What You Need to Know Before Buying Your First Home
There are a million reasons why to buy a home and many reasons not to. With the housing market in the toilet, many people have been scared away from real estate and home ownership at a time when it makes all the sense in the world to buy...at least, for some. To find out if you should buy or rent, take into consideration the pros and cons of buying and whether or not it makes sense in your situation...
Pro: Mortgages are currently at an all time low
My first home was purchased back in 2004 at a 6.9% interest rate, which at the time was a great deal. I had an $85,000 mortgage on a 30 year fixed loan with no points (for those of you just starting out, this means I owed $85,000 which I was promising to pay back to the bank in thirty years with 6.9% interest and I was not paying any extra fees up front apart from my down payment and normal closing costs in order to lower my rate). As a new home owner, I had shopped around for a good rate and was confused by the different types of loans out there. So, assuming you are in the same position I was, here is a basic rundown of my choices:
1. FHA, VA, RHS and State and Local Housing loans: These loans are loans sponsored either by the Federal Housing Administration, the Rural Housing Service, State Government or the Department of Veteran Affairs. They are usually easier to obtain than traditional bank loans and are available based on your situation (for instance, VA loans are for Veterans and their families, FHA loans are for lower to middle income families who would have a hard time coming up with a decent down payment, but both require a decent credit record, as do bank loans, as well as other specific criteria). Typically these loans require less money up front but are much more restricted in the amount of money you can borrow as well as what type of homes you can purchase.
2. Conforming or Non-conforming loans: Known better as conventional loans, conforming loans are what most people think of when they think about getting a home loan. They are based on a fairly standard percentage rate according to the housing market (my 6.9% for example) and your credit score, your income, your banking history, etc. They have set guidelines for how much can be loaned for the number of families living in a house and how much money can be loaned according to the above requirements. Non-conforming loans tend to have a higher rate than conforming loans but are more lenient on their requirements, ie. your credit score does not have to be as good to get a non-conforming loan, but it will cost you and many times are only available for commercial real estate loans.
3. Jumbo loans: these are very similar to conforming loans, except they allow you to borrow a greater amount of money and end up costing you more in interest.
4. B/C loans: these are loans for people who do not meet the requirements for conforming loans...this would be if you had a very low credit score due to bankruptcy, foreclosure, etc. These loans are created to help a person get limited financing and grow their credit in order to get a normal conforming loan. Their rates vary greatly depending on your situation.
5.Fixed Mortgages: This is the type of mortgage I chose, because it is the least risky for someone with good credit standing. There a few different types of fixed mortgage loans, but typically they are offered in 15 year and 30 year rates. This simply means you will either pay the loan off with interest in the span of 15 or 30 years and your payment will reflect that. You can always pay more on a monthly basis to shorten the life of your loan, but you can't stretch it out any further normally than thirty years to lower your payment.
6. ARM loans: there are various types of Adjustable Rate Mortgages, but in the end the basic idea is that a bank will offer you a lower rate than a normal fixed loan in order to lower your monthly payment for a certain period of time, and then your rate will change over the lifetime of the mortgage...some ARMs the adjustment is laid out at the beginning of the loan so you will be able to see your future adjustments, and some are not. This may mean that a mortgage where you were once paying only $400/mo can quickly become one in which you are paying $800/mo. Many times this is how people get in over their heads. They see that small payment and jump at it, not realizing how it might affect them down the road.
6. Hybrid mortgage: this is a mixture of a traditional fixed loan and an ARM loan. This basically means that your rate will function as a fixed loan for a certain period of time and then they will change to behave like an ARM. There are also various types of Hybrids, that correspond with the different types of ARMs.
Whew! All that laid out, the bottom line is, if you are looking for a good deal on a mortgage rate, now is the time to buy. My fixed 30 year loan in 2004 ended up, not including escrow and insurance, costing me around $560.00/month (which was actually a $950/mo payment after all the extra add-ons, but you can see that under Cons!)...If I were to take out the exact same loan today I would most likely have to pay a 4.01% rate, which would lower my monthly bill to $406.00 simply because of the market. This would remain at this low rate for the entire life of my loan because I chose a fixed rate no matter what happens to the economy in the meantime. Definitely a plus!
The Cost of Home Ownership
So, the price of homes with this market combined with the low mortgage rates has created a market where it is almost cheaper to buy than to rent, right? Well, initially, yes. But many times first-time home-buyers don't take into consideration the true costs of home ownership. Although your monthly mortgage cost may be significantly lower than rent for a comparable property, there are many other things one needs to consider before signing on the dotted line.
Con: Added fees and cost of owning a home vs. renting
1. Down payment on your home: Unlike renting a property, your down payment on a home will be significantly larger than your deposit on a rental. The recommended minimum amount for a down payment is 20% of the property's cost, or $20,000 up front on a $100,000 property. For many, the idea of coming up with $20,000 in cash is impossible. This is not to say you cannot buy a home with less than 20% down, but if you do, you will end up paying PMI, or Private Mortgage Insurance...this is insurance that you pay your lender as a security blanket in the case that you aren't able to pay the full amount of your loan. The average cost is around $55/mo on a $100,000 loan, which basically just raised that low mortgage by an extra $660/yr or tacked on an extra $19,800 over the course of a 30 year loan.
