Buying a New House? 10 Tips for First Time Homebuyers
If you’re buying a new house or condo for the first time, make sure you have the right information! These ten tips for first time homebuyers will help you figure out mortgage rates, interest payments, credit scores, financial budgets, and insurance costs…
Before the tips, a quip:
“One only needs two tools in life,” said G.M. Weilacher. “WD-40 to make things go, and duct tape to make them stop.”
If you’re buying your first home, make sure you have WD-40 and duct tape! And, friends and family who are handy around the house are handy to have, too. For more info on buying a new house or condo, click on Nolo’s Essential Guide to Buying Your First Home (book with CD-Rom & Audio)
Buying a New House? 10 Tips for First Time Homebuyers
1. Apply for a mortgage loan when home prices are low. Home prices dropped at a record annual pace of 18.7 percent last March. If you’re a first time homebuyer, you can find real bargains. For extra help, read 7 Tips to Make Buying a House Easier.
2. Buy a new house when interest rates are good. While interest rates have risen from their historic lows earlier this year, they’re still are appealingly low. In June, rates hovered around 5.25 percent for a 30-year fixed-rate mortgage. Remember – buying a home is one type of good debt.
3. Remember that tax credits help. First time homebuyers can get money back from tax credits implemented as part of last year’s American Recovery and Reinvestment Act. An $8,000 credit is available to first-time buyers (a category that includes people who have not owned a home for several years) for homes purchased before Dec. 1, 2009. Legislators are considering increasing the credit to $15,000 and expanding it to include other home buyers.
4. Check your credit scores. While houses are widely available, financing is only for those with good credit. Credit scores range from 300 to 850, with the median U.S. credit score about 725. A score below 660 usually results in a higher interest rate or denial of credit. Check your credit score before making home-buying decisions. If your credit score is poor, wait a few months and work to rebuild your credit score by paying every bill on time, paying down as much debt as possible and disputing any erroneous information on the report.
5. Make sure you have enough saved up. Whether or not you’re a first time homebuyer, a down payment is essential today! Ideally, put down 20 percent of the purchase price. If not, talk to a mortgage lender about options. And, learn how to save your money!
6. Don’t stretch your financial budget too far. Standard guidelines call for keeping housing expenses below 35 percent of total income. “Breathing room” in your budget will help secure a home even if something unplanned does occur. If you are uncertain, wait to buy. Read 4 Steps to Setting and Achieving Your Budget Goals.
7. Understand private mortgage insurance. Mortgages with less than 20 percent equity (which means a 20 percent down payment for those purchasing a home) require private mortgage insurance in case the owner defaults on the loan. When the home owner pays a conventional mortgage down to 80 percent or less of the home’s value, the home owner can request the lender to cancel the private mortgage insurance and then be able to stop paying the additional amount. Meanwhile, private mortgage insurance is tax-deductible, at least through 2010.
8. Know the real costs of being a first time homebuyer. The principle and interest on a mortgage payment are only the beginning of home-related costs. Escrow payments – the funds withdrawn to cover home insurance and taxes – and private mortgage insurance can add a few hundred dollars per month (or more) to a mortgage payment. In addition, first time home owners (all home owners, actually) must pay for repairs and maintenance, of course. A general rule of thumb is to budget 1 percent of the home’s purchase price per year for upkeep.
9. Avoid prepayment penalty on your mortgage. If the mortgage has a prepayment penalty, borrowers face hefty charges if they pay it off early. This provision also can be triggered by refinancing down the road, so if you’re a first time home buyer – be forewarned! Review the Truth in Lending disclosures that your loan officer sends you prior to signing your loan.
10. First time home owners: “Buyer beware!” Some of the lowest prices on homes today are “fixer-uppers” or homes sold “as is” because of foreclosure. Invest in a home inspection (typically costing under $400) before agreeing to purchase any home. An inspection informs buyers of any faults in the home, and helps determine the approximate cost to remedy those problems.
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Comment by Bryan on 11 February 2010:
My question pertains to #6 Don’t stretch your financial budget too far. Standard guidelines call for keeping housing expenses below 35 percent of total income.
Can you clarify total income to equal one’s monthly gross income or monthly net income? Also, should “housing expenses” include what one would pay for utilties (i.e. gas, water, cable, etc.)?
Thanks for your help.
