How Not to Move Back in With Your Parents

Finances After Graduation Podcast Episodes

Home Ownership
home-ownership-2

Listen to the Podcast

Pete and Alex are joined by Phil Schuman to talk about the factors that go into determining when is the right time to by a home and what finances are involved in the process.



Read the Show Notes

The entire process of buying a home is a daunting, frustrating, and, ultimately, rewarding experience. For many, the moment they are handed the keys to their new home is a symbol that they’ve made it. However, jumping into the world of homeownership too soon can cause you to dig yourself into a financial hole. It’s important that you understand the considerations that go into buying a home so that you can determine when the appropriate time is for you to buy a home.

Things to Consider

Flexibility

Whenever you graduate from college, prepare for your life to be filled with unknowns. You may have a job lined up, but in this day and age, by no means does that mean that it’s a long-term thing. What if you decide the job isn’t for you? What if your company decides you’re not right for them? What if your company opts to transfer you to another office? These examples (and there are several more) illustrate the need for you to be flexible in your living arrangements when you graduate from school. Owning a home makes it harder for you to be flexible with your life. It’s best to wait to buy a home until you know your situation is more stable.

Renting vs. Owning

At some point in your life, you’ve probably heard that renting is throwing away your money. It’s not. Renting is buying you the flexibility that we talked about in the previous section. The worst-case scenario for renting is that you have to break your lease, which is significantly less costly than selling a home (realtor fee, potential loss on home, mortgage every month you don’t sell, etc.,). Don’t listen to others that try and convince you that you need a home rather than an apartment as soon as you graduate, you’ll be much happier and less stressed if you do.

Your Savings vs. House Maintenance

Maybe you have enough money to cover the down payment on your house, but will you have enough left over to take care of the things that will break after you move in? You need to have a rather sizeable savings account established to cover the things that break in the first year you own the home. If you don’t have the savings, then you probably shouldn’t be considering buying a home.

The Finances

When you are ready to buy a home, there are a lot of financial topics you need to cover. The most important thing to know when it comes to finances is that it is up to you to know what you can afford, not your lender. If your lender or a calculator you found online tells you how much home you can afford, know that they don’t know your spending habits or many of your financial obligations. They are giving you a number based on a formula. What you should focus on is not having a mortgage payment that is more than 25% of your monthly take-home pay (i.e., net pay minus student loan payments).

Down Payment and Private Mortgage Insurance (PMI)

When you do buy a home, part of the purchase will involve a down payment. The down payment can be as low as 3.5% (FHA) to full payment of the house. However, as Pete mentions on the podcast, it is not wise to purchase a home on less than 10% down payment because it indicates that you probably don’t have enough saved to provide regular maintenance of the house.

Another factor to consider with the down payment is that if you make a less than 20% down payment on the sale price, you will have an additional fee tacked on to your monthly mortgage payment: private mortgage insurance. This fee, “Protects your lender in case you default on the payments. As a borrower, you pay the premiums, and the lender is the beneficiary.” [1] The PMI fee varies based on how much down payment you make and interest rate of the loan, but for your first home don’t be surprised if the payment is around $75/month. It should be noted that once you’ve managed to hit the 80% loan-to-value ratio of the home, PMI is no longer required. However, do remember that PMI is considered part of your mortgage, meaning it is eating up part of your recommended 25% housing budget.

Loan Type

We’re not going to advocate for adjustable-rate mortgages, simply because they are riskier and not the best decision for those getting started in the homeownership game. Instead, we will focus on the two most common fixed rate mortgages: 15-year and 30-year. In the case of the two, the first thing you should note is that a 15-year loan will mean that your house will be paid off 15 years sooner than a 30-year mortgage. This, of course, means that you’ll have higher monthly payments on the 15-year loan. But since 15-year mortgages have lower interest rates, the amount you will pay over the life of the loan will be considerably less. Let’s look at an example using average mortgage rates on 10/19/14:

Sale price of house: $175,000

30-Year Fixed Mortgage Rate: 3.93%

15-Year Fixed Mortgage Rate: 3.04%

30-Year Monthly Payment: $828.43*[2]

15-Year Monthly Payment: $1,211.89*[2]

30-Year Life of Loan Payment Total: $298,234.80

15-Year Life of Loan Payment Total: $218,140.20

As you can see, although the monthly payment for 15-year mortgages is higher, you will end up paying considerably less over the life of the loan than you would with a 30-year. If you can afford the extra monthly amount, a 15-year mortgage is a much better deal.

Bottom Line

This lesson could be considerably longer (chances are we’ll write another lesson on buying a home in the future) because there is so much involved in the purchase of a home. Do your thinking and determine whether or not you are in the stage of your life where owning a home makes sense. Remember that there’s no need to rush into the home-buying process, take some time to build up your savings so that you have a more sizeable down payment. If you need some help determining what you might be able to afford given your salary, take a look at our budget calculator in our resources section (http://moneysmarts.iu.edu/resources/paycheck-estimator.shtml).



[1] Does not include PMI (if necessary)

[2] Bankrate.com. (2013, April 25). The basics of private mortgage insurance (PMI). Retrieved 10 19, 2014, from Bankrate: http://www.bankrate.com/finance/mortgages/the-basics-of-private-mortgage-insurance-pmi.aspx