I moved a total of 11 times in my twenties.
And this isn’t including all the temporary stays I had in between, for less then a month.
And I’m sure many of you who have moved to new cities seeking new opportunities and taking on new jobs can relate.
So it’s no surprise that so many Americans dream of owning a home.
A permanent place you can call your own.
But before you run out the door and put a downpayment on the next dream home you see, there are few things you may want to consider.
In this post, I want to review some basic rules to follow before you go out and purchase your dream home.
So that when you finally get that home that you always wanted, you are making the best financial decision for yourself and your family.
Home Ownership Wasn’t Always The American Dream
But first, I want to give you some broader context regarding home ownership in general, so let’s have a quick history lesson.
For many of us, it may be normal for us to believe that home ownership was always the American Dream.
That’s because for a majority of us, home ownership has been pushed as this pinnacle of success and security.
But that hasn’t always been the case in America.
A 100 years ago, Americans were much more likely to be renters than homeowners. And that’s because mortgage options that we take for granted today weren’t available back then.
If you wanted to buy a home back then, you likely needed to save up half the purchase value in cash because a typical mortgage in the early 1900s might have a term of five years and require a 50% down payment.
Then came the Great Depression. This unprecedented economic collapse forced many people to foreclosure and real estate prices plummeted.
In order to stabilize the housing market, the Federal Government created the following:
- Home Owners’ Loan Corporation in 1933
- Federal Housing Administration in 1934
- Federal National Mortgage Association (now Fannie Mae) in 1938.
And It was during these reforms that the Federal Housing Administration stepped in with an insurance program on mortgages, an amortization plan, and terms of 15-20 years.
These new programs got some major fuel after World War II, when the low-rate and low-down-payment federally subsidized mortgage helped millions of returning veterans into homeownership.
And the scale started to tip towards home ownership over renting as the new norm.
Home Prices Don’t Always Go Up
And we took this concept of home ownership one step further.
Not only is homebuying the norm and the American Dream. It’s a great investment as well!
Because home prices always go up, right?
For many of us who have limited experience with real estate, this may seem like a factual statement.
Just look at the real estate market right now. At the time of this article, home prices are at record high. And this doesn’t look to be slowing down any time soon.
However, when we step back and look at history more broadley, things aren’t so clear cut.
Based on one of the most widely cited home price index, the Case–Shiller index, when we expand out a 100 year time period, there were several times in history when we had sustained periods of low home price. And this is looking at the overall national average.
When you break down the data to individual regions, the disparity between cities is quite prominent. Yes, if you purchased a home in Miami or Los Angeles, your house might be worth more. But what if you purchased a home in Cleveland or Detroit.
I’m not saying you shouldn’t live there because I’m sure they are lovely neighborhoods.
But we should be careful to jump to conclusions that home prices will always go up because the homes in our neighborhood went up in value the last 2 years. It’s a limited view of a bigger picture.
Real Estate History Takeaways
There’s a lot that I covered. So, thank you if you stayed with me so far. I wanted to give some broader context to home ownership before we delve into some actionable steps.
The main takeaways so far is to recognize that:
- One – home ownership is not a must. If renting works out better for you because you enjoy the flexibility, you shouldn’t be pressured into buying a home because everyone says to.
- Two – but if you do want to enter into home ownership, do not look at it as an investment because you believe home prices will always go up. Categorize it as a purchase. And I want to differentiate the actual investment property vs. home you are going to live in. In this case, I’m talking exclusively about the home you are going to live in.
Home Buying Checklist
Alright, now that we have that out of the way, let’s get into the good stuff. 6 Action Steps I recommend you take before you purchase your home.
1 – Get Your Debt Under Control.
First, even before you consider buying a home, is to get your debt under control.
You might be thinking? What?? I thought we were going to start looking at house curtains. What are you talking about debt?
Let me explain.
When you apply for a mortgage, the bank or the mortgage broker will ask you about your monthly debt obligations. This includes car loans, student loans, credit card debt and any other debt you have under your name. The reason is because they are trying to calculate your “debt-to-income” ratio. The amount of debt you have in relation to your income. If your “debt-to-income” ratio is high, the bank will consider you at high risk for future default.
So if you don’t have your debt under control, you’ll be hard pressed to find a bank willing to issue you a mortgage. There are institutions that will give you what’s known as “nonconforming loans.” Mortgage that does not meet government standards. They aren’t insured by the Federal Government and will have a higher interest rate. I highly recommend steering clear of them. There is a reason why they don’t meet government standards.
Instead, get your debt under control so that when you do start shopping for a mortgage, you are looked at highly favorable.
2 – Fund Your Emergency Account
Two is to fully fund your emergency fund.
I know. You want that home. But I need to ask you, “do you have a fully funded emergency savings account?” If you don’t yet, please pause. And no, your emergency fund is not your down payment.