Comment by Rick on 12 February 2010:
The rule of thumb is that housing expenses should be <35% of gross income and that housing expenses include mortgage payments (principal & interest), property taxes, house insurance, mortgage insurance. The 1% of purchase price per year maintenance is relative to the condition of the house since a newer or completely remodeled house generally needs less maintenance. And the home owners ability/inability to do repairs can make a huge difference. It is smart to recognize the cost of utilities as well and estimate them in your monthly/yearly budget but they are not typically included in the magic 35% number.
Comment by Laurie Pawlik-Kienlen on 13 February 2010:
Interesting — I would’ve thought that “housing expenses” do include the cost of utilities! But, I’ve heard from Rick here on Quips and Tips before, and his financial advice was solid.
Comment by Bryan on 17 February 2010:
Thanks, Rick and Laurie. If you don’t mind, another question.
35% of gross income is one theory and then there are some who say you can afford 2.5 times what you make (assuming annual income).
To illustrate how different these theories are let’s say I make $100,000. If you divide that number by 26 pay periods, my monthly income would approximately be $7,700. Multiply this by 35% and you have about $2,700 to spend on a house monthly. Take away $200 for PMI and insurance and another 500 for taxes (assuming $6K a year) – leaves you with $2K. Based on mortgage rates right now, I would be able to afford a house somewhere around $370K.
If you go with the theory that you can afford 2.5 times your salary, well $100K x 2.5 = $250K. A difference of over $100,000.
I am obviously missing something here. Your thoughts and feedback are appreciated.
Thanks again.
Comment by Rick on 19 February 2010:
There are no hard and fast rules to the amount you can afford. These general rules of thumb, 35% of gross, 2.5-4.0 times salary, etc, are there to provide guidance. Different lenders use different formulas based on what their experts predict. Sometimes the percentage of gross income might be 30% to 35% depending on interest rates and general economy. Other experts may be very conservative and suggest you never put yourself at financial risk so they may say 20% (which is close to the 2.5 times salary). You need to determine what you can afford and are comfortable with. Make a budget and allocate all your income verses expenses: food, entertainment, car, utilities, savings, insurances, etc, being as detailed and accurate as possible. Consider whether your income will increase or decrease based on your employment prospects and career plans. Then look at how little or how much is there at the end of the month/year. Use an online calculator from the bank or mortgage company website to determine the total cost to borrow various amounts of mortgage money ($300,000, 400,000, etc) until the amount of monthly payment fits your budget. Those calculators should also show the amount of mortgage insurance you pay based on the down payment. The higher the down payment the cheaper the insurance so put as much down as possible. One bit of advice I have is buy almost as much as you can afford, living frugally, and with every left over penny pay down your mortgage with penalty-free prepayments.
Comment by Laurie Pawlik-Kienlen on 19 February 2010:
When you’re buying a new house, you also need to take into account where you live (urban versus rural), your lifestyle (big spender versus frugal), your occupation (do you need designer clothes or do you work from home in your pajamas?), your love and family life (are you married with 5 kids, or are you single?), etc.
I think that those are the differences that may account for the difference between the “34% of gross income” theory and the “2.5 times your salary” theory.
Like Rick said (or alluded to), each person is different, and each potential home buyer needs to calculate his or her own mortgage and housing costs.
Just to confuse things further
here’s another set of calculations that I found:
10% of your income should be going to savings or investments
25-40% to mortgage or rent
8-15% to home-related expenses (utility bills, etc)
10-20% to food
15-25% to transportation
8-15% for medical expenses
3-5% for clothing
5-10% to personal or miscellaneous
less than 5% to personal debt such as student or personal loans
Again, these calculations depend on the person’s lifestyle. For instance, 3-5% is WAY much for me to spend on clothes each month — I don’t even think I spend that in a year! And, I’m Canadian with extended health coverage through my husband’s work so I don’t spend 8-15% on medical expenses. So I can shift those monies over to paying off my mortgage, going on exotic vacations, etc.
I think it’s also important to sit down with a few mortgage brokers and bankers, and see what they say about interest rates and being a first-time homebuyer in your area. Of course, it also depends on your line of credit and amount of debt!
I hope this helps…..and please do come back and let me know what you end up doing — if you bought your first new house and if it was within the 35% theory or the 2.5 times your salary theory.
Laurie
Comment by Bryan on 24 February 2010:
Thank you both again for your insight. I will be sure to post my results (hopefully this spring)!