Preparing for Homeownership

Home - No Place Like ItFor many of us, a home will be the single largest purchase we will make during the course of our lifetime. Buying a home requires an understanding of all the factors that will impact a potential purchase and savvy management of finances to close the deal.

Getting it done the right way, limiting emotion to the greatest extent possible, will serve you well. What follows is a one-year plan for preparing for homeownership.

Suggested activities during the first six months:

• Start saving and understand the different types of available loans
• Check and improve credit reports as necessary
• Determine your needs
• Determine the mortgage you can afford through budget analysis

Your Primary Residence is a Home, Not as Asset [RetirementSavvy]

Day 1 of Month 1, Start Saving: The down payment required will vary by loan type. With a VA loan, $0 down is required for eligible members (i.e. service members, veterans, and eligible surviving spouses). Another government program, the FHA home loan, requires a minimum of 3.5% down. With conventional loans, a minimum of 5% down is possible with a good credit score. However, if less than 20% is put down, the lender will likely require Private Mortgage Insurance (PMI) which will increase your monthly mortgage payment. The more money you put down, the better the chances of securing a loan and avoiding PMI.

Month 1, Check Your Credit Reports: A good credit report, generally considered to be a FICO score above 700, can be a valuable asset. With a higher score you can get a better interest rate on a loan. Even seemingly insignificant errors can result in a higher interest rate or cause you to be denied a loan completely. Therefore, check your credit report regularly for completeness and accuracy from all three bureaus (Experian, Equifax, and TransUnion). Free credit reports are available through Annual Credit Report, a government-approved site.



Months 2 – 3, Determine Your Needs:The home’s neighborhood, square footage, number of bedrooms, etc. will determine the cost. Spend some time researching different potential neighborhoods and evaluating how much house you really need early in the process. By doing so, you will get an idea of how much your desired home will cost and the amount needed for a down payment.

Months 4 – 6, Determine The Mortgage You Can Afford: Developing a budget – a spending plan for the money you earn – is critical for determining the mortgage payment you can afford. The first step in the budget process is to track expenses over a three-month period, identifying ways to decrease expenses – freeing up more money to contribute to savings for the down payment – and helping with determining the mortgage payment you can afford are two benefits to tracking expenses and budgeting.

Suggested activities during the second six months:

• Account for new expenses in your budget
• Continue to save, save, save
• Perform detailed research

Month 7, Account For New Expenses In Your Budget: You can expect larger bills and new expenses with a home. As a renter, some of your utilities (e.g. water) may be paid by a landlord, and those you pay now are likely to be higher in a larger house. Additionally, there will be new expenses such as property taxes, homeowner’s insurance, and maintenance. Be prepared to update your budget accordingly.

Months 8 – 10, Continue Saving: Along with your credit score, the amount you are able to save will be a key factor in determining if you will be able to afford a house. During this period, verify the anticipated amount of money you will have for a down payment as you will need that information when you speak with potential lenders.

Months 11 – 12, Perform Detailed Research: Get recommendations for potential lenders from friends and family. Evaluate your bank, other mortgage bankers, as well as credit unions. From these sources, identify at least three potential lenders. The lenders you have chosen will pre-qualify you for a loan based on your gross monthly income, total monthly payments (e.g. car and credit card payments, etc.), and credit score to determine the amount of the loan – and the interest rate – they would be willing to make to you.

With the costs of potential homes in mind and the offers from the lenders in hand, use an online mortgage calculator to determine what your monthly payment would be based on the loan amount, the down payment, the interest rate, and factors such as PMI if necessary. Doing so will reveal if you have enough money for a down payment on a home that meets your needs and if you can afford the monthly payments. If not, do not get discouraged. Now that you have started saving, managed your credit report, understand the process of picking a lender, understand how much you will need for a down payment, and identified the amount required run a home on a monthly basis, you are in a good position to buy a home at a slightly later point in time.

Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.

20 Comments

  1. It was mentioned in comments that some home owner expenses were left out. Another thing left out is mention of how long you expect to own this home. As this calculator https://www.yourmoneypage.com/home/buyorrent.php makes clear it takes a long time to come out ahead buying.

    • Indeed, the expenses associated with owning a home and how long the house is expected to be owned should be part of the calculus. As I note in the Your Primary Residence is a Home, Not an Asset post, homeownership is not the “American Dream” it is often portrayed as, and it certainly is not for everyone. While it can be a good thing, care should be taken when purchasing a home, and its true value should be well understood.

      Thanks for stopping by, Mark.

