Home Sweet Home
Buying your first home is considered one of the biggest milestones — in life as well as finances. It’s a big commitment, and there’s a good chance this will be the largest purchase you’ve made to date.
If you are a first-time home buyer, here are five guidelines to assist you in your financial preparation. Determining your housing expenses is a critical step in your budget planning. You will need to figure out if you can afford to buy the house and afford to own it on an ongoing basis.
Establish an emergency savings to cover three to six months of living expenses. As you transition from a renter to a home owner, the chance of having unexpected expenses increases. Establish a cash reserve to cover your non-discretionary expenses, such as food, clothing, utilities and insurance, if your income takes a sudden hit or if you need to make a large home repair.
If you are a two-income family with stable employment, a three-month reserve should be adequate. However, if you are self-employed or if only one spouse works, a six-month reserve is advisable.
Calculate your total housing costs carefully. When determining your fit for financing, lenders take into account the four “C’s” of lending; capacity, capital, credit, and collateral. They will employ a housing debt ratio to determine the cost of a home that you can afford. Total costs should be no more than 28% of your gross annual income.
For example, if you have monthly income of $6,250 ($75,000 per year), your housing costs should not exceed $1,750 a month. Housing costs include mortgage payment, homeowners insurance, taxes and association fees if applicable.
The second housing to debt ratio that lenders look at should not exceed 36% of your gross annual income plus current outstanding liabilities, such as car loans and student loans.
Take into account on-going maintenance expenses. On average, you will spend 1% of the value of your home on maintenance expenses. For example, for a $350,000 home, you should plan for maintenance costs of approximately $3,500 per year.
However, this does not mean that you may incur this expense every year. Some years you may spend more on maintenance costs than others. Other factors include the age of your home and costs of labor and materials in your geographical location.
Plan to make a down payment of 10% to 20% of your mortgage, but you will need to put at least 3% down to qualify for a mortgage. For example, if your mortgage is $300,000, ideally your down payment is $30,000 to $60,000. If you make a payment of less than 20%, some lenders may require you to purchase private mortgage insurance (PMI) to protect themselves against loan default.
On average, PMI costs about 0.5% to 1% of your total mortgage. With a $300,000 mortgage, your PMI would cost about $1,500 to $3,000 a year. Lenders typically require you to keep this insurance for at least two years. You can drop the insurance after five years if your home equity is 20% or more. Lender requirements may vary so consider comparison shopping.
Estimate the costs for furnishing your home. You may spend up to 25% of the purchase price to furnish your new home. Another estimate suggests furnishings may cost $50-$100 dollars per square foot. Make sure you get estimates of furniture and other items, such as appliances, before you purchase your home. If you already own furniture, you may spend less. Other costs to keep in mind include start up costs for energy service, internet and cable, and moving expenses.
My husband and I are starting the home search process and with the current, crazy market we are finding that having a prequalification letter from a lender as well as being flexible on contingencies is key. Working with a real estate agent that you trust and is knowledgeable of the area you want to live in is essential and makes the process enjoyable.
Purchasing a new home is one of the most important decisions that you will ever make, and your success as a homeowner depends on getting the budget right. We are here to help you set goals, decide what you can afford and design a sustainable plan.