You’re thinking about buying a home, that’s very exciting!
Home ownership has always been an integral part of the American Dream, and home values account for a large portion of many Americans overall net worth.
With that in mind, it makes sense you want to buy a house, and I want to help you successfully do it.
I say successfully because there are ways to buy a house unsuccessfully. There’s a good chance the purchase of a home will be the biggest one you ever make. Buying “too much house” and becoming “house poor” is what I want to help you avoid.
Making a bad decision and buying too much house hurts more than other bad decisions. This is because the mortgage you use to purchase the house will probably last for 15 or 30 years.
So a bad decision will not only stay with you for a long time, it will also prevent you from pursuing other financial priorities.
Buying a home can also be a confusing and intimidating process, and I want you to go into it understanding every step along the way.
I want you to be happy. I want you to be financially successful. I want you to have the life of your dreams. Therefore I want you to make the right decision on what could be the biggest purchase you’ll ever make. That’s my motivation.
There is a lot of information available to us, and most everyone has an opinion about real estate. It’s my goal to help you cut through all of it and to share the wisdom I’ve picked up over the years as well as my 20 plus years as a financial advisor.
It’s also important to know that my approach may not be easy. But it’s the correct one.
Here’s what we’re going to cover:
- We’ll make sure you’re ready financially to buy a house
- We’ll make sure you understand the total costs of owning a house
- We’ll get you ready to start the home-buying process
- We’ll help you understand the six steps of the process
- We’ll help you implement and buy your house
Are you Ready?
Are you ready to buy a house? I want to make sure you’ve got your i’s dotted and your t’s crossed.
The first thing I want you to check on is your credit score. To be ready to buy a house, your minimum credit score should be 620. That’s because having a score of at least 620 will allow you to qualify for a conventional mortgage, more on this later.
Now, I want you to do two things. The first is to get a copy of your credit report which you can get from sites like FreeCreditReport.com. There are a lot of sites you can get yours from, this is just very easy to remember.
It’s important to look at your credit report because often, there are discrepancies that need to be taken care of. In fact, it’s estimated that 40 million Americans have discrepancies on their credit report. Negative items need to be removed as soon as possible.
The next thing is to check your credit score. You can obtain your score by contacting any of your current lenders like credit card companies, auto loan, or student loan providers.
Once you know what your score is, you can go about increasing it if necessary.
If you’d like some help getting your credit report cleared up, one of our Academy Partners, Dovly, has a free program that can help. You can find the link in the Additional Resources section.
Now it’s time to talk about how much you should save for your down payment.I want you to be happy. I want you to be financially successful. I want you to have the life of your dreams. Therefore, I want you to make the right decision on what could be the biggest purchase you’ll ever make. That’s my motivation for writing this.
A $0 down payment is a lot easier than a 20% down payment. In the short-term.
Over the long-term, the approach I advocate will be far better for you. So stay with me.
Why a 20% down payment, can’t I do it for a lot less?
Yes, there are programs that require smaller down payments, but that’s not the whole story. When deciding which loan program is right for you, it’s important to weigh all the costs, not simply the down payment.
It’s important to understand the concept of basis points, which is how banks and financial institutions make money. 1% equals 100 basis points (kind of like how $1 is 100 cents). When evaluating different loan options and large numbers, we can sometimes lose sight of how small amounts can become big amounts over time.
Programs which require smaller down payments often have higher expenses (more basis points) over the entire life of the loan. For example, if you choose to go with an FHA mortgage instead of a conventional mortgage, you’ll pay 1.75% at closing and up to an additional 1.05% every year.
Odds are, you’ll also have to buy Private Mortgage Insurance (PMI) which can be up to 2% every year.
Again, these small amounts add up to big amounts over time. Putting 20% down allows you to avoid many (if not all) of these costs. It also means you’ll pay a lot less interest because you’ll have a smaller loan amount. Your payment will also be a lot less.
Next, I want you so save six months worth of monthly expenses.
Why six months?
I told you I wanted you to be financially successful. The only way to achieve financial prosperity is to first have financial security. Six months of expenses provides that.
Six months is a fully funded emergency fund which is there in case you need it and will be enough to absorb most of the common problems life throws at us.
Please keep in mind I’m not talking about your current expenses. I’m talking about what your expenses will be once you own the home. This will be included in the planning process later.
Understanding total costs
All too often, we only think about the cost of a home in terms of the mortgage payment. It’s really important to understand the total cost of home ownership so you can make an informed decision about how to move forward. Spoiler alert, it’s going to be more than you think.
