Buying a home can seem like a daunting process — it just may be the most expensive and emotionally charged purchase of your life.
The Decision to Buy…
Before taking the plunge into the buyer pool, it’s important to consider whether homeownership is right for you.
Rent vs. Buy?
When looking for a new place to live, the first question you ask yourself will help drive the rest of your decision-making. Should you rent or buy? Buying may seem appealing because you will put an end to escalating rent and can build equity. But the reality of routine home maintenance and repairs can quickly drain a bank account.
In general, whether renting or buying is better for you largely depends on your specific circumstances.
Here are some basic questions to consider when thinking about buying a home:
How long do you plan to stay there? If you expect to relocate in just a couple of years, renting is likely a better option.
How much home can you afford? If you can’t afford a home large enough to fit your family in a few years, it may be worth it to rent while you save a bit more.
What’s on the market? If you can’t find a home you like, it’s likely not worth tying yourself to something you’re unhappy with.
Another consideration: Stretching your budget for that dream home may actually make you miserable, as a growing body of research suggests.
Still can’t decide if buying is for you? Check out The Times’s rent vs buy calculator to dig deeper into the difference in expenses.If both your lifestyle and the hard numbers point toward buying, the next step is to determine how much home you can afford.
Can I Afford to Buy a Home?
Buying a home is the biggest financial decision most people will make, with many factors going into that decision.
How Much House Can I Afford?
To determine how much you can spend on a home, take a close look at your budget. Review your bank statements and spending habits for the last couple of months to figure out how much you are spending on everything from cellphone bills to restaurants. The Consumer Financial Protection Bureau offers a spending tracker that can help you figure out where your money is going each month.
Once you have a better picture of your spending habits, determine how much you want to allocate toward a monthly home payment. This figure includes your principal, interest, tax and insurance payment, which add up to your monthly mortgage sum.
The Federal Housing Administration formula, used by many lenders, recommends allocating no more than 31 percent of your monthly income to your housing payment. This figure will change based on your amount of debt. Buyers with no other debt may be able to budget as much as 40 percent of monthly income to housing. (But remember that the rest of your budget is going to have to go toward heat, water, electricity, routine home maintenance and food.) Overall, your total debt-to-income ratio, including car payments and credit card bills, should not exceed 43 percent.
So, for example, if you make $50,000 in annual gross income, your monthly gross income is $4,167. That should leave you with $1,292, or 31 percent to devote to your monthly mortgage, provided your overall debt does not exceed $1,792 a month. Our mortgage calculator can help you determine what your monthly mortgage may be.
But remember that besides the mortgage, buying a home includes additional one-time payments that can quickly add up, including closing costs, legal fees and other expenses associated with buying, such as a house inspection. And don’t forget about moving fees or home improvements.
More About Deciding to Buy a Home…Organize Your Finances!
It’s time to assess your spending, clean up your credit and figure out what you can afford.
Count Your Pennies…
Have you decided to buy? Before you jump into the world of open houses and real estate agents, take the time to get your finances in order. It will help you once it’s time to apply for the mortgage. It will also help you get some financial perspective before you fall in love with that perfect center-hall colonial or the studio with views of the park.
1. Check Your Credit Score
Lenders use credit scores, also known as FICO scores, to evaluate the potential risk of lending to you. The higher the number, which runs from 300 to 850, the better your score. The best mortgage rates go to borrowers with credit scores in the mid- to high-700s or above, according to the Consumer Financial Protection Bureau.
To find out where you stand, go to annualcreditreport.com, which offers a free report annually. Be aware that the three major credit-reporting bureaus, Equifax, Experian and TransUnion, generate their own FICO scores based on the data they collect; you’ll be able to find out all three here.
Is your FICO score low? You can improve your score by paying down high credit card debt, and by cleaning up any financial mistakes, like errors resulting from identity theft or mixed-up files belonging to another person with the same or similar name. Be aware that it takes time for these changes to be reflected in your credit score, from months for an inaccurate bill to years if you’ve had tax liens or bankruptcies. But if you can clear up your credit, it can make a big difference in your mortgage rate.
