The American dream of home ownership simply won’t go away. You would think that there never was a credit crisis even though it wasn’t that long ago that we were bombarded on a daily basis with stories about underwater mortgages, foreclosures and crashing prices. If anything, it was an American nightmare, not a dream.
The reasons, both emotionally and economically, that most people want to purchase a home rather than rent are not so hard to understand however. If you ask most financial advisors, they’ll tell you that first-time home buyers usually want to buy a home for the following reasons;
- They don’t want to pay a landlord when they could be building equity in their own home
- They feel like paying rent is akin to “throwing money away”
- They don’t want to put their trust in stocks or bonds but rather in real estate
- They believe that renting is temporary and instead want to “put down roots”
- They want to be able to “do what they want” with their home, something that they can’t do when they rent
These are relatively good reasons, to be sure, but what really needs to be done before any decision is made to buy new home is an analysis of the key financial components that must be in place, including what a person is earning and what money they have saved.
Comprehending the costs of the new home
There are a number of questions that simply must be asked before purchasing a home, including how much the person has saved for a down payment, the closing costs are and what type of cash reserves that they have on hand. Most experts will tell you that it’s best to put at least 20% down so that the borrower can receive gifts of up to 100% of the down payment and not need private mortgage insurance (PMI). This is vital as PMI can often add several hundred dollars to a monthly mortgage payment.
Many first-time homebuyers are very restricted due to cash flow however and some will probably request a Federal Housing Administration (FHA) loan, something that allows them to put down only 3.5%. Many opt to put down 10% however, which allows them to pay only 5%, put the rest of the down payment as a gift and get PMI.
Another thing to consider are closing costs, which normally are about 2% of the purchase price and include costs like title insurance, appraisal fees and escrow fees. On some home purchases there may also be a local transfer tax, a cost that can oftentimes be quite substantial.
There is also the fact that up to 12 months’ worth of cash reserves are required by lenders, money that will cover the monthly mortgage costs, insurance, property taxes and other debts. Some of that can be cash reserves held in retirement accounts but, unless a person is over 59 ½ years of age, only 65% can be in those accounts.
Let’s say that Joan and Richard want to buy a home for $400,000. Let’s also say that, together, they bring in $90,000 a year and opt to put down 10% as a down payment. Their lender requires them to have a cash reserve of 5 months and their closing costs will be 2% of the total price. Richard and Joan will also split a $15. per-$1000. city transfer tax with the seller and they have approximately $500 a month in other debts that they need to pay.
With all of these things taken into consideration, Joan and Richard would need to have just under $66,000 saved in order to purchase a $400,000 home. There might also be a considerable cost for moving from their rented home into the new one.
If all of these numbers look feasible (for your particular situation, of course) that you should probably talk to lender and get prequalified for a loan. If you have a credit score above 700 you shouldn’t have any problems but, below that, you should speak to a mortgage professional and get advice on how to improve your score. Finally an excellent real estate agent and being extremely patient are also two things that will help you greatly in your quest to become a homeowner.