Obviously, there’s the cost of the mortgage.
You’re also going to need homeowner’s insurance.
You’ll have to pay property tax every year as well.
If there’s an HOA, you’ll be responsible for that as well.
You should be able to estimate what the monthly utilities will be.
Then there’s the regular monthly costs of maintaining the property like landscaping and cleaning.
Finally, the most difficult and often largest expenses are those which are unexpected. Having to fix a roof or replace an air conditioning unit can be very expensive.
So, when making the decision about which house to buy, it’s imperative to take all potential costs into consideration.
To help determine how much you should be spending on a house, the 28% rule is helpful. This rule tells us a household shouldn’t spend more than 28% of it’s gross monthly income on housing expenses. Gross monthly income means pre-tax and pre employee benefits. So, add those deductions back into your paycheck and that’s the number to work with. Determine the total cost of the home you’re considering and see if you’ll be within 28%.
Another helpful rule of thumb is the 36% rule. This rule tells us a household shouldn’t spend more than 36% of it’s gross income on debt service. Meaning housing costs and car loans, student loans, credit card debt, etc. As you’re evaluating options, make sure you’re within the parameters of this rule.
I want you to avoid living paycheck to paycheck. Spending too much on a house and taking on too much debt can lock you into a vicious cycle of debt that keeps too many Americans trapped.
The cost of making a bad decision can be higher than you think.
Have you ever heard the expression “house poor” which I mentioned in the introduction? It simply means someone bought a house that was too expensive and it’s consuming all of their money.
I don’t want you to be house poor.
Are you at risk of falling into this trap? If you opt for a lower down payment and don’t have six months worth of expenses saved, I believe you are.
Buying a house is the largest purchase most of us will ever make and it’s an important one. We do it in partnership with banks who lend us money. Commonly, the term is 30 years and sometimes 15 years. That’s a really long time.
If you make a bad decision and become “house poor,” that bad decision will haunt you for a long time.
It can prevent you from doing other important things such as saving for retirement, helping kids with college, and can even stop you from taking vacations.
We all have a finite amount of money. When we allocate it to one place, it means we can’t put it to work somewhere else. That’s known as opportunity cost.
Why do I bring this up? Because the people selling crappy mortgage programs want you to buy from them. They entice you with talk of zero down payments and low rates, but don’t tell you about the fees and expenses that I talked about earlier. They also don’t tell you about opportunity cost.
The reality is this; if you can’t save up a 20% down payment and emergency fund, you can’t afford to buy a house.
How to Get Ready
Let’s talk about getting ready. To be ready, you’ve gotta know your facts. In terms of personal finance, your facts are your cash flow, budget and goals. Consistently reviewing your cash flow can help you avoid spending money on things which are no longer serving you.
Setting up and maintaining a personal budget increases your chances of reaching your financial goals and objectives. Taking the time to think about and write your goals has been proven to increase your odds of achieving them. You can access our Goals Course at no cost when you’re ready to dig into this.
Getting out of credit card debt before you buy a house is a really good idea. Not only will it increase your credit score, it’ll give you peace of mind.
If you’d like help creating a plan for getting out of credit card debt, you can access our Get Out of Debt course at no cost.
Knowing your financial goals and priorities, and setting those plans in motion prior to buying your next house will also set you up for success.. Set short, mid and long-term financial goals and get on track to meet them. This means knowing how much you need to be contributing on a monthly basis to reach them, and to be doing it.
Doing these things will position you for financial success today, 10 years from now, and 50 years from now. And again, that’s what I want for you.
It’s important to have a firm understanding of the difference between needs and wants, and how that applies to your personal budget.
Needs are the things you can’t live without like housing, food, clothing and transportation to name a few.
Wants are things that accentuate your life like mansions, eating out, designer clothes and fancy cars.
As you’re going through this process and you recognize you’re running short of funds to accomplish everything you want, you may need to make changes, keeping in mind needs and wants.
Are there areas you can cut back on to free up some money? If you’re having a hard time deciding to make cuts, keep this in mind; these cuts won’t be forever. You’ll make the necessary cuts in order to position yourself for long-term financial success.
Once you’ve paid off debt and gotten on track to meet your goals, you can go back and choose to add back the things you cut.
Make the commitment to go through the process of thinking about and setting goals. Create your plans and put them in motion. Once you’ve done those things, you’ve put yourself in a great position.
Understanding the Home Buying Process
Let’s get into the six-step home buying process.
There are four important to keep in mind as you embark on your process. The first is to be clear in your expectations. Frustration happens when our expectations are not met, so be proactive in sharing what your expectations are with everyone involved in the process.
