Thinking about buying a place to call home? Then it’s time to think through the home buying process. It can be tempting to start by cruising through your dream neighborhood or checking out house plans, but the most realistic place to start is with the costs.
The cost of buying a home depends largely on where you live and what you’re buying. No matter your budget, you’ll need to keep certain costs in mind that apply to any purchase. First, you’ll need cash for a down payment, usually a percentage of the total cost of the home. First-time home buyers may be able to put as little as 3-5% down in cash—on a $300,000 home, 3% is $9,000, so that’s still a good chunk of change. Some programs require less of a down payment—ask your lender what is available for you.
Traditionally, buyers are encouraged to put down 20% to avoid paying for private mortgage insurance, or PMI. PMI is a protection for the lender against you defaulting on the loan. If you put down 20% or more, you won’t need mortgage insurance. Otherwise, plan on that additional cost, which could be as much as a few hundred dollars a month on top of your regular mortgage payment.
Speaking of your mortgage payment, you’ll want to get preapproved for a mortgage so you know what you can afford. Preapproval is not a guarantee that you’ll qualify for a mortgage, but it’s as close as you can get. A lender looks at your income, assets, and credit score, then gives you an idea of the types of loans you qualify for, how much you can borrow, and potential interest rates.
Your mortgage payment depends on the principal amount borrowed, the interest rate for borrowing the money, and the term or length of the mortgage.
Typically, lenders want your mortgage payment (including PMI, property taxes, and homeowners’ insurance) to stay below 28% of your gross monthly income (that’s the amount before taxes are taken out). For example, if your gross pay is $50,000 a year, or roughly $4,100 a month, that gives you a max payment of $1,148 a month. As part of this process, lenders assess your other debts, like car and credit card payments.
Just because you qualify for a specific payment doesn’t mean it’s a wise idea for you. Your mortgage lender has no idea how much you spend on other bills and costs, like groceries, savings, and vacations. It’s up to you to decide how much of a margin you need to keep in your budget to feel financially secure. As a first-time buyer, especially, it may be a good idea to look for a home on the lower end of what you can afford.
Somewhere around 10% of all mortgage loan applications are denied, with a slightly higher rate for Federal Housing Administration (FHA) loan applicants. If you’re turned down for a loan or during the pre-approval process, take the time to find out why. Make sure they are working off of current information—you could have an error on your credit report that is impacting your credit score. If you do find issues on your credit report, contact the credit bureau to report them.
If the denial isn’t because of an error, now is the time to take steps toward securing a mortgage in the future. Keep the following best practices for good credit in mind.
- Build your credit history
- Keep your debt-to-income ratio down
- Make credit payments on time
- Report inaccuracies right away
- Keep accounts open
- Diversify the types of credit accounts
- Minimize new credit lines and inquiries
Under the Fair Housing Law, lenders cannot turn you down because of your age, race, gender, marital status, or religion. If you think you’ve been discriminated against, file a complaint with the U.S. Department of Housing and Urban Development. You can also report the violation to the appropriate government agency provided by the lender, or check with your State Attorney General’s office to see if the creditor violated state laws.
Many homebuyers—especially first-time ones—use a real estate agent to purchase a home. Real estate agents know the market and price trends, know which neighborhoods and features are most desirable, and can help you with price and contract negotiations.
These services come with a cost, though. Real estate agents are typically paid a commission of 5-6% of the purchase price. On a $250,000 property, that’s $12,500 split 50/50 between the buyer’s agent and seller’s agent. Good news though: if you’re buying a home, typically the seller pays the real estate commissions.
Before a home is truly yours, you’ll need to finalize the sale and sign the documents (many, many documents!). At this time, closing costs are due, too. These are one-time costs that you can either pay upfront or possibly roll into the mortgage. Closing costs cover all of the expenses of applying for the loan and finalizing the sale, and typically run between 2-5% of the overall purchase price. Your closing costs may include fees for services required by your mortgage lender, including:
- Property appraisals
- Title search
- Title insurance
- Origination fee
- Underwriting fee
- Points
The costs associated with buying a home can be overwhelming, but that doesn’t mean it’s the wrong choice. It’s up to you to weigh the benefits of ownership vs. renting.
- Don’t pay property taxes
- Don’t pay for maintenance
- Less cash tied up in the property
- No risk of declining property values
- Not tied to a geographic location
- Deduct mortgage interest and property taxes on your federal tax return
- Build equity as you pay down your mortgage
- Potential profit if home value increases and you decide to sell
- Access to equity through a home equity line of credit (HELOC) if needed for personal loans or other uses
- Feelings of security in owning a home
There is no specific home buying timeline that works for everyone, so make sure you don’t rush the process. Consider the costs, pros, and cons before you make this life-changing decision.
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