Why Your First Home Shouldn't Be Your Dream Home
Since 2000, homeownership rates in the U.S. have hovered around 66% to 67% of the population. In 1900, less than half of Americans owned their own home. The biggest surge in home buying came after World War II, when many young families were encouraged to buy a "starter home". (To learn more, see Top Tips For First-Time Home Buyers.) IN PICTURES: Financing For First-Time Homebuyers
Attitudes about how to buy a home have fluctuated as much as interest rates during the decades since World War II, and eventually many first-time homebuyers were encouraged to "buy big", in order to stretch their budgets as much as possible, and buy the home they wanted to live in forever. Given the high level of foreclosures and the loss of value in many homes, today's buyers are more wary of taking on a home they cannot afford, but many are still tempted to make their first home purchase their dream home rather than their starter home.
A recent Coldwell Banker Real Estate Brokerage survey of their brokers revealed that while affordability was the number one concern of first-time homebuyers, 81% of those buyers consider move-in conditions very important when moving into a home. Only 7% were considering buying a fixer-upper.
Jim Gillespie, president and CEO of Coldwell Banker was quoted as part of the survey, saying, "In the past, first-time homebuyers were willing to purchase older, more basic houses in an effort to save money and break into homeownership. It is important for first-time homebuyers to remember that by considering a fixer-upper for their first home purchase, they can build equity over time and later move up and into their second-stage home that better reflects their expectations." (Read more, in 4 Types Of Home Renovation: Which Ones Boost Value?)
The Economy and Your Home
Personal finance writer Liz Pulliam Weston describes four economic changes that should discourage buyers from overspending on their house payment:
Rising prices, while hard on the household budget, usually came along with substantial annual raises. These days, homebuyers cannot count on a significant raise to make their housing payments easier to handle.
- Two-Income Couples
Weston says that when more families had a single wage earner, the other spouse could go to work to pay for the house if they were in financial trouble. Today, most households have two workers and that double-income is needed to make the mortgage payment. Consider trying to base your budget on one income or perhaps one and one-half an income to make sure your housing payment will still be affordable if one spouse stops working.
Thirty years ago, it was very difficult to qualify for a loan for more than was easily affordable, but as lending practices changed, mortgages qualifications became looser. Standards have tightened today, but lenders will always give borrowers the maximum amount they qualify for - not necessarily what they should spend.
Thirty years ago and more, most people had their retirement covered by a pension and could count on Social Security. Today, retirement savings are more typically individually funded in 401(k)s and IRAs that come directly from your budget.
Each of these changes suggests that today's homebuyers should be shrinking their housing budget rather than expanding it, making sure that they can comfortably keep up with their payments, pay down their principal and build equity in their property.
Calculating Your Housing Budget
Lenders will qualify you for a loan based on your credit score, your debt-to-income ratio, income and assets and your employment history. But each potential buyer should do their own calculation to determine their comfort level with a budget. While lenders these days generally prefer to limit housing expenses (principal, interest, taxes and homeowners insurance) to 28% of the borrowers' monthly gross income, each individual should think about their own spending habits.
A lot depends on your other debts and anticipated income and expenses. Most lenders prefer to keep total debt to income (including all the minimum payments on revolving debt or other loans such as auto or student loans) to less than 36% of your gross income; although under some circumstances this can rise to 40% or even 45%. (To learn more, see Too Much Debt For A Mortgage?)
Make sure to budget about 1% to 3% of the home value for future repairs and maintenance, since those costs can quickly derail your budget.
Most homeowners should plan to stay in their home for five to seven years, so consider what may change in those years. If you plan to have children and may want to have one parent work less, your income could drop. If you enjoy golf or travel or skiing, you need to factor that into your budget or decide if you are willing to reduce your spending in that area. If you work on commission or overtime or as a freelancer, make sure you base your budget on a low-end year rather than a high-earning year in case your income drops. On the other hand, you can consider increasing your housing spending if your retirement is fully funded, you are debt-free and you anticipate a guaranteed increase in income.
The Bottom Line
While no one can predict with accuracy whether or by how much home values will increase in future years, purchasing a home you can afford and building equity by paying down the principal are the surest ways to get started climbing the property ladder. (For pitfalls to avoid, check out the 10 Worst First-Time Homebuyer Mistakes.)
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