What can I do to better prepare for a home purchase down the road?
I am currently studying to become a teacher. I plan to own in a home within the next five years. I don't know what the market is like, but by then, my children will be about ages 8 and 5. What exactly should I start doing now to better prepare me in the long-run to buy a home? I have started to work on my credit as well.
I think the best advice I can give you is: "Look at your home purchase as an investment, not a dream house". We have been conditioned to want to buy our dream home. Most people make that mistake, including yours truly. Many years before I became a financial planner, I bought my dream home, only to figure out that a few years later, trends changed and my dream home wasn't as great anymore...
If you look at your home purchase as an investment, no more than 25-30% of your net income should be spent on your household payments (mortgage, real estate taxes and insurance), preferably under a 15-20-year mortgage. Which means that if you clear $4000/m, your household payment shouldn't be more than $1000/m. This will enable you to avoid being house poor while being able to save money. A short-term mortgage (shorter than 30-years) will ensure that more of your monthly payment goes to your principal, enabling you to build equity quickly.
Before you buy your home, make sure you save 3-6 months-worth of expenses. Being able to do so will add security to your plan. If something goes wrong early in your home ownership, you should be able to pay to fix the home out of pocket instead of using debt.
Once you own the home, you should also create your own "HOA" fund. Nobody likes to pay HOA dues, but these associations normally do a good job at planning for future expenses. I recommend you do the same. Build a "HOA" fund by transferring $100-200/m into it for future renovations need.
I hope this will help you get prepared when purchasing your home and maintain it as well.
The most important thing you can do is not to gamble with your money. Put it in something completely safe like a bank account even if it is paying only 1%. Don't take risks with overvalued U.S. stocks and similar dangerously overpriced assets. You can put money into http://myra.gov/ which pays 2.25% guaranteed by the U.S. government.
Don't buy a house too soon. Wait three or four years for real-estate prices to be much lower as the Fed's zero-interest policy unwinds. You will be able to save a hundred thousand dollars or more depending upon where you live, simply by being patient and waiting for significantly lower housing prices.
What a great question. First of all, congratulations on becoming a teacher and setting a very worthwhile goal for yourself in buying a home in the next five years. For most of us, our home is the single largest asset we'll own in our lifetime, so making a plan beforehand is a good thing. Working on improving your credit score is great because the higher your credit score, the more attractive mortgage offer you'll receive from the banks. Your interest rate will be a little lower and possibly even the fees too. I'm assuming that improving your credit score means paying off all your debt or at least the debt with the highest interest rates. Make sure that you never miss a payment on any credit card debt because one missed payment will ding your credit score. Also, when you pay off your credit cards, don't cancel the account. Just leave it there unused as the banks like to see that you have a credit line available and are either not using it or you're making regular payments.
If you know the area in which you'd like to purchase a home, start following the real-estate market now. Look at the homes for sale and make note of what their asking price was and what they eventually sold for. You'll want to start saving money for at least a 20% down payment. Put those savings into a CD or money market fund so that you'll earn a little bit of interest but you're not putting your money at risk. The stock market is great if you don't need the money for a long time, but if you need the funds within 5 years, you don't want to take any risk of losing some of the principal.
When you have the 20% down payment and a secure position as a teacher, go to your local bank or credit union and get pre-approved for a mortgage. They will tell you how much you can afford to spend on a house and they'll be able to calculate your monthly payments. If you make an offer on a house with a pre-approval letter from your bank, you'll be in a better position to negotiate with the seller. The rule of thumb that banks look for is a debt to income ratio of no more than 35%. In other words, your total household debt (including your mortgage) shouldn't be more than 35% of your gross monthly income.
And finally, remember the #1 rule of buying real-estate: Location, location, location. Buy the best house you can afford in the best area. Don't ever buy more house than you can afford - it's not worth the sleepless nights of trying to figure out how to make the mortgage payments. You can always move up as your income increases.
Good luck to you!
Here is a read I normally recommend for people looking to buy a home in the next few year. Buying a home is major purchase and often takes some work.
Without knowing anything about your situation, I can’t tell if right now is the perfect time to buy a piece of real estate. But I can offer a few tips to help make sound financial decisions that ensures you don’t feel trapped in a house you can’t truly afford.
Indulge me in a brief overview of what I call, “Boot Camp for Smart Home buyers.” Regardless of your income, savings or savings habits, everyone considering buying a place should consider these next few steps.
First step at Boot Camp for Smart Home Buyers
Get an idea of what a house or condo where you would like to live would cost. Search sites like ziprealty.com by location to get a feel for what the ideal place will cost. Do you want to live in the Gayborhood? Because that’s likely to be more expensive. How much space do you need? How many bedrooms and bathrooms would you need (or want)? All of that adds up.
Say Yes to the House
For some mortgages, a 20% down payment might be required. A buyer can easily spend another 6% on closing costs, plus there are other expenses that come with moving.
Smart Home Buyers before moving any further, answer a few questions, and be honest with yourself:
– “How is my credit?”
– “Do I have a reliable income?”
– “Where is the down payment going to come from?”
– “What am I willing to give up to make my mortgage payment?”
As a simple rule of thumb for Smart Home Buyers:
Payment on your home/rental/house should be around 25% or less of your income. Use sites like www.mortgagecalculator.com to estimate what your payment would be. Although you may qualify for a loan at 50% of your income or even higher, can you really afford that? It’s unlikely.
To get a rough but useful calculation of expenses, enter purchase price, take off the down payment, while estimating the property taxes. You may be surprised by the cost of what you want to buy.
If you’re pre-approved, then that gives an idea of the size of loan you may qualify for. The next step is to figure out the difference between what the mortgage payment costs (plus home-owners association, home insurance, property taxes) and what you are paying on your current home. You should consider saving the difference between your current payment and new payment for at least six months to help decide if you can adequately cover the new higher housing expenses.
If you are having trouble doing this, what are you willing to give up to make the new mortgage payments? Are you willing to cut back on travel? Going out? Dinners with friends? Is this too much to give up? If so, you may need to find a cheaper property, or save for a larger down payment.
Smart Home Buyers look Beyond the down payment:
You should have six to nine months of payments in reserves. Life happens and closing on real estate, and moving are expensive. I rarely see someone move into a new property and not have to “update, change, fix” something, no matter how nice the property. Remember, when you own a property you are responsible for the fixes. You also may get sticker shock if moving from a rental to a house, which may have an inflated electric bill, as well as new bills for water and waste services, for example.
While I will admit these steps aren’t as exciting as running out and buying a property right away. They can help avoid some of the pitfalls home buyers succumbed to during the recent housing crisis.
Ensuring you can afford the payments, have money to pay for repairs, and weather fluctuations in housing prices, will help you avoid falling behind on other bills. Some unprepared homeowners ended up in short-sales, or foreclosures during the past few years. Not to mention those who racked up credit card debt levels that continue to spiral.
As a final parting gift, maybe there’s a nice tax deduction in your future for mortgage interest and property taxes, and that could help make a dream home closer to becoming real in your budget
Make your Dream Home a Reality
DAVID RAE, CFP® is a retirement planning specialist with DRM Wealth Management, specializing in helping people make smarter financial decisions. His is also a regular contributor to the Advocate Magazine, Huffington Post as well as regularly appearing on various News Shows. For more visit www.davidraefp.com. or the Financial Planner LA blog.