Buying a new home should be a time of excitement and celebration of achievement, but it can also be a time full of questions and anxiety. Especially for first time home buyers. However, if you arm yourself with the knowledge of what to expect and how to plan ahead, you can alleviate that stress.
There are 10 main things that every buyer should be aware of when searching for a home. It’s important to remember that the average person or family lives in their home for 13 years, so the decisions you make today will affect you for years to come.
Bank Pre-Approval
First thing first, unless you have a large amount of cash on hand, before you purchase a new home you must get approved for a loan. This typically begins with getting a pre-approval from a financial institution such as your bank. So once you’re pre-approved, does this mean you have been approved for financing to buy a home? Well, not exactly. A pre-approval letter is just that, a pre-approval. It is the bank’s way of saying based on your credit report, W-2 or 1099 provided that they will LIKELY approve you for a certain amount of money towards a mortgage IF you can make it through the underwriting process, which can be a large hurdle by itself. The underwriting process involves going deeper into your finances and also conducting an appraisal on the home to be sure that the price you’re paying is at least roughly in line with the market with any glaring issues found with the home being noted and needing to be fixed. This applies to conventional loans, and even more so on FHA loans.
When meeting with a loan officer, ask them to provide a list of conditions from the underwriter BEFORE finding a home. By getting this ahead of time along with any available documentation in advance it will significantly reduce your stress level versus having to rush last minute, as some loan officers tend to hold onto this information until after you have found a home. As an example, some underwriters may ask for your tax transcripts mailed from the IRS, which can take a couple of weeks and potentially push back your closing date, or even potentially cause you to lose the home.
Know Your Maximum Buying Power
A lot of buyers go into the market with a rough idea of what they would like to spend on a home, so when speaking to a loan officer, they may have a number in mind that they would like to get approved for. When this happens the loan officer will likely only get them approved for up to the number provided, when in fact they can be approved for much more. If a buyer asks to get approved for $500K, then later finds out that the perfect home for their family is in the $575K price range, getting them into the neighborhood or school district that they really want, they may assume that $500K is the max amount of money they are approved for. Of course spending more on a home will raise your monthly payment, but in some circumstances such as a child being able to attend public school versus being enrolled in a private school, the long-term savings may outweigh the additional cost.
Just Because You Can Doesn't Mean You Should
As important as it can be to know your maximum buying power, it’s just as important to know that just because you get pre-approved for up to a certain amount of money, it DOESN’T mean you should (or need to) use all of it. Lenders use your current income and credit score to determine how much home they think you are able to afford, but keeping the uncertainty of the future in mind, we know that things can change - and quickly. A buyer who has a steady income and good job that decides to use their maximum amount available to purchase a home may find themselves in a bind if they later lose that position. Additionally, by having a smaller mortgage payment, it allows you to save money to go towards emergency and retirement accounts, or investing to help grow your financial wealth. By doing this, even in a worst case scenario that you were to lose a job, that emergency account could help cover any bills and carry you through a tough time until a new job is secured.
Avoid Becoming House Poor
People who choose to spend the maximum amount they get approved for may find themselves spending a disproportionately high amount of their income on their home, including the mortgage payment, insurance, taxes, maintenance & utilities, leaving them broke at the end of each month and struggling to afford the basic necessities. This is called being house poor. Mortgage companies will typically approve you for between 36% up to 43% of your gross income. However, we recommend buying in a price range that no more than 28% of your income goes towards when considering your monthly payment. This should leave enough room in your finances to cover additional bills, necessities such as food, and still have a remainder to invest into savings and retirement without going broke.
Beware of Hidden Expenses
Owning your home definitely has its advantages to renting, but part of owning a home also comes with their own expenses, some of which can be hidden or unexpected. One of these unexpected expenses can be property taxes. Depending on the size and location of your home, this can vary greatly. A safe way to estimate what annual property taxes may be on a home is 2% of the sales price. This may be on the higher side, but it’s better to overestimate than under. When you do find a home that you are interested in, your agent can contact the assessor’s office to find out roughly what the next owners will pay.
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Homeowner’s Insurance is Required
All banks and mortgage companies will require proof of homeowner’s insurance before they will release the funds to purchase a home. You can often receive a discount if you pay a year up front, as well bundling policies such as your auto insurance, so be sure to ask what you can do to help lower the premium on your policy. When searching for a company to use for homeowner’s insurance, do so through a broker. This is important because brokers typically shop your policy with numerous companies to get you the best deal, which will save you money and likely better coverage as well.
