If you have dreamed about owning your own home one day, you’re not alone. Part of American culture has been built upon the image of a house with a white picket fence. In fact, government loan products were created such that it can be easier for more individuals to buy homes to fulfill those dreams even if that means taking on larger payments. It’s important, however, to make sure you have enough monthly income and initial savings to afford a home purchase.
How much is needed? What does this process entail? Depending on where you reside, or plan to purchase your home, the amount you’ll need can vary wildly. In order to understand what is right for you, let’s dive into the home buying process.
What are the basic steps to buying a home?
- Determine how much you have saved, today. Take a look at your savings, subtract out retirement funds, emergency savings, and any shorter term money (think wedding, new car, or big trip). This is your current available money to purchase your home.
- Figure out how much down payment you can afford, today. Unfortunately, the down payment is usually the largest hurdle for most people even if you have a high income. A down payment can involve years of savings. To buy a home you will need ~22% of the cost of the home available in cash when you purchase. The standard requirement to avoid mortgage insurance is a 20% down and then there will be an extra 1-2% for closing costs. Depending on where you buy and which lender you go through, you’ll need anywhere from 1-2% of the value of the home as a fee for distributing the loan to you, known as the closing costs.
As an example, if you have $50,000 available to devote to a home purchase you can. buy a $230k home.
Also, we don’t recommend utilizing all of your savings for the down payment either. Remember you’ll need to retain enough cash to cover your emergency savings fund after you buy your home. Not sure how much to hold back? This article will help you. figure out the appropriate amount. If you have other goals in the near term we’d. suggest keeping even more of your assets available, remember children, wedding and. college are all very expensive!
- Start to look online or with a real estate agent at properties you may like. This will help you determine what the cost of your ideal home will be. You will learn from this process if you need to expand your search to other neighborhoods or even states. As you explore, we are first determining if we have 22% of the expected purchase price.
- Confirm your salary covers the mortgage and property taxes and insurance. Once you know you can afford the down-payment, we need to make sure you can cover the monthly costs. We’ve created a housing analysis tool to help you determine how much the housing costs would be for your ideal home.
We recommend that your total housing costs not exceed 28% of your gross income. This ensures you can pay for your daily living expenses and still save for your future.
- Get prequalified. If you’re ready to move forward with purchasing, get prequalified to confirm you are eligible for the mortgage loan and for what amount. Shop around with multiple lenders so you can get the best rate. As a note, you don’t need to buy a house up to the maximum you are prequalified for, in fact we’d recommend against that.
What if I can’t afford the home today?
Don’t worry, you're not alone. Typically when the idea of buying a home jumps on your radar it’s still a few years (or more) before it can become a reality. If you fall into this boat, here are a few things to do:
- Determine how much more you need to hit your down payment goal. If you have $50k today and you know that your home will be in the range of $500-800k then you are between $60k-$126k off from your downpayment goal.
- Open a home-saving goal and save monthly for your target. It’s important to still focus on retirement savings and other critical short term goals during this period so every penny shouldn’t go into the home goal. Instead evaluate other short term goals (do you have a big trip, a wedding or old car that might require cash?) and save any additional money not earmarked for those goals. If you are looking to buy the home in less than 3 years you should not invest these savings. If it’s between 3-5 years you may use very conservative investments like bonds. If your timeline is longer than 5 years you can utilize slightly more volatile investments but remember, the closer you get to your goal the less volatility you want.
What other costs should I account for?
When you’re estimating the other costs of homeownership it’s important to evaluate the current property tax and how property tax is assessed annually. For example, in Texas, your property is re-evaluated annually and therefore your property taxes could increase if the value of your home increases. In California, the property tax is based on the purchase price plus inflation.
Additionally, home ownership can be expensive to maintain. You will want to plan for annual expenses like a new water heater or stove. It’s important to account for a few thousand dollars a year in maintenance costs.
If I have enough should I put more than 20% down?
This comes up periodically or in the form of “should I try to pay down my mortgage faster than 30 years?” If you are young and relatively far away from retirement, there is no reason to put more than 20% down if your interest rate is under 5%. The additional dollars you put towards the down payment typically won’t significantly decrease your monthly payment (which might be your rationale for putting more down). Feel free to mess around with putting more down in our Housing Analysis tool and see how it affects your mortgage!
Also, the cost to borrow money is 5% (or lower) in this scenario. If you can borrow at less than 5% and invest the money elsewhere and make 7% or 8% that is a better use of those dollars. Lastly, your home is what is considered an illiquid asset which means you can’t easily convert it to cash to use for expenses like college or a car. We don’t want you to tie up too much money in an illiquid asset if you will have other expenses that require additional cash.
Does home ownership grow my net worth?
It’s important to know that while adding a large asset to your net worth may seem like the next step in life, it’s not always the most economical. Why? Not all homes will appreciate as much as a stock investment would and your home is not liquid as we mentioned above (i.e. you can not sell it immediately if you want or need to). Your stock investments can be easily sold and used to pay for expenses in retirement, your home can’t. These cautions apply to individuals who are buying a home and utilizing most of their savings to do so. If you’re having trouble saving to make a down payment on a home, renting may be the best option for you. You don’t have to own a home to reach the American dream, in spite of what might be ingrained in our culture.
How can I get help with deciding what is right for me?
Reach out to your Origin planner. We can help you evaluate your goals and see how a home purchase fits in.