2. Get a Mortgage Preapproval
A preapproval letter is a written estimate from a lender of how much you will likely be able to borrow from them. This letter will help you determine how much you can afford, and help demonstrate that you can secure a home loan when you are ready to make an offer on a house.
Getting preapproved for a mortgage is different from getting prequalified for a loan, which is essentially a back-of-the envelope calculation of how much of a loan you may qualify for based on unverified information. The preapproval application for a mortgage often requires submitting pay stubs, bank statements, tax returns and other financial documents. Take the time to get one now, so you’re ready to make an offer as soon as you find a home you love.
How Do Down Payments Work?
There’s a reason why people talk about saving to buy a house. Your savings will go into your down payment.
3. Line Up Cash
The more cash you can pay up front toward your home, the less you will have to borrow. A bigger down payment means your monthly payments will be lower and you will pay less interest over the course of your mortgage. If you can afford to put down 20 percent or more of the total home price, you typically won’t have to pay for mortgage insurance, a premium that protects the lender in case you default on the loan. But don’t use all your money toward a hefty down payment.
Lenders will want to see that you have some reserves in the bank. Closing costs typically add up to thousands of dollars, according to Bankrate.com, which conducts a survey of closing costs nationwide and offers a fee breakdown of the average costs by state. You’ll also need cash on hand for moving, renovations and other incidentals.
Now that you have a better sense of your budget, figure out where you want to live.
1. Choose a Neighborhood
What makes a good neighborhood? The answer to that question is going to be different for everyone. But you can quickly narrow your choices by focusing on some key factors:
Where can you afford a home?
What is the length of your commute?
Do you want to be near good schools?
Talk to friends and co-workers about where they live. Then, visit shops and restaurants in neighborhoods you’re considering, to get a better feel for the place, including the overall community atmosphere and whether you could be friends with the people who live there.
If you like a certain zone, go back at different times and days of the week to get a sense of what the traffic is like at rush hour and if that seemingly sleepy village at midday is party central at night. Some real estate firms have expanded their services by offering seminars and guided neighborhood tours. (You may also want to take a virtual tour around the neighborhood using Google Street View.) There are also online tools designed to help you find the right neighborhood.
2. Comparison Shop
Once you’ve determined where you’d like to live, start browsing websites like nytimes.com/realestate, Realtor.com and Zillow, to see the homes available in that area. Eliminate sections of your chosen town that don’t have the style or size home you want at the price you can afford.
Setting up alerts on these sites based on your criteria can help automate some of the work. Many search sites show how long a given listing has been on the market, if the price has been raised or lowered, past sales and other useful data that can help determine if a listing is overpriced or has been languishing on the market. From there, figure out which homes you want to see.
3. Time to Visit
Visit a range of open houses to help narrow your preferences. This will help you get a sense of the housing stock in the area, and what is meant by a dog-trot house or a railroad flat. If there’s a crowd at an open house, you may also gain insight from the questions and comments made by other potential buyers.
When you have a better sense of what you want, line up some private showings. A private showing with a real estate agent will allow you to take your time at a place without the pressure or distraction of competing buyers. Tip: If you can, schedule a showing during the week before the open house, so you can use the open house for your second visit.
During your tour:
+Open the closets to check the storage space.
+Pull back the curtains to consider the view.
+Walk through the backyard and consider the maintenance needed to keep it in shape.
Ask a lot of questions: How far is the home from trains and buses? Why do the sellers want to move? When were the last improvements? How much do utilities cost? Have any offers already been made?
Open houses can also be a good way to meet real estate agents with whom you might consider working.
4. Find a Real Estate Broker
You can find homes for sale on your own, but a good broker can help you make sound decisions and guide you through the home buying process. They can also help you get access to homes as soon as they hit the market, before they may be listed online.
To find the right broker for you, talk to friends and family members who have bought or sold recently in your area. Look for a broker who has a track record working with buyers in your situation, and who will get back to you promptly. Keep in mind that your broker’s commission, typically 5 to 6 percent split with the seller’s broker, will ultimately come out of the sale proceeds. So even though you may not be paying your agent directly, you can expect that fee to be accounted for in the list price. And remember: your broker works for you, but he or she doesn’t get paid unless you buy a home.