Ready for your First Home?
So, you have a decent income, you have a job you like (or at least don’t hate), you’re sick of renting, and thoughts of homeownership have been creeping into your head. Maybe one of your parents or friends has been getting on you about not wasting your money on your apartment rent anymore. Perhaps you long to mow your own lawn. But you still just don’t know if you’re ready yet.
There are a lot of pre-qualifiers to successful homeownership. Knowing what they are is a good first step in determining if you’re ready to making that leap:
1. You plan on staying in town for at least three years (preferably five)
If you’re in a job you like, in a town you like, and see stability in your job, chances are you could see yourself sticking around for at least three years. Why 3 years? If you move sooner than that, the odds are that you’re probably going to lose money on your transaction.
Closing costs are usually at least $2,000. This doesn’t include commission that goes to the agents who worked on selling your home. I am a big advocate of selling for sale by owner (FSBO), however, many people are not. If you go with an agent, you’ll have to fork up about 6% of the selling price for their services. So, right from the moment you purchase your house, you’re about 6-7% in the hole and will have to make it up through building equity in your home (sell it for more than you bought it). This can come from hard work, or simply time for the home to appreciate in value. The outlook for the housing market is indicating that appreciation in value is not going to happen for a few years to come, so five years is more ideal than three, but there are never any guarantees.
2. You’ve run the math and have built-in other investments into your personal budget
In most cases, home ownership is going to cost more than renting (even with the tax deductions for your mortgage interest and property taxes). Run the math on what you can reasonably afford. What I’ve learned from owning two homes is that you don’t need the space you think you’ll need, especially if you don’t have children. I easily moved from a 1,500 sq. ft. home to a 1,000 sq. ft. home. I’ve actually enjoyed the smaller home because it is more liveable, cheaper to heat and cool, and easier to clean. Don’t worry about impressing your friends by buying a big house that you can’t fill.
Keep in mind that your home is not an investment. It is four walls, a sense of pride, and a way for you to build sweat equity. Any calculation you come up with should include built-in methods for saving for retirement and non-retirement accounts. If you’re banking on your house to fund your retirement, you’re incredibly misguided. Everyone has to live somewhere, and by definition if an asset is a necessity, it is not an investment.
3. You don’t have any black marks against your credit
Previously, I highlighted how you can receive three free credit reports per year. Make sure that your credit reports have a clean bill of health. Some items to look for:
- Do you have any accounts listed that you didn’t know about? Get them taken care of. Dispute any that you did not personally open.
- Close any accounts that you do not use anymore. Keep your long standing accounts open.
- Consolidate credit accounts, if you are able to.
When you start applying for loans, the mortgage institution will pull your FICO scores. Anything over 700 is considered pretty good, so don’t let someone tell you otherwise as negotiation leverage. Also worth noting is that a long credit history is overrated. I was able to get the best mortgage rates with only one year of credit history (simply, 1 credit card) behind me. However, lenders may have tightened up since then.
4. You are willing to negotiate
If you’re not, you’re going to get hammered. A general rule of thumb for a first offer is to go 10-12% below asking price. In this market, you may be able to go up to 15-20% without offending the homeowner. There will always be exceptions, but you should be able to get at least 10% off asking price.
You’d also be wise to negotiation the rate on your mortgage. Some lenders post their rates to the public and don’t bend to anyone. Others don’t and are willing to negotiate. Everyone is desperate for business these days, so throw around your best offers elsewhere, and see if anyone can beat them (everything else being equal).
5. You have a positive attitude towards taking ownership over things and are ready for the responsibility
It sounds silly, but I love mowing a lawn, shoveling a driveway, and painting a wall. There is a sense of pride in doing these things that is irreplaceable. I don’t expect someone who has only rented and hated doing these chores as a child being able to understand this, but it’s true. If you think this is simply not possible and the thought of doing these things sounds horrific, then home ownership is probably not right for you.
What kinds of things have prevented you from buying a house? Please do tell.
