By Geoff Williams
The spring homebuying season is in full bloom, and odds are, if you're reading this, you may be thinking it's time to finally start looking for your first house. But before you dive in, it's important to get your finances organized and know what you can afford. Here's a checklist to get you moving toward this major purchase.
Pay down your debt. And while you're at it, check your credit score and look over your credit report. "Before you start the process, you should make sure your credit score is OK," says Michael Eisenberg, a certified public accountant and personal financial planner with Eisenberg Financial Advisors in Los%VIRTUAL-pullquote-"Everyone thinks about the mortgage and interest, but there's more to it than that."% Angeles. "If you don't have a good credit score, you may not get the best [interest] rate. In fact, you may not get a loan, period."
So before you do anything else -- with any luck, long before you do anything else –- focus on paying down your credit cards, paying your bills on time and raising your credit score. (A score of 720 and above is generally considered good, and 750 to 850 is excellent). You want your future mortgage lender to like what it sees when it comes time to request a loan for a house.
Have money in the bank. Most experts suggest that you have at least 20 percent of the house's purchase price saved as a down payment. You can certainly buy a house without that -- and many people do -- but there are plenty of good reasons to put down at least 20 percent. For starters, you'll almost certainly avoid paying private mortgage insurance, or you won't have to pay it for long. PMI is typically 1 to 2 percent of the value of the loan, split into monthly payments. It may not seem like much, but if it adds, say, $100 to your monthly mortgage payment, you can see why you'd like to avoid it.
In other words, if you happen to have $20,000 in a bank account, and you're thinking of buying a house in the not-so distant future, hang onto it. This isn't the time to buy that motorcycle you've always wanted or invest in a coin collection.
Fine-tune your budget. Regardless of what you have in the bank now, this is a long-term, year-after-year, month-after-month expense you're going to take on. "So the first thing I would say to anyone buying a home is, 'Let's see how much you can afford to spend,' " Eisenberg says. "Everyone thinks about the mortgage and interest, but there's more to it than that. What about the property taxes? Will you have homeowner association fees? Are you renting now, and will your house be much bigger? That means you'll pay more for utilities. Are there amenities that you're going to have to take care of? Does the house have a pool? You need to plan much more than by asking yourself if you can afford the mortgage."
Pej Barlavi, a real estate broker in New York City, agrees. "I always recommend to work your numbers backwards," he says. "First, know your budget or set a monthly budget that you will be comfortable with paying that will not put you under a difficult strain should you not be able to work for several months."%VIRTUAL-pullquote-If you can do a 15-year loan, it's a no-brainer that you'll spend less on your house than you will with a 30-year-loan, but plenty of people can't swing that.%
That might sound a little grim, but think about it. If this is going to be a house you'll live in for years, there are going to be good and bad times ahead. You want to be prepared.
Think about how you'll pay for the house. Yes, with money. But will you take out a fixed-rate mortgage or an adjustable-rate mortgage?
ARMs had a terrible reputation after the Great Recession, and for good reason. With an adjustable-rate mortgage, you'll get the lowest rate available -- but then it will adjust after several years, often based on an index, like the Cost of Funds Index. The main point here is that your payment with an adjustable-rate mortgage won't stay the same.
"During the economic meltdown of 2007-2009, many homeowners lost their jobs and then discovered the interest rates on their mortgages were going up," says Diana Webb, an associate professor of finance at Northwood University. Small wonder she says: "Adjustable rate mortgages are the scariest mortgages that I see."
But the interest rate for an ARM is low, and if you believe you aren't going to live in your house for long, it might be a good fit for you. Some ARMs also have a limit on how much they can adjust, which may make them more appealing.
Still, some financial experts are wary. "These ARM's are basically predatory," says Doug Leever, a mortgage sales manager at Tropical Financial Credit Union, which services South Florida. "First-time homebuyers also may not know mortgage brokers are paid a higher commission for an ARM than on a fixed-guaranteed loan."
Consider the length of your home loan. Most homeowners go with a 30-year mortgage. Others try for a 15-year loan or somewhere in between. "The immediate benefit of a 15-year loan is that it's a shorter-term loan, and you typically get a much lower rate than a 30-year loan," Leever says. For instance, according to mortgage buyer Freddie Mac, if you were to take out a 15-year mortgage now, the average rate is 3.25 percent; for a 30-year mortgage, it's 4.14 percent.
If you can do a 15-year loan, it's a no-brainer that you'll spend less on your house than you will with a 30-year-loan, but plenty of people can't swing that. "The payment will be higher, and you need to make sure you're comfortable with the higher payment," Leever says.
Start gathering paperwork. Not everything about buying a house involves calculating numbers. You'll also want to start looking at paperwork with numbers on it. Yep, the fun never ends. So start gathering your federal income tax records for the past couple of years, recent paycheck stubs, canceled checks for rent or utility bill payments and any other paperwork a mortgage lender might want to see, like credit card and student loan information.
Scout out where you want to live. It isn't enough to think you want to live in a certain geographical area, like the west side of the city. You really need to drill down. "Many neighborhoods are different and change from one block to another, so the purchaser should be aware of what their money will get in their favorite neighborhood," Barlavi says.
Tax rates will be different in different communities, of course, so that's another consideration. There are some neighborhoods you may not be able to afford, so it's good to get a sense of that early on to avoid experiencing a huge letdown. Of course, you can wait until after a lender approves you for a mortgage, and you may want to wait until you've found a real estate agent to show you the ropes. But once you truly know you can afford to buy a house, driving around a neighborhood will start to make the idea of homebuying real -- and besides, it'll provide you with a much-needed break with a more enjoyable set of numbers: street numbers. It's far more fun imagining yourself living somewhere than envisioning how you'll pay for it.
By Geoff Williams