2. Closing Costs: If you purchase a home through a real estate agent, whether your own or the person selling the home's agent, you are going to end up with something called closing costs. These are fees that are added on at the time of "closing" when the deed of the home transfers from the original owner to you. The average cost of closing varies, but can be expected to be around $3,000 for an average one-family home. These costs include fees charged to you by the real estate agents, title fees, application fees, recording fees, etc. At this time you might also opt to pay points, which is a way of lowering your interest on your loan. For every "point" purchased you will lower your interest rate by 1%. All this can add up to a hefty fee on top of your initial down payment. Closing costs are, however, negotiable to a certain degree...depending on the seller and their need to sell a home, many times you can have them pay most or all of the closing costs as part of your contract, but this will not be known until you make an offer on the property.
3. Interest and Property Insurance: There are very few people in this world that will ever be able to afford to buy a home without a mortgage. So, unless you are one of those lucky independently wealthy few, you will have to borrow money. You will then end up paying the lender you borrow the money from in interest. But many people don't understand quite how much money this ends up being over the course of a loan, or exactly how it is paid. Take for example, a $100,000 loan at 4% interest rate. If you pay $600/mo your interest payment will be an average of $190/mo, or $2280 a year in interest...this is $68400 in interest alone over the course of a 30 year mortgage...which means your $100000 house is actually going to cost you $168400...and your $600 mortgage payment (assuming you're not adding on that additional $55 in PMI) is going to actually cost you $790/mo. In addition you will need to have property insurance, which will cost you around $300 a year for this loan, and raise your payment an extra $25/mo. Your actual mortgage payment each month to own this house is now in actuality $815 not that $600 advertised by your lender.
4. Cost of Maintaining your Residence: This is one of the greatest costs that come with owning a home that can be saved by renting. As a tenant, you are living temporarily in the home you rent and are not responsible for its long-term maintenance. If your furnace breaks, you call the landlord to fix it. Not so with a home. Any and every repair will cost you...from small things such as yard maintenance that might run around a few hundred per year, to a new roof that can cost anywhere from $2000 to $8000 depending on your location, type of home and insurance. If you move from an apartment to a home, you will have the added cost of tools to maintain your home, such as a lawnmower, sprinkler, power washer, etc. as well as the added cost of utilities that many apartment complexes include in their monthly bill. Even if you already pay utilities, the difference in cost can be hundreds of dollars due to sewer bills, increased square footage to heat/cool and added water usage needed to maintain your property. If you purchase a home in a subdivision, there is also the possibility that you will be charged subdivision fees for maintenance of the neighborhood grounds. Depending on amenities offered (swimming pools, clubhouses, etc) these fees can be in the $300s or more per year. All these things can add up if you are on a limited budget.
Investment Return on a Home
The big question today is whether or not real estate is a good investment in the long run. A few years ago the resounding answer would have been YES! But with the unexpected plunge in the market, what was thought to be a reliable investment medium only four years ago is now a very risky financial venture. In fact, most people who purchased homes four years ago have lost tremendous amounts in the value of their homes. My second home, purchased in 2008 at what was, at the time, an inexpensive $130,000 investment, is now appraised to sell only three years later at a measly $90,000...and that is only if I can find a buyer. Still, the investment potential in buying anything when the market is down is great. Although there is no gaurantee that the housing market won't continue to plummet in the next few years, I think it is safe to say we have come pretty close to rock bottom. Which means, in terms of payback, things really can only go up from here. But apart from simple capital, there is a lot to be gained in investing in a home...
1. Pride of Ownership: There truly is nothing like living in a space that is officially yours. You can only do so much to personalize an apartment or a rental home. You can paint it how you'd like, rebuild or tear down walls, and renovate spaces to fit your family's individual needs. Knowing it is yours gives you a sense of pride that will truly make you want to take care of your home and make it everything you'd dreamed it could be.
2. Tax breaks: Along with the added costs of interest payments and property taxes on a home comes added tax benefits as well. Nearly 100% of all interest and taxes paid on a mortgage are tax deductible, which can result in a very nice end of the year return. Along with the yearly tax breaks, most states still offer first time home buyer incentive programs which also allow new buyers to collect extra returns their first year in their new home.
3. Long term family stability: If you invest in a home you plan on staying in for the long run, the rewards can be numerous. Not only will you (though it seems like it will take forever) someday pay off that loan and never have to pay for rent or a mortgage again as long as you remain in there, you will also gain credit, equity in your home and an asset that can not only pay off later on in your life, but can be passed on to generations to come. When you own your own home you will never have to fear your landlords changing tenants, selling your home or eviction (so long as you make your payments!) and you will never again have to prove you are worthy of someone else's living space. You can raise your children in a place that they will cherish for the rest of their lives as "home". All things aside, this is the true beauty of ownership...when your house stops feeling like a piece of property and starts feeling like home.