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G.E. – great advice! Thanks for the post. I had been considering purchasing a house in Ann Arbor recently. The thought was if I picked a place near Central Campus I’d be able to rent it out to 2 or so people while living there myself. Using this approach, I anticipated I could get my own mortgage payment to be about equal to renting, which seemed like a good way to go.
Although it’s likely I leave Ann Arbor in under 3 years, I thought the house would be a good investment if the rental payments could become a source of income, or with a 3rd tenant (replacing myself) my own payment would be lowered to $200-300/mo; a good deal for getting a 2nd house that would eventually become a true asset.
What prevented me from purchasing? Two reasons.
1) I’m working on a side business that has more profit potential than renting a house out, and would be a lower labor-commitment in the long term compared to being a landlord. If I purchase a house, the mortgage would limit working capital for the new business, and the house may become a burden that limits entrepreneurial work on the side.
2) Greatly prefer living alone. If my side business were already successful pulling in another ~$1K/mo, I wouldn’t even consider purchasing a house and having to live with tenants. I’d think about purchasing a house anyway and renting the entire thing out, but then I’m competing in the landlord business which is not my area of expertise & probably requires time I’d not be willing to give.
Your advice here has me thinking about purchasing a house again, since it seems like if you’re in a good market for buyers and you play it smart you stand to gain quite a bit in relation to the time you put in… I might wait until after the side business is up & running then reconsider the housing strategies available. Thanks again.
Hi Michael. You bring up some really strong points, and your reasons for not buying at the moment are very solid. Although right now is a good market for buyers, I wouldn’t worry too much about missing out on opportunity. I think you will see a continued drop in prices for at least the first half of this year, with a slow move towards appreciation again over the next two years. But nobody knows how to time these things for sure.
This should give you some good time to focus on your side business. There are opportunity costs for everything. Owning a home, especially when renting all or a portion of it is a lot of work. Although you would be gaining equity through the rent funds you collect, there is significant value in the time you give to manage the operation. Either way, you’re doing well for yourself and have a plan, so keep up the good work.
im looking to purchase my 1st property in give or take 7 years from now. what are some good ways to save for it and how would i go step by step in doing the purchase? im totally clueless with real estate stuff. thanks~
Hey Billy,
Great question. Planning seven years in advance is a great head start, in fact, I only planned one year in advance before I bought my first house – but I would not recommend that route. With mortgage companies and banks tightening their belts, I would recommend going for the standard 20% down payment on your purchase. Where do you live, what’s your income, and what is an average home price in your area? That will help me craft some next steps for you – and this is such a good question, I might make a post out of it. ~G.E.
Michael, I’m wondering if you can offer advice on where to allocate my savings. I’m nearly 30 and have a pretty decent nest egg already in my retirements accounts. I’m looking to buy a home in the next couple of years. Do you think it’s worth scaling back my 401 contribution in favor of saving for a down payment on a house? Obviously it differs from person to person but perhaps there are some general guidelines you could suggest. For example, save $10k per year into 401k and anything above that put into the house fund? Thanks!
Dan, I don’t have much expertise here to be honest. G.E., do you have any thoughts?
@ Dan/Michael: It really does vary from person to person, and a lot of the gurus out there differ on exact %’s of how much you should allocate to each. Many recommend 10% of salary to retirement, but I tend to actually think that is a little on the low side and feel a lot more safe at 20%+. Amount you have saved already, willingness to take on risk, and age are also factors to consider. A lot of the big fund companies have retirement calculators that you may want to test out. In terms of a house fund, the recommended amount to put as a down payment is 20% so that you can avoid PMI (private mortgage insurance) or having to take out a second loan.
Still good advice after the RE meltdown. I think there will be a true buying opportunity from 2009 to 2010.
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The funny thing is that this article is TIMELESS! Even though it was written like 5 years ago during a TERRIBLE housing market, the steps are just as relevant today! Nice work G.E.!
Michael, thanks for the advice about having a FICO score over 700. I’m not sure what mine is, but I don’t think it’s very good. Maybe I should find a real estate consultant service to see if there’s anything I can do to get a better score, or if there’s a house I can get with my credit score as it is.