First Time Home Buyer? (Part 1)
Buying your first home can be terrifying. You aren't sure where to start, you aren't sure what to look for, and you aren't sure what the next steps may be. We sat down with our friend Lacey, real estate investor and first time homebuyer, to discuss what to know before you buy a home. She told us that there are some preliminary steps to decide if home buying is right for you. She stated many people think it's the right time to buy but there are many factors that may not make that true. She gave us 5 factors to be aware of before buying:
1. Price-to-Rent Ratio
Price-to-rent is how expensive it is to buy a home compared to renting. Many cities have an extremely hot real estate market currently and it may make more sense to rent than to buy. This all depends on where you live. Also, Lacey notes, as a rule of thumb that you should plan to be in a home more than 5 years so that buying is a good financial decision with all the fees associated. Here's how you find out if you should rent versus buy:
The Equation: The median price of home you're looking for / (average rent *12) = price-to-rent ratio
Example: $200,000 median home price / ($1,000 rent * 12) = 16.6
- Price to rent ratio of 1 to 15 = better to buy than rent
- Price to rent ratio of 16 to 20 = could be a risky buy
- Price to rent ratio of 21 or more = better to rent than buy
2. Consider Other Costs
Many people look at the downpayment and monthly mortgage costs however, there is a whole slew of other costs associated with buying a home. What are they? Realtor fees, title change, home inspection, transfer taxes, closing costs. That is quite a hefty list. You need more in the bank than you think to buy a house. You don't want to go into a home cash poor and plan on renovating if these other costs will break your bank.
- Closing costs = 2-5% of your home cost
- Home inspection = $300 average
- $200,000 home you can expect to pay an additional $4,000 - $10,000
3. First time home buyer loan (federal program)
Finally a program to know that might be in your favor! The First Time Home Buyer Loan or FHA loan allows you to put 3.5% down instead of the usual 20% to buy a home. We advocate you put 20% down however, this is still an option you should be aware of when buying a home. Here are the qualifications:
- 580 credit score minimum
- worked with the same employer for the past two years
- full requirement list found here
4. Shopping around for a mortgage
You know you can shop around for a mortgage, right? You can shop, compare, and negotiate with lenders. Your first conversation does not have to be the lender you choose. You can obtain a loan from thrift institutions, commercial banks, mortgage institutions, and credit unions. Speak to at least 2-3 lenders before you choose. Questions to keep in mind:
- Ask for the list of current interest rates and whether the rates quoted are the lowest for that day or week
- Ask if the rate is fixed or adjustable
- Ask for an itemized list of fees - what does each fee include? (loan origination or underwriting fees, broker fees, and closing costs
5. How much can you actually afford?
Even though you may be approved for a high mortgage doesn't mean you can afford it. Remember, these companies are in it to make money and not look out for you and your family. The more that you borrow = the more you owe. Focus on monthly cash flow, what can you afford to spend in a month? Once you have a reasonable budget, find a mortgage that fits that.
Up next: Once you have decided to buy, what are the order of operations?