By Wendy Mihm | December 28, 2010
Buying a Home 101
A Guide for First-Time Home Buyers (or a refresher course for everyone else)
If you are considering buying a home for the first time, congratulations! It’s a big step and a milestone that has been a pivotal part of the American Dream for generations. But buying a home is also a serious financial transaction that can potentially affect you and your family for many years to come and should therefore not be taken lightly.
When my husband and I bought our home back in 2005, we did some things right and some things wrong, not the least of which was, well, buying a home in 2005. In this guide, I’ll pass on what we’ve learned since then, as well as some basic, time-tested home-buying wisdom so you can execute a savvy transaction and move on to the fun stuff. Like planting petunias in the flower boxes.
1. Figure out how much house you can afford.
Unless you spent 2008 and 2009 with your head stuck in a bowl of Jell-o, you are aware that, at a very basic level, the catalyst of the Great Recession was the fact that banks were handing out gigantic mortgages at low rates to any shmoe who happened to walk by. We even heard one story of a guy who submitted a picture of himself in a mariachi outfit as proof of employment for his mortgage application—he was approved.
The point is, banks were handing out huge mortgages to people who were not qualified, and in turn, people were fooling themselves into believing they could afford more expensive homes than they really could. Then everything caved in on itself and lots of people lost their homes.
The message here is: exercise common sense. Do not buy more house than you can afford. A good general rule is that your mortgage should not be much more than about 28% of your monthly gross income. This is the number at the top of your paycheck each month – before the taxes and all the other expenses get taken out.
2. Consider getting “prequalified.”
It often makes sense to get “prequalified” by a lender (a bank) once you get serious about shopping for a home. Being prequalified to receive a loan for a certain amount of money from a specific bank makes you a more attractive buyer and will speed up your buying transaction. But remember, just because you are prequalified for a certain amount, does not mean you must spend that amount! You are free to submit a bid for a lower amount if you think you can get the home for the lower price.
3. Don’t forget the down payment.
You will probably also need money for a down payment. Some loans through the Veteran’s Administration offer 0% down, but it is much more typical to need anywhere from 10% to 20% of the purchase price of the home saved up in order to buy the home. The larger the down payment, the more attractive buyer you are and the less you generally will have to pay in mortgage insurance. Mortgage insurance? Yup. More on that next.
4. Be aware of the other cash costs of buying a home.
You’ll need more cash on hand than just the down payment when buying a home, but it’s up to you to avoid being fooled into paying more than you need to. I was fortunate: I used to date someone who was in the mortgage industry and he tipped me off to look out for bogus charges and boy was he right! First let’s list the legitimate charges that you could expect to pay for:
- Termite inspection (varies by state)
- Points (prepaid interest)
- Title search and insurance fees
- Adjustments for utilities or property taxes already paid by sellers
These could add up to anywhere from 3% to 8% of the purchase price of the home. You should feel free to look carefully at each one of these fees and ask about any of them that strike you as arbitrary or inaccurate. Perhaps the application or recording fee can be waived – you won’t know if you don’t ask. As for bogus fees, our husband and I got a couple of ridiculous fees eliminated, such as an “email fee” (isn’t email free?) and a copy fee (isn’t their job to make copies?). We also got them to waive the application fee—all we had to do was ask.
5. Get to know the neighborhood – at all hours
You are going to be spending a lot of time in your house. You might as well lose a little sleep for one night so you don’t lose a whole lot of sleep for the next 12+ years. I’ve always thought it was strange that we can do all sorts of online research for much smaller purchases like cameras and shoes and backpacks, but when it comes to buying a home, all that many of us ever do is visit the house once or twice at an open house, and then make a decision on the spot! Why not camp out in your car in front of the house at 11:15pm on a Saturday night to see if it’s quiet then? Do you have a baby that will need to take a nap at 9:30am? Better swing by the house and see what it’s like at that hour. Is there a barking dog (or three) next door that the realtor conveniently had removed for the open house? Are there loud neighbors that hang out in front of the house and play music at odd hours? Better to learn about them before you buy the house, not after.
Talk to the neighbors. What do they like about the neighborhood? Do they have any complaints? Are they all saying the same things? If so, listen to them – you may end up thinking the same thing after you move in. Can you walk to anything? Safeway? Starbucks? The park? Is it near the fire station – meaning, are you going to hear sirens all day and night? What are the schools like? Even if you don’t have kids now, you might have them sooner than you think (we did), and the quality of the school systems matters immensely – for their education and for your property value.
Walk around the block. What does it sound like? What does it feel like? Do you feel safe? If you have kids or plan to have them soon, would you feel safe with them toddling down the sidewalk? When we bought our home, we felt fine ourselves, but I did not project well enough into the future. Now we have two kids and I don’t feel that the street is safe enough for them. Don’t make that mistake, because it can be an expensive and difficult one to fix later.
6. Mind the #1 real estate rule: location, location, location.
We broke this rule because we had virtually no choice. 2005 was a home-buying frenzy and the home we bought was the 7th one we had bid on. And we only got it because the leading bidder fell through. Five years later, we still love our house, but I don’t love our neighborhood and so we’re contemplating a move because of it. This is a very disruptive situation that I wish we weren’t in. You can avoid it by heeding the #1 rule in residential real estate: choosing your home based on location, location, location.
By this, I mean, pick a house in a neighborhood you love. You can make changes to the house, but you can’t make changes to the neighborhood. You can’t make noisy neighbors move away and you can’t make an unsafe atmosphere safe. If you are constrained by budget (and if you are not, you are not reading this article and are also not living here on planet earth), consider buying the most modest house in the best neighborhood you can afford. Get the number of bedrooms and bathrooms you absolutely need (not want, need) but don’t worry about the guest-room-in-law suite, the walk-out basement, the Viking range, the double oven, and the twin whirlpool tubs just yet if you can’t afford them. As your finances grow over time, you can add whatever you want. Really.
7. Don’t underestimate post-purchase expenses.
You will have to pay property taxes each year on your home. These are no fun at all, they vary by state and are calculated by multiplying the property tax rate in your state by the value of your home. You will typically be billed for these taxes twice a year, but it makes sense to set the money aside each month so it will be there when you need it.
You may have to pay for private mortgage insurance (PMI,) which is insurance that protects the bank that makes your mortgage loan against the possibility that you will not make your payments. The key things to understand about this insurance are that you make the payments to protect the bank. How’s that for a double whammy? The only thing you get out of it is that mortgage insurance may allow you to purchase a home without putting down 20% of the price of the home. How much does PMI cost? Typically about 0.5% or 1% of the value of the total loan will be your premium each month. For example, if you took out a mortgage for $350,000, your PMI monthly premium would be about $146 ($1750 per year) if it were on the lowest end of that range. As you pay down your mortgage and/or as the value of your home rises, you may be able to stop paying PMI.
As a renter, you were used to paying utilities such as phone and electricity, but now you’ll pay for water, gas and even trash removal. Also, if you are in a planned community or a condo, you may also owe homeowners association fees or condo fees as well.
And remember, now that you’re a homeowner, you can’t call the landlord to fix the leaky faucet – you are the landlord, so start emailing your friends to find out if they know of a good plumber in the area. And while you’re at it, see if they have a good electrician, a good AC guy, a good chimney sweep, a good floor refinisher – you get the idea.
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