We all have unexpected financial setbacks. Someone loses his or her job. Someone gets sick. The car needs new tires.
And when you own a home, the number of unexpected events just multiply. I can’t recall how many times something in our house broke.
It’s the water boiler one month. Then the roof starts leaking. And at the same time, my son suddenly has 7 cavities. ***not my fault*** clip
Neither our homes nor our lives are predictable. Be prepared. Fund your emergency fund first. Then start the process of purchasing a home. If you buy a house without an emergency fund, you are not only increasing your financial risk, but risking all the people that might be dependent on your decision.
3 – Know How Much You Can Afford
Third on our list is to know how much you can afford.
We’ve all experienced shopping at Target without a list and without a budget.
I don’t know what happened. I just walked in with intent on buying milk and for some reason I walked out with a new pair of shoes for my daughter and a new playstation… for my son.
Experts recommend spending no more than a third of our take-home pay on housing costs. If we can do less, much better.
Housing is one of the most expensive expenses in our budget. Therefore, if it’s more than we can comfortably afford, it can leave us financially vulnerable when something inevitably goes wrong.
A good way to start what you can afford is to get your mortgage pre approved by a bank before looking at homes. A quick caveat, just because a bank says you can afford a million dollar home based on your debt to income ratio doesn’t mean you should get that much for your mortgage. It’s just a rule of thumb to start out with.
Also, by having a budget to start out with, you won’t be pressured by real estate agents who work on commissions. They stand to make more money by persuading you to buy something more expensive than you intended. This is not to say all real estate agents will do this. I’ve worked with some great ones who respected our budget. But understand what everyone’s incentives are.
Also, some might try to persuade you to buy by saying if you don’t buy a house right now at this price, you won’t get another chance. I recommend finding a new real estate agent. Remember, you are in control. If you have a budget, you know what you are looking for, so don’t let others make the decision for you. Only buy when everything on your list checks off, including the price.
4 – 20 Percent Down Is Best
Fourth is to put at least 20% down.
I know, for those of you who may be living in high cost of living areas, this is a tough order.
But know that more money you can put down, lower the financial risk you are putting on you and your family.
Not only will you have lower monthly mortgage payments. But by putting at least 20% down, you are avoiding what’s called Private Mortgage Insurance, PMI.
Banks want to minimize the risk of lending money on their end. So for people who put less than 20% down, they tack on PMI to protect themselves against the chance that they might default on their loans. Essentially, if you are putting less than 20% down, banks believe you are more likely to default.
PMI can range from 0.5% to 1% of the loan amount per year. If you take out a $500,000 mortgage with a 1% PMI, you are liable for $5,000 annually on top of your monthly mortgage payment. That is additional $417 per month.
I don’t know about you, but that extra PMI makes me cringe.
Aim for at least 20% down.
5 – Stick to Fixed 15 or 30 Year Mortgage
Number 5. Stick to a fixed 15 or 30 year mortgage.
If you are comparing at initial interest rates, it might be tempting to get an Adjustable Rate Mortgage, ARM. That is a mortgage that begins with a lower interest rate, but can increase after a set period of time. You might be thinking, I’m only going to be in this home for 5 years, might as well take advantage of the lower mortgage rate.
True. You can lower your initial monthly payments by getting an ARM. But know that there is a risk. At the time of this article, the interest rates are near historic lows. There is a serious risk that your ARM could eventually cost you more. Maybe much more.
As the Sandwich Generation, you are busy with trying to manage a full household. Why bring more complexity and uncertainty into your life?
It’s hard to forecast where our life will be in the next several years. Our plans and circumstances can quickly change.
Go with a traditional 15 or 30 year fixed payment mortgage with 20 percent down. If you are struggling to afford that, the chances are your budget might be stretched too thin. Don’t allow yourself to be financially vulnerable.
6 – Shop Around For Mortgage
Number 6 is to make sure you shop around for mortgages.
Consumer Financial Protection Bureau report finds nearly half of borrowers do not shop for a mortgage. Instead we settle for our home bank or the lender that sent us the latest mailer.
Comparison shopping is crucial. Mortgage brokers do not have a fiduciary responsibility to pursue your financial interests. They might have incentives to sell certain mortgage products because that’s the company’s bottom line priorities for that month.
Shopping around gives you a broad perspective on the mortgage market and you can see the trending rates.
To verify if what the lender is quoting sounds reasonable, you can also check out Freddiemac’s latest Primary Mortgage Market Survey. I’ll have a link in the description below.
Getting the right interest rate is probably one of the biggest financial decisions you can make in your lifetime. On a $500,000 30 year mortgage, a 1% interest rate can mean the difference of $94,000 in interest paid over its lifetime. That’s a lot of money.
We spend hours figuring out which Amazon seller has the best water bottles. The least we can do is invest the same amount of time selecting the best mortgage provider.