I know my posts have been a bit few and far between lately, but real life (getting engaged, and now looking at buying a house) has gotten in the way of my online ventures. In this post, I’d like to tell you my thoughts on the house-buying process from a frugal person’s perspective.
When Should I Buy a House?
The answer is: when it makes sense for your lifestyle, and you have enough money to support it. You shouldn’t buy a house unless you plan to stay in it long-term (meaning at least 7 years, generally) because of the money you lose in the initial house-buying transaction. “Lose money?” you ask. “I thought one of the main reasons to buy a house was to build capital, instead of throwing it away on rent!” While that’s partially true, you still incur closing costs (this is stuff like origination fees to your mortgage lender, inspection fees for the property, and so on) which can be substantial, often 2-5% of the purchase price of the home. If you know you’ll be moving in the next couple years, a house is likely not for you. However, if you think the details of your situation might still justify homebuying, check out this awesome rent vs buy calculator. Children are another major lifestyle factor that can push people to buy a house–but did you realize you can also rent a house? If you have kids, and won’t be staying in one area for very long, use the aforementioned calculator to figure out if buying or renting is better for you financially. The answer may surprise you!
How Much Should I Spend on a House?
The conventional advice on this is to only buy as much house as you can pay a 20% downpayment on. However, with interest rates being as low as they are (around 3-4%), it could make sense to buy now rather than later. Be aware that any time you don’t have a 20% downpayment, you’ll pay PMI (prime mortgage insurance) to your lender. This is their way of protecting themselves in the event that you fail to pay back your loan. The amount varies, but might be between 0.5.-1.0% of the home price per year, depending on your credit score.
Some of my coworkers just bought homes with a 5% downpayment. To me, this felt way too risky, not to mention they’d be paying PMI for several years because of their low downpayment amount. I felt more comfortable with the 10% downpayment that I’m planning to make–and even that was a stretch for me. I think ideally I would have had 20%, but my life circumstances were such that buying a home right now made a lot of sense for me (it’s very likely that I’m staying in the same place for several years, I’m going to be married soon and want the experience of sharing a home with my spouse, interest rates are low, and the real estate market in my city is very hot right now). Honestly, waiting until next summer could have wound up being the slightly smarter financial decision (we’ll see how the numbers pan out in the long run), but now is a great time in my life to do this, and it was something I really wanted. I encourage you to strive for 20%, but if you’re not quite there yet by the time house buying makes sense for you, I feel like you can fudge that a little.
The other consideration in determining how much house you can afford is your monthly budget. If you don’t yet have a budget, now is the time to make one. Figure out how much you spend each and every month, and also figure out how much income you make. Try to figure out how much a house will cost you each month–don’t forget property taxes, HOA fees, PMI, principal and interest mortgage payments, and maintenance. If you have trouble with this, try asking for a quote from a mortgage lender–they will usually outline this for you. As a rule of thumb, it’s recommended that you don’t spend more than a third of your income on housing each month.
How Do I Prepare Financially for House Buying?
Make sure your credit score is in the best shape possible. This is the one time in your life that credit score can save you thousands and thousands of dollars, so whip it into shape before applying for a mortgage. Don’t apply for any credit cards for at least 6 months before applying for a mortgage. Keep the balances on your credit card accounts low in the month or two before applying. Keep your last two month’s worth of checking and savings accounts clean of big, suspicious-looking transactions (such as unexplained deposits more than $5,000) or at least have these transactions well-documented and explained.
Scrimp and save for that downpayment–but make sure you don’t use your emergency fund toward it! When you own a home, everything that goes wrong with your property is your problem and your problem alone. If you move in and a hail storm hits, guess who gets to pay to fix the roof? You! Your emergency fund should be a saved amount of cash worth 3-6 months of your normal expenditures with your new housing situation included in those expenditures.
Other Tips and Tricks
- If you live in a city that has a thriving real-estate market, real-estate agents are in competition with one another. Use this to your advantage–ask your agent for part of their commisssion! Buyer’s agents get 3% of the selling price at closing, that’s how they get paid. It’s not uncommon for agents to give a percentage point or two back to the buyer at closing! A friend of mine even skipped the buyer agent alltogether and approached the selling agent directly–when there’s no buyer agent, the selling agent gets the full 6% commission, making them more likely to give you a slice of the pie. This is not for house-buying newbies though, as it might be worthwhile to have someone on your side who understands the process, too.
- When figuring out how soon you’ll be able to pay down PMI, or the loan itself, check out mortgage amortization calculators. These show you the value of your loan principle (the amount you actually owe) every month given a certain monthly payment (which goes partially to interest, partially to principle).
- Many financial independence bloggers support the idea of paying down your mortgage ASAP. However, with current interest rates around 3-4%, you might be better served making minimum payments and throwing the extra money into the stock market for a closer to 7% return in the long run. This decision largely rides on your risk tolerance and debt aversion. If a guaranteed 3% return is better than a likely 7% return to you, or if being in debt gives you the willies, maybe you’re someone who should pay down their mortgage faster.
Do you rent or own your place of residence? Have you ever bought a house, or thought about what it would be like?