Be Aware of Floodplains
Another aspect of homeowner’s insurance that buyers sometimes overlook is whether or not a property is located in a floodplain. More than 13% of all Americans live in the 100 year floodplain and here in Metro Detroit, that number is a bit higher. If you are purchasing a home located in the floodplain, you will definitely want to purchase flood insurance, which will cost you a few thousand dollars extra each year. That being said, when looking for a home, work with an agent equipped with the knowledge to look up the home on the FEMA Floodplain Map. If this is overlooked until reaching the closing table, you may end up needing to spend an extra few hundred dollars on insurance coverage each month to protect your investment.
Plan for Maintenance Expenses
Part of owning a home is also keeping up on the maintenance needed to keep the home in good condition. Things like the HVAC, roof and windows eventually wear out and will need replacement, which can cost thousands of dollars. The four monthly expenses on a home are principal paid down each month on the loan, interest paid on the loan, taxes on the property, and insurance. This is commonly referred to as PITI. Add a silent M on the end for maintenance. When figuring out your monthly payment, it is a good idea to plan ahead and imagine this being built into it, setting aside a certain amount into an account that can be used for any maintenance costs. A safe amount to judge by is to set aside 0.5% of the purchase amount, per year. Simply divide this amount by 12 to calculate how much extra per month you should be saving.
Your Credit Score
One of the most important things to be aware of before purchasing a home is your credit score. This can determine whether or not you qualify for a mortgage and can have a large effect on your interest rate, which can be the difference of up to a few hundred dollars on your monthly payment. We recommend building your credit score to at least fall into the “good” range of 670 to 739. You might still qualify for a mortgage if your credit score falls below this range, but aside from determining how much your interest rate will be, it also plays a role in which type of loan you qualify for, such as a conventional loan versus a FHA loan. Thanks to apps such as Credit Karma and Smartcredit, monitoring your credit score has never been easier. These are both completely free and in addition to monitoring your credit, offer a number of services such as credit disputes and simulators that will estimate what your credit will look like in certain scenarios such as paying down a credit card or purchasing a new car. They also offer suggestions as far as options for new credit cards, personal loans, refinance options, and more.
20% Down Myth
A common myth about purchasing a home is that you need to have enough money to put down at least 20% of the offer price. Yes, the more you put down up front the less your monthly payments will be, but it is completely untrue that a minimum of 20% down is a requirement and it could potentially cost you THOUSANDS of dollars by waiting to save up that amount of money. Home values have skyrocketed in the past couple of years and this year alone we have seen interest rates more than doubled while the Fed continues their battle against record high inflation. This means depending upon location and condition, that a home purchased in 2020 for $300K could easily be valued at $375K or more today. In addition to the extra $75K in price, to purchase that same home today a buyer would be paying much more in interest, raising their monthly payment significantly. So in this scenario, by putting 5% down versus waiting to put 20% down they kept $45K in their pocket and GAINED $75K in equity, plus tax write offs and being locked in at a lower percentage rate for additional savings every month.
Now, if you do purchase a home for less than 20% down, you will have to pay Primary Mortgage Insurance (or PMI) if purchased using a conventional loan, or Mortgage Insurance Premiums (MIP) if purchasing using a FHA loan, which is figured into your monthly payment. Many people believe in doing so, the ONLY ways to remove these payments are to refinance or wait until you make enough payments to bring the remaining balance under 80%. This is also false. Once the value of a home can be shown to exceed 20% equity a homeowner can request that the mortgage company remove the additional charge from the monthly payment. Asking your realtor to reassess the value of your home for a rough estimate, followed by an appraisal is an easy way to do this. The appraisal report can then be mailed to your mortgage holder to remove the PMI/MIP.
Without question, there are a lot of moving parts that go into purchasing a home and it's understandable that it can be intimidating if you are not prepared. If you take the time to educate yourself on the process and plan accordingly, buying a home is exactly what it should be… fun! After all, there’s no place like home.
If you’re ready to make a move, we would love the opportunity to work with your family! Call us anytime at 248-886-4450 or visit HERE to see homes currently listed on the market.
Posted by Michael Perna on
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