Buying a home is an exciting step in life. But it’s also a big step. Your purchase will affect your finances and your lifestyle for years and years to come. Although you undoubtedly will ‘fall in love’ with some of the homes you check out, it’s important to be sure that the house makes sense financially as well.
Fit Your Home in Your Budget Before You Buy
Before you buy your first home, you’ll need to get pre-approved for a mortgage. Your lender will give you an amount that they will pre-approve you for. Don’t make the mistake of thinking that this is what you can afford! The lender’s job is to figure out the maximum amount of debt you can take on without defaulting. In other words, you’ll probably be able to squeeze out your monthly payments each month, but you’ll very likely be living paycheck-to-paycheck doing it, and very possibly putting a lot of your other goals on hold.
If you’ve been living with a budget up to the point, congrats. If not, start one now. A budget becomes even more crucial as a home buyer. It’s important to fit a home into your budget before you buy rather than having to make tough cuts after you’ve bought too much home. And be aware that fitting a home into your budget is more than just replacing rent with a mortgage payment. Home ownership comes with several expenses that you never had to deal with while renting.
Although you’ll have several other expenses, the mortgage payment is likely the largest expense. Your mortgage payment is based on a few factors- the amount borrowed, your interest rate, the length of mortgage, and whether you have to pay PMI.
The amount borrowed is simply the difference between the purchase price of the home and your down payment. Aim for a low purchase price and a large down payment to keep the amount borrowed down.
Your interest rate has a surprisingly large effect on your mortgage payment. Quarter percents matter here. A lower rate is pure savings so shop around at different lenders to find the best rate. LendingTree lets you compare offers from several lenders in one place. This is a good place to start, although I’d also encourage you to check out your local banks as well.
Mortgage length is typically 15 year or 30 year. I strongly recommend taking out a 15 year mortgage even though this means higher payments. The difference in interest paid over the life of a 15 year and 30 year mortgage is huge, and the payment difference is not as large as you might think. Furthermore, getting rid of your mortgage will give you tremendous financial freedom. Given that a 15 year mortgage is still manageable, I find it hard to drag a mortgage out an additional 15 years. True, taking the 15 year mortgage might mean settling for a smaller, more affordable house. To me, settling for more affordable is worth only having a 15 year mortgage, but ultimately, you need to make your own decision.
PMI or private mortgage insurance is added to your mortgage if you put less than 20% down on your home purchase. PMI is typically an additional 1%/year of the loan value and can easily be an extra $200 per month. Because PMI can be completely avoided by simply putting 20% down, I strongly suggest waiting until you have that 20% to buy a home. This also lowers your overall amount borrowed, which in turn means an even lower mortgage payment.
Owning a home means you have to pay property taxes on the home. The more expensive the home, the more you pay in property taxes. You can find property tax estimates on sites like Zillow, or contact your local assessor’s office for exact tax information.
Owning a home also means that you need to pay for home insurance. While renting, you may have had rental insurance covering your belongings within your rental residence. Home insurance, however, covers not only your belongings, but also the structure itself. Since your home is more valuable and more vulnerable to damage, home insurance ends up costing much more than rental insurance.
Although I’d argue that rental insurance is optional at best, and in many cases an unnecessary expense, home insurance is a must. Not only is it required by the lender, it protects against an otherwise catastrophic financial loss.
One of the biggest advantages of renting is that you’re typically not responsible for any home maintenance or repairs. Home maintenance costs are hard to predict. Although there are rules of thumb on how much to budget for home maintenance (typically 1-3% of home value annually), there’s no cosmic rule that requires a house to only cost you x% in home maintenance. Things happen haphazardly. Different styles and ages of homes will have different home maintenance costs. Appliance lifetimes can be all over the board. This can make budgeting for maintenance a huge headache. Just to give you an idea of the costs you can look forward to and the wide spectrum they fall on, I’ve listed a sample below.
Roof repairs- $500 to $10,000 every 10-50 years depending on the size and type of the roof and who does it. Yes, talk about a wide range of costs.
Hot water heater replacement- $1500 to $2000 every 7-15 years.
Furnace replacement- $2,000 to $4,000 every 15-20 years.
Air conditioner- $500 to $2,000 every 10-20 years.
Replacing siding- $2,000 to $10,000 every 10-50 years.
On top of some of these more major repairs, you have a slew of smaller things that add up. Additionally, you will either need to spend sweat equity or money on lawn maintenance and snow removal.
If you have been renting, you may or may not have been responsible for utility payments. If you were, be aware that moving to a larger house will mean higher utility payments. More square feet costs more to heat and cool. If utility payments were bundled with your rent, this is another item you’ll have to now budget for. You can typically get estimated costs for prospective homes by calling the homes’ various utility providers.
In equal home sizes, however, this is one area where owning a home gives you a distinct advantage over renting. As the home owner, you can opt to invest a little more up front for more energy efficient appliances, light-bulbs, insulation and windows. Of course, it probably won’t make sense to replace working appliances with more energy efficient ones. But over time, as you need to replace different things, you can gradually make your home more energy efficient and cost effective.
Remember to Keep the Long View
Before you completely abandon any thoughts of home ownership, do remember the big picture. Indeed, in the short term- meaning the next 15 years at least- home ownership will indeed take a larger chunk out of your budget than renting did. However, keep in mind that a good chunk of your mortgage payment is building equity, especially if you stick with the 15 year mortgage. Once you pay your mortgage off, you’ll have a sizable asset to your name. A paid off house will suddenly mean significantly smaller home expenses. A paid off house also means that if you decide to downsize as you get older, you’ll have a significant chunk of cash to help fund retirement.
On the flip side, you may decide either to rent for life or rent until you can buy a house debt free. Since renting takes less out of your budget in the short term, you can grow more of your money in other investments until you are ready to become a home owner. Even in the long term, renting can be more cost effective if you stick to smaller living spaces or if you move frequently.
Either way, you’ll be better off making your decision knowing how your choice affects your budget, rather than discovering the impact on your budget after you pull the trigger. Once again, an ounce of prevention is worth a pound of cure!
While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.