Buying a home can be one of the biggest purchases in your life, so you want to make sure to ask the right questions and do your due diligence to make an informed decision. Whether you’re buying a home soon or plan to someday, there are several important financial considerations. Here are our tips:
- Assess Cash Flow and Reserves: A home is an illiquid asset, meaning your money will be tied up and not easily accessible. Do you have confidence that your job will provide a steady stream of income to cover expected and unexpected costs? Do you have an appropriate emergency fund (3-6 months of spending) to fall on if your income changes? Do you still have the bandwidth to save for retirement?
- Research Home Costs: Do some research to uncover the real cost associated with homeownership. It’s not simply mortgage payments but will include other expenses such as property taxes, HOA fees, landscaping, and home maintenance costs and projects (ex: new roof, furnace). A good rule of thumb for home maintenance costs is to anticipate 1-2% of the home value on average per year (Ex: $500,000 home value would incur on average $5K-10K of home maintenance costs annually).
- Determine Budget and Debt-to-Income: A popular guideline to follow is the 28/36 rule, which helps quantify your buying capacity. The rule says you should not be paying more than 28% of your monthly gross income to mortgage debt each month, and your total debt payments should not be more than 36% of your monthly gross income (mortgage, credit card bills, student loans, car payments etc.)
- Carefully Consider Down Payment & Closing Costs: Aim to put a down payment of at least 20% on your home otherwise you will have to pay private mortgage insurance (PMI). This is an additional insurance expense and does not go towards paying the mortgage down. If you are unable to put down 20%, you will need to factor PMI into your home budget. In addition to your down payment, remember to factor in other costs associated with buying a home, such as closing costs, homeowners insurance, repairs, and moving expenses.
- Ascertain Timeline: Think about your future in this new home. If you sell the home within two years of purchase, you will not receive preferable tax treatment on any appreciation on the home (homeowners can get up to $250K per person or $500K per couple of home sale tax exclusion). In addition, if you buy and sell a home in a short period, you should evaluate the transaction costs on both sides, which could significantly erode the appreciation you might receive on the sale. We advise to aim to own your home for at least five years.
- Understand Tradeoffs – Opportunity Cost: When you buy a home, it’s also important to understand the impact of the purchase on your portfolio’s future. If you buy a home on the higher end of your range, that could limit your ability to pay down higher-interest debt or save/invest more towards other goals. Explore the tradeoffs. Will your home costs hinder saving in other areas (ex: retirement, kids’ college)? Do you plan to stay in the home for +5 years?
Buying a home can be your biggest investment decision and asset, so it’s important to think through the details and not rush into it.
Take Action Now!
- Do your research and put together a home budget of anticipated costs. Our HTG spending and housing spreadsheet will help!
- Put a savings plan in place for your down payment and emergency savings (factoring in future home-related expenses in your emergency fund).
- Work on improving your credit score as this can affect the interest rate you will be charged on your mortgage. Look for more detailed information on credit scores in a future Financial Foundations email!
- Gather paystubs, tax returns and other financial documents so you are ready when applying for a mortgage.
- Read our blog Should I Buy or Rent a Home? for further insight.