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 put you in a deep financial hole.
In other words, how sure are you that you’re going to stay where you’re at for a while? It doesn’t make sense to buy a home unless you plan to live in it for at least five years.
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?
As a new grad, it’s often important to stay flexible—and owning a home makes that tough. It’s best to wait to buy a home until you know your situation is more stable.
If your only reason for purchasing a house is because you’ve heard that renting is throwing away your money, stop right now.
It’s not. Renting is buying you the flexibility that we talked about in the previous section.
If you’re renting, the worst-case scenario 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 who try to convince you that you need a home rather than an apartment as soon as you graduate. It’s just not true.
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 it. If you don’t have the savings, then you probably shouldn’t be considering buying a home.
First things first: you should decide how much you can afford, not your lender.
The numbers you get from your lender and online calculators don’t take into account your spending habits or your financial obligations. They are giving you a number based on a formula.
Your mortgage payment should account for no more than 25% of your monthly take-home pay (i.e., net pay minus student loan payments).
When you buy a house, your mortgage will require you to pay a certain percentage of the total home price at closing. That’s your down payment.
It can be as low as 3.5% up to the entire purchase price. Realize that if you can’t put at least 10% down, you probably don’t have enough saved to provide regular maintenance of the house.
If you make a down payment less than 20%, you will have to pay private mortgage insurance (PMI) every month. 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.
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. Once you 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.
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 mortgages.
The first thing you should note is that going for a 15-year loan means you’ll be able to pay off your house 15 years sooner than if you get 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
As you can see, although the monthly payment for a 15-year mortgage is higher, you will end up paying considerably less over the life of the loan than you would with a 30-year mortgage. If you can afford the extra monthly amount, a 15-year mortgage is a much better deal.
Think hard before you decide whether or not you are in the stage of your life where owning a home makes sense.
Remember, 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.
There will always be homes to buy. But you only get one chance to set yourself up for a stable financial future.
