Buying a home is an undertaking that can render you broke in a flash. Not only are most homes ridiculously priced, but the expenses associated with owning a home aren’t cheap either. Luckily, certain home buying tips can save you tons of cash and right now I want to share with you a homebuying rule that helped me about financial turmoil when buying my own home!
You see, while buying a home is one of the most rewarding ventures you’ll ever embark on, you must understand the risks involved. This will help you ease through the process and avoid common pitfalls in the home-buying process. For instance, one common risk that comes with purchasing a home is the risk of overbuying. This refers to a situation where the asking price for a house is more than it should be, or a potential buyer settles for a home they can’t afford without strain. As a new buyer, spotting an over-priced home isn’t as straightforward, making you a potential victim for overspending. Sadly, this isn’t a pitfall that you can easily climb out of. Once you exceed your budget when buying a home, you automatically commit yourself to decades of financial sabotage. How is this?
Cost of Over-extending
For one, buying a home for more than you had intended tampers with your finances. Suppose you had planned to buy a home worth $300,000 and end up going for one that’s valued at $350,000. That’s an extra $50,000 on top of what you had intended to pay, before considering all the extra interest that $50,000 will come with. To add to that, mortgage payments are just a fraction of the total costs of owning a home. There are one-time payments that you’ll need to pay upfront. These include a down payment, moving costs, closing costs, local fees, and property taxes. All these can add up and consume a big chunk of your budget. Suppose you factor in other expenses such as maintenance costs, electricity bills, insurance premiums, and yard work. In that case, these costs could clock up more than $10,000 annually. Without proper financial planning, you might be forced to work yourself sore from seeking additional income streams to sustain your lifestyle and avoid debt. Alternatively, you may need to downplay your lifestyle by shrinking your budget to create room for your mortgage payments.
Secondly, over-stretching your finances when purchasing a house makes you miss out on high-value investments. Keep in mind that a home, not unless you’re planning to flip or rent it out, is a huge liability. So why spend an extra $50,000 on a venture that won’t make money for you anyway? $50,000, when invested towards a viable business, can potentially multiply ten-fold in terms of profit. Heck, you could even sink it into the stock market and watch its value balloon exponentially. If you’re not interested in investing, you can put this money towards your kids’ college fund. You’ll thank me in a few years.
The third risk of over buying a home is this; what happens if you weren’t in a position to finance your mortgage? Assuming you fell ill or lost your job, would your other income sources support your bills plus your mortgage? If no, then I strongly advise you to think twice about over-buying a home. The thing is, defaulting on home-payments accrues secondary expenses on top of your mortgage and home bills, and the costlier your mortgage, the higher these fees will be. In the event that something knocks you off your feet financially, an expensive home will only put you in more trouble.
Avoiding The Biggest Buying Mistake
So, how can you avoid all these risks? It’s simple; Look out for the tell-tale signs and common pitfalls. The first way is to avoid houses that are priced beyond their real value. You can tell that a house is over-priced by comparing its price with homes within the same neighborhood. If the price is out of touch with that of neighboring homes, then there’s a strong likelihood that it’s overpriced.
Secondly, use a dependable real estate agent. Sometimes, realtors can convince you to stretch your budget and purchase an expensive home so they can reap higher commissions. At the onset of the home-buying process, set the record straight about your budget, and stand your ground when they try and convince you otherwise. If they keep insisting, hire another agent.
Thirdly, ward off toxic comparison. Don’t kill yourself with an expensive home simply because your friend Molly owns a sprawling bungalow. Most potential homebuyers find themselves contorting their budgets because of public perception. They allow external influence to set a precedent for their homeownership process, yet they are the ones who will pay for the home. Don’t be part of the statistics. Once you’ve laid-out your homeownership budget, stick to your guns no matter how lofty other people’s houses look. Instead of focusing on what other people have, start thinking of ideas that could make your own home better, without straining your finances, of course.
Lastly, don’t make the mistake of over-buying a home because you believe your career prospects are bright. It’s good to be ambitious and all that, but you can’t afford to gamble with a home that shelters you and your whole family. Even the luckiest of us have had our fair share of bad luck, so always leave wiggle room for rainy financial days. Also, consider budget-altering life changes that you’re yet to experience. For instance, if you intend to start a family, having kids will definitely require you to adjust your budget upwards. If you’re yet to have them, make sure you purchase a home that you’ll be able to pay for once children arrive.