  2. Great and on point article as we are currently in the home buying process.
    I wanted to add: beware of FHA, due to changes in 2012: MIP is “Mortgage Insurance Premium” (similar to PMI but for FHA loan) is for the LIFE of the loan instead of just up to the 22% mark (in effect for loans made after May 2013). That easily adds over $74,000 paid over the life of a $300k 30yr FHA loan.

    I wanted add another way to avoid PMI: there is the LPMI option (for conventional loans with downpayment under 20%). That stands for Lender Paid Mortgage Insurance. Basically with this option the lender pays the PMI for you in lieu of a slightly higher than market interest rate. With excellent credit this would only add .125% – .375% to your already low interest rate. For example, on a 300k home, with the differences between paying PMI and doing LPMI is: PMI adds $207/mo, whereas LPMI adds $81/mo. AND all of LMPI is tax deductible up to AGI’s of $254k whereas PMI phases out at AGI’s of $100k. Hope this helps…

    • Thanks for the feedback, Char, particularly your points regarding PMI, MPMI and MIP. Great information that should help anyone preparing to go through the process of buying a home. Best of luck as you go through the process yourself.

      • Many thanks! This market over here is going strong! Smh @ multiple bidding being the norm here….!

  3. Great post. It is amazing how many people just turn up at their local bank and ask for a mortgage without having done any prepatory work or even having thought about it very much.

    • Thanks for adding to the conversation, Robert. You are absolutely correct. Too many people fail to conduct their due diligence and preparatory work prior to making financial decisions; particularly those as significant as buying a home. Doing so has the potential to pay handsome dividends.

  4. I think a great suggestion, which you do mention in your article, is really to strive for that 20% down payment to avoid PMI. This is just another expense that is unnecessary in my opinion and should be avoided. I like the idea of the 12 month plan, because it ensures that the potential homebuyer takes time on such an important purchase!

    • Thanks, GreenMoneyStream. Like you, I believe the 12-month plan gives a potential home buyer time to get their savings together, improve their credit report, and conduct overall due diligence to ensure they get the best house they can at a price they can afford…to include all the extra expenses that come with owning a home vice renting.

      Make sure you stop by tomorrow and check out the latest Living Frugally blog post as SavvyTaz sends a shout out to you and your blog.

      Savvy Readers should take a moment to check out – http://greenmoneystream.com – a great blog for living more frugally.

  5. Great article, SavvyJames. I wish I would have known this when I bought my first house. This is great info. Although I did do the majority of your suggestions, I wasn’t even thinking about furnishing or maintenance. I was just excited to get in the house!

  6. Home ownership is a way of life – mortgage repayments, insurance cover, decorating, repairs etc.
    It can be a lot of work that your average renter doesnt factor in while thinking about buying their first home

    • Agreed, Mike. In fact, the reality is that home ownership is not for everyone (this article that touches on that was shared with me on Google+ http://l.egal.bz/1aFQNiA ) or individuals should wait for a better time to purchase a home. The key is to understand how purchasing a home fits into your life (with regards to factors such as being married, being single, kids or no kids, etc.), to properly prepare for the event if home ownership makes sense, and to understand the financial implications. As you note, many people do not consider costs that they may not have had as a renter and should consider how a home fits into their retirement plans.

  7. I like the idea of a 1 year plan. I’d like to add 2 things.

    1) You can get your credit score for free using Credit Karma. I tried it and wrote about it. Bottom line: it’s good. Works like Mint.

    2) Continue saving 🙂 You mentioned the cost of the downpayment which is a good first step. But don’t forget the other costs: closing costs (2-5% of the sales price), repair costs, moving costs, additional furnishings, etc. I highly recommend having a maintenance reserve fund of a few grand built up too.

    • Thanks for joining the conversation, Scott. While I did mention maintenance costs and that individuals should continue to save, save, save…I did not specifically mention closing costs and you are correct, that is something that must be considered. The cost of buying and maintaining a home will likely be greater than first time home buyers expect. It really does behoove them to prepare early and save as much money as possible to really enjoy the new home.

    • Great reply Scott@HomeBuyerNation. Very good advice. Buying a house is close to buying a business, in my opinion. You need money for not only the initial investment but also those things that come along with that investment. Many home buyers, especially the young ones, get caught up in achieving the goal of purchasing a house and forget about the cost of maintaining it. One major expense and they’re in hot water for months or years.

  8. Really great info, not only for those preparing to buy a house but also those who already have. It’s never too late to reevaluate and make improvements in your spending and saving.

    • Absolutely. As many people will probably seek to lower their mortgage payments in their current home at some point; and will likely buy multiple homes over the course of their lifetimes – up sizing as their family grows and perhaps down sizing as they prepare for retirement – financial preparedness (e.g. careful evaluation of interest rates, attention to credit scores, etc.) is a constant activity and not a one time objective.

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