The second is to keep communication open and honest. Make sure you’re letting your thoughts and feelings be known, as well as getting any and all requested information back to the professionals you’re working with in a timely manner.
Being prepared for each step will also ensure the process moves as smoothly as possible.
And finally, be patient. This will be an emotional process, so go into it with that in mind, trusting everyone is doing the best they can.
There are a lot of people in involved in the home buying process.
Obviously, you and your family. You’ll need to select a loan officer to help you secure a loan. You’ll work with a Realtor to help you buy the house. You’ll work with title and escrow officers to close the deal. Underwriters will be part of the loan process. A home inspector will look over the house to ensure there are no problems or issues. And finally, an insurance agent will get you the necessary coverages.
Working with top-tier professionals is extremely important. I can’t encourage you enough to seek out people who are ethical and experienced. If you’re in need of a referral, we’ve got great Partners who can help you.
Step one in the process is getting pre-approved for a mortgage. You’ll do this with your loan officer and it will let you know how the loan amount you qualify for. In order to make this process smooth, have current statements for all of your financial accounts as well as income statements.
Step two is mortgage approval. Once you receive this, you know what you qualify for and you’ll be able to make decisions around the value of the house you’re going to start looking for. This is where the work you did determining the total cost of a house will come in. Please keep this in mind; simply because you “qualified” for a certain amount, doesn’t mean that’s the value of the house you should buy.
Now it’s time to find a Realtor and to start looking for a house. There are a lot of important things to keep in mind during this stage of the process.
From this step forward, emotions play a big role. We all experience FOMO, or fear of missing out. We’re all susceptible to burn-out when we make an offer and someone outbids us. And, even though it may sound funny, it’s possible for a house to break our hearts if we let it. What I mean by that is, if you find a house you really, really like, and the deal doesn’t go through, we can feel heart broken. As you’re getting ready to start your house buying journey, be mindful to not let a house break your heart.
I talked earlier about knowing how much you’re going to spend on a house, and it’s also important to be clear in all your expectations, needs and wants. Make a list of the features you need to have. Make a list of the features you want to have. And, make a list of the features that would be nice to have.
Odds are, you’re not going to find a house that meets 100% of your desires, but if you can get to 70%, and the other 30% isn’t location, that could be the house for you. Your realtor can help you through this process.
Here are some of the common features to consider:
- Location/Neighborhood/Schools
- Lot size
- Age of home
- Style
- Layout-Bedrooms/bathrooms/kitchen
- Amount of space/storage
- Projects
- Commute
- Maintenance
The fourth step in the process is making an offer. Once you’ve found a house that meets enough of your criteria, you’ll make an offer to buy.
From there, you’ll negotiate the final price with the current buyer. When the price is agreed upon, you’ll negotiate the time frame for closing and completing the sale. And finally, you’ll negotiate any contingencies, meaning any actions or requirements to be met before the deal can be completed.
The fifth set is the escrow period. This is the time when your mortgage will move from pre-approved to completed and when all the home inspections will be completed.
The sixth and final step is the closing. You’ll sign your loan documents, the transfer of ownership will take place and you’ll get the keys to your new house!
Making it Real
I’ve talked about the steps to follow to successfully buy your next house and get your part of the American Dream.
I want you to make a good decision so you can love your new house while being on track to reach all of your other important financial goals.
So, when will you do the required work to prepare yourself for this process? I want you to pick a day and time, and to actually schedule a meeting in your calendar. Make sure you pick a day and time where you won’t have any conflicts and you’ll be able to give this work your undivided attention.
It may take more than one scheduled meeting, so commit to however long it takes.
So help you on your journey, we’ve got some additional resources I want to share with you and you can find the links in the course.
You can access our Goals Course at no cost which will help you get clear on your priorities. If you need to get out of debt, you can access our Get Out of Debt course at no cost. If you’d like help cleaning up and improving your credit, one of our Partners, Dovly can help. And if you like to connect with any professional to help with this transaction, a loan officer, Realtor, etc, we can facilitate that as well.
If you’d like to dig deeper, check out our Buying Your Next House course.
If you’re ready to take control of your financial life, check out our DIY Financial Plan course.
We’ve got three free courses as well: Our Goals Course, Values Course, and our Get Out of Debt course.
Connect with one of our Certified Partners to get any question answered.
Stay up to date by getting our monthly updates.
Check out the LifeBlood podcast.
Congratulations on making the decision to buy a house, we’re here to support you however you need.