It’s really not that complicated.
If you have been renting for a while or living at your parents’ house, this question may have crossed your mind, “Should I buy a house?”
When you are moving to a new stage of life, see those beautiful homes on HGTV or, when you drive by a very charming neighborhood, you just can’t shake the feeling that you want to have your own home.
When you call your realtor friend, the first thing she asks you is, “Are you pre-approved?” You have no idea what she’s talking about and start to feel the tension of the process. You are back to square one — confused, scared, and back to procrastination.
Don’t worry. I got you covered.
To discover if you should buy a home or continue to rent is easier than you think.
According to a joint study of The National Association of Realtors and Google, 52% of first-time homebuyers start their search online. It is important to know the market and, diving into the reports, and charts are necessary. However, there is one thing homebuyers always forget — your own needs and ability.
Believe me, knowing this upfront can save you a lot of time, and money.
Here are five simple steps to get you started:
Step 1 — Your “Why?”
Ask yourself why you want to buy a home. These are some common reasons:
- You want more space and privacy
- You are sick of dealing with landlords
- You have a growing family
- You want to start building equity instead of paying for your landlord’s mortgage
Knowing your why can help you focus on what you are looking for and better communicate it with your mortgage loan originator and realtor.
Step 2 — How Long?
You should also have an idea of how long you are planning to live in the house. This is so crucial, yet nobody talks about it.
Buying and selling a house costs money. Lots of money. Closing costs for purchasing a house can range from 2% to 5% of the sale price. The cost of selling a house can range from 6% to 10%. Even if you include the appreciation rate, you will still need several years to recoup the costs.
Below is an illustration I ran on Nerdwallet’s Rent vs. Buy calculator. Every scenario is different, so please do this based on your specific situation.
Say, you are looking to buy a house in Los Angeles with a purchase price of $580,000 and planning to put 20% as your down payment. After adding in all related expenses (mortgage payment, property tax, insurance, repairs, renovations, buying closing costs, selling closing costs, etc.) with an estimated 3% annual appreciation rate and 15% capital gains tax rate (please consult your own tax preparer), your breakeven point is on year 3.
(Nerdwallet - Rent vs. Buy Calculator)
Here are the variables I used:
Based on this scenario, if you are planning to live in your home for over 3 years, great! If not, it doesn’t necessarily mean you should stop looking to buy a house. There are other solutions, for after you move, such as renting it out. This is a fantastic way to help you build equity using other people’s money!
I once met an engineer from Taiwan. His job takes him to different parts of the world — from Taiwan to China, then to the US. Every time he moves, he buys a new home. When he leaves, he rents it out. He is now 53 years old, and he owns a total of 12 houses on two different continents that are all generating positive income for him.
Step 3 — How Much?
It’s time to dig into your finances. Come up with how much money you can bring to the closing table. It can be your personal savings, investments, retirement funds, life insurance or even, a gift from family.
The minimum down payment required for a conventional loan is 3% to 5% (it may be temporarily higher because of COVID-19). There are also special loan programs that provide down payment and closing cost assistance.
If you are able, put a higher down payment than the minimum requirement. It can reduce the total cost of financing, give you a better interest rate, and lower your monthly expenses. I understand the power of leverage, but there’s a fine line between optimal-leveraging and over-leveraging.
Although a lot of lenders do not require you to have reserves, consider setting aside emergency funds. I usually put away at least 3 to 6 months of my monthly expenses. And now, after seeing what COVID-19 can do to your bank account, I raise it to 6 to 8 months.
Step 4 — Monthly Budget
I encourage you to know this number and stick to it. There are a lot of tools online to help you with budgeting.
Don’t just look at what your lender is comfortable with, look at what youare comfortable with. At the end of the day, you are the one who is making the payments. Every household has different spending habits and financial needs. A family of four with two young children budgets differently than a one-person household.
After knowing how much you are comfortable spending a month, you can go a step further to understand how lenders look at income and expenses. The most common measure lenders use is the debt-to-income ratio (DTI). This is one of the most critical measures your lender will look at, so it is useful to understand the concept.
Don’t worry if you find this part challenging. I am sure most mortgage loan originators are happy to help you figure this out.
The DTI compares your monthly debt payments to your monthly gross income. Usually, your lender would like to keep this ratio below 40% to 50% depending on the loan program, and where we are at in the economic cycle.
This is the formula to calculate DTI:
(PITIA + Verified Monthly Debt)/Verified Income
Let’s break it down.
- PITIA of the new house = Principal + Interest + Monthly property tax + Monthly home insurance + Homeowners association fee
- Verified Monthly Debt = Monthly payment of all the debts you owe, e.g. car loans, leases, student loans, credit debts, personal loans, etc.
- Verified Income = Income lender can verify and is calculated based on the lender’s guidelines
Using the example under Step 2, here’s what the DTI calculation looks like:
Always check with your mortgage loan originator, because different lenders may look at debt and income differently.
Step 5 — Your Experts
After going through Step 1 to 4, and if it still makes sense for you to buy, it’s time to talk to the experts!
Start with talking to your mortgage broker (or a direct lender) and get pre-approved. The pre-approval process involves a mortgage professional collecting and reviewing your financials, so you know how much you can borrow.
Once this is done, you get to the exciting part — house hunting!
Talk to your realtor, so she/he can provide insights about neighborhoods and recommendations based on your budget and needs. Your dream home is now on its way.
Going through these steps is vital because it can guide your thoughts and eliminate the “noise”. There are always people who think it’s a great time to buy, and people who think it’s a terrible time to buy. The determination should always be based off your own needs and abilities.
Message me or set up a 15 min call with me for further mortgage-related questions.
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Disclaimer: All information provided is for informational purposes only and does not constitute professional advice. Please contact an independent professional for advice regarding your specific situation.