal loan.
Buy a Home in a Good School District
This rule still applies even if you don’t have children or school-age children. From a resale perspective, strong school districts are a top priority for many home buyers. Good school districts boost property values.
Understand Points and Rate
Points (also known as a loan’s “origination fee”) are interest charges paid up-front when you close on your loan. They are a one-time fee paid to the lender as a percentage of the loan amount (one point is equal to one percent of the loan amount). In general, the more points a loan has, the lower its interest rate should be. Points paid for on a mortgage are deductible in the year you pay them. However, if refinancing your home, the points paid for when refinancing must be amortized over the life of the loan. For example, you could deduct one-thirtieth of the points on your taxes each year if you get a 30-year mortgage when you refinance.
The mortgage rate is the most expensive part of buying a house. With a 30-year mortgage, you’ll probably pay more in interest than the price of the house. There are fixed rate loans, which lock in a monthly payment amount that remains consistent throughout the life of the loan (even if interest rates rise). If rates fall, you could refinance (though you would pay additional closing costs). An adjustable-rate mortgage (ARM) has an interest rate that rises or falls with the financial index. There are also hybrid loans which offer a fixed rate for the first 5 to 10 years then converts to an adjustable rate for the remaining term.
Which choice is better? This depends on what you can afford to spend every month and on how long you plan to stay in the house. It also brings into question the possibility of refinancing the loan if rates tumble in the future. When deciding between points and rate, it is helpful to determine the break-even point, or the month when you will have saved exactly as much in monthly payments as you spent at closing.
To determine this, divide the cost of the points you would pay at closing by the potential monthly savings. Also, don’t forget to factor in tax write-offs, inflation or alternative investment options. Consult your tax attorney, accountant or financial planner.
Seek Professional Guidance
Although the Internet provides buyers with access to home listings, it’s still wise to use an agent. Find an “exclusive buyer agent” where the “seller” agrees the fee to be paid to the listing agent for selling the home. The listing agent shares this fee 50/50 with the agent representing the buyer. Agents will assist with strategies during the bidding process and may be able to negotiate to have the seller pay the points.
Getting pre-approved will put you in a better position to make a serious offer when you find the right house. Pre-approval is based on your income, debt and credit history (pre-qualification is based on an initial review of your finances).
Research Prior to Bidding
Before making an offer, research the sale prices of similar homes in the neighborhood in the last three months. If you find that homes have recently sold at 5 percent less than the asking price, consider making a bid that’s about 8 to 10 percent lower than what the seller is asking.
Have the Home Inspected
Although your lender will require a home appraisal anyway (as a way of determining whether the house is worth the price you’ve agreed to pay), you should hire your own home inspector. Find an engineer with experience in conducting home surveys in the area where you are buying. The home inspector will point out potential problems that could require costly repairs down the road.