Buying a house is one of the biggest financial decisions you can make. It requires significant cash upfront and usually includes signing up for 15 or 30 years of monthly payments before you own the house outright.
But it’s also often seen as one of the best ways to build long-term wealth.
Before shopping for your dream home, be sure you understand the financial aspects so you’ll feel confident that purchasing the property is the right decision.
That can make the difference between feeling comfortable in your new home and feeling underwater.
You may not be able to afford what you want
There’s a difference between what the bank tells you you can afford and what you can actually afford month-to-month.
Sit down and create a housing budget detailing all the costs you’ll pay, including property taxes, utilities, homeowners association fees, maintenance, insurance, and other regular expenses.
Then, work backward from there to decide what’s a realistic monthly expense.
You should improve your credit score
Your mortgage lender will look at your credit score and report to determine what you can afford and approve you for a home loan, so make sure your credit score is top-notch.
You can do that by paying your credit card and bills on time and maintaining a maximum debt-to-income ratio of 43%. You can get a free credit report from Equifax, Experian, and TransUnion once a year.
You need to pay down your debt
Part of a bank’s calculation for how much money it will lend you involves your debt-to-income ratio. Before you go house hunting, pay down as much debt as possible.
Add up car payments, student loans, credit card debt, and any other monthly debt commitments you may have. Take on extra work if you’re looking for ways to pay off your debt.
Preapproval can tip the scales
Before your Zillow scrolling turns into making an offer, you will want to have a mortgage preapproval from a bank or credit union.
When you go through the preapproval process, the lender will verify your income and employment, check your credit report, and review your financial health.
The lender will then give you a letter spelling out the amount and type of mortgage you can get. When you find the home you want, you can act quickly in this competitive market to make a deal.
You may pay PMI with a lower down payment
While programs exist to help first-time homebuyers who may not have the cash on hand for a 20% down payment, there are still downsides to making a smaller down payment.
If you put down less than 20% of the home price, you may have to pay private mortgage insurance (PMI).
This will be in place until you reach 78% to 80% equity in the home, which you would have had with the 20% down payment.
Closing costs aren’t cheap
The down payment isn’t the only cost you’ll pay on closing day. Closing costs can also run up your bill that day, thanks to title insurance, property taxes, and other fees.
Expect to pay 2% to 6% in addition to the down payment. It's possible to include closing costs in your loan, or you may want to take advantage of first-time homebuyer programs that assist with these costs.
You need extra money beyond the down payment
You may want to pour every penny into the down payment, but it’s important to have a savings account specifically for repairs and expenses that may happen after you’ve moved in.
From a kitchen appliance that breaks on move-in day to an HVAC that gives out before its time, you’ll be glad to have a rainy-day maintenance fund from day one.
You need to do your loan research
Beyond the fun research, like looking at neighborhoods and deciding if you prefer a fixer-upper or a new build, you also need to do your financial research.
Banks, credit unions, or mortgage lenders may have different rates, types of mortgages, and other terms. It’s up to you to determine which mortgage will be the best for you.
Remember, this loan may be with you for 30 years and could impact your finances.
A backup lender can be a wise decision
After all the excitement leading up to closing day, the last thing you want is for the loan to fall apart in the final hours. That’s why some experts recommend having a backup lender on standby.
Get a preapproval with that lender so that if you need to lean on them and switch midway through the process, you’re already prepared to keep things moving.
Property isn’t a retirement plan
You may be watching the property values in your neighborhood tick up, and you’re thinking that investing in a piece of real estate would be a surefire way to build wealth for your retirement.
That can be true, but it’s also not a liquid asset; to tap into that value, you have to sell the house. Is that a contingency you want in place for retirement?
In addition to signs of financial fitness like saving money in investments and a healthy emergency fund, there are other economic realities to face when buying a house. It’s a huge commitment and one that will make a dent in your cash on hand.
But it can also be a way to build long-term wealth. Using first-time homebuyer programs and creative ways to pay your mortgage, the investment can be worth it if you go in with open eyes.
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