With that said, don’t automatically settle for the first mortgage offer presented to you. This is a common loophole that deceives most potential home buyers into overbuying a house. The thing is, just because a mortgage company pre-approves you for a certain amount doesn’t mean you should purchase up to that limit. It doesn’t matter whether you’re anticipating a raise/promotion. Just stick to what you can afford now. Remember, while lenders are in the business to mint money, your target is to take advantage of every money-saving loophole. Talking of saving money, there are ways you can actually save tons of cash when buying a home so lets talk about them now!
Primarily, budgeting holds the key to a blissful homeownership process. Fortunately, budgeting for a home isn’t complicated at all. With the most basic math skills, you can calculate the nuts and bolts of homeownership without a fuss. In this section, I’ll introduce you to three fundamental rules that underlie proper budgeting. These rules should help you buy a home without overspending and putting your future at risk. Besides that, planning in this manner helps lay bare camouflaged housing costs that most first-time homeowners tend to ignore. This way, you can peek into your financial future and determine how the biggest purchase of your life will affect your lifestyle going forward.
So the first rule of thumb for buying a home is that your home financing costs should not exceed 25% of your gross monthly income. Before you go mortgage shopping, first calculate 25% of your gross monthly income. This should include your total household income if you have a working spouse.
As an example, let’s assume you receive two monthly paychecks: $4,000 and $2,500, and your partner receives one of $4,000. In this case, you add up all these to come up with a total gross monthly income of $10,500.
If you calculate 25% of this, you get $2,625. According to the 25% rule, your monthly mortgage payments should not go beyond $2,625, and if it does, you’ll be adding to the statistics of homeowners who are house poor. This is a term used to describe homeowners that spend almost all their income on homeownership costs while submarining other aspects of their lives. Also, keep in mind that this 25% limit covers your mortgage payments, interests, homeowners’ insurance premiums, and property taxes.
The second rule is the 4X rule that states that the maximum cost of the home you should buy is four times your annual gross income. To put this into perspective, let’s assume that Josh earns a monthly income of $3,000. In this case, he can afford a house worth four times his salary, which is $144,000. What I did here is that I simply multiplied Josh’s gross monthly income by 12 to get his total annual income of $36,000. Next, I multiplied this by 4 as dictated by the 4X rule.
Quarter Cash Rule
The third and maybe most crucial house-buying rule is that you should have 25% of your house’s value in cash before buying. In the real estate world, this is referred to as a down payment. Once you get pre-approved for a mortgage, the gist is your lender will require a cash payment. You’ll need to make this payment at the initial stages of your financing arrangement. Wondering why it’s important? I’ll tell you. So, what happens is that paying a large down payment diminishes the size of the risk on the lender’s side. Most lenders assume that putting down a cash payment reduces the likelihood of you defaulting. To some extent, this presumption holds water, but what’s in it for you?
Well, laying a sizeable down payment of 20% exponentially reduces the principal and interest that you’ll need to pay going forward. On top of that, it strips you of the risk of binding yourself to private mortgage insurance. This is an insurance cover that homeowners are required to have if they’re laying a down payment that’s less than 20%. Suppose you default in paying your home loan. In that case, this policy duly compensates the lender. Additionally, it protects them from potential risks that could have lowered the house’s value and exposed them to incur a loss. Conceivably, mortgage insurance comes with additional expenses to your homeownership plan, which strongly contradicts your goal of saving some money. And lastly, paying more money upfront ensures you walk away with more equity in your home. How rewarding is that?
So what’s the best way to calculate your down payment goal? The answer lies solely in how much you’re willing to spend on a house. Let’s use the following example: If, for instance, you’re approved for a $300,000 mortgage, a 20% down payment equates to $60,000. However, it’s important to remember that a down payment isn’t the only upfront costs you’ll incur. Other upfront costs incurred at the early stages of the home-buying process are collectively known as closing fees. These include expenses such as moving to your new house, survey fees, property taxes, real estate commissions, title insurance, and escrow fees. Added together, these amount to roughly 2–5% of the total purchase price. So, suppose you’re going for a house worth $300,000, and the closing costs are 5% of this price; you’re looking at $15,000 worth of closing costs.
If you add $60,000 and $15,000 together, you get to 25% of the value of the house or $75,000 which is why the 25% rule is a must for anyone who wants to buy a house without going broke!