For most young people, buying their first home can be a scary proposition. It not only represents the biggest purchase most people make, it is a decision they literally have to live with every day.
This is why experts advise taking the time to make the most informed decision possible — it can reduce costs, aggravation and regret. These days, it is advice more easily followed given the recent slowdown in home sales.
“Think about your plan for the next year, five years, even 10 years. Look at what you hope to accomplish professionally, personally, as a couple and as a family and what kind of home and neighborhood will best serve those plans,” advises Tom Stevens, who recently stepped down as president of the National Association of Realtors.
He also advises buying real estate only for "real" reasons: “Don’t get caught up trying to pursue ‘hot’ markets. That is a good way to get burned.” Similarly, avoiding "cold" markets can freeze one out of a well-priced purchase.
Know your score
“Usually first-time buyers are not thinking about how their credit histories impact their home buying options,” says James Raysbrook, a Realtor with Coldwell Banker Bain Associates in Seattle, who works with many young home buyers. Recent applications for multiple credit cards, a spotty record of late payments or even a lack of credit history can all hurt a mortgage application by lowering credit scores. “We also have them check their credit reports to see if any corrections are required.”
“Make sure your budget can handle a mortgage payment,” advises Curt Weil, a certified financial planner with Lasecke Weil Wealth Advisory Group in Palo Alto, Calif. “In California, a mortgage payment can easily be two to three times as much as monthly rent was.” That can seriously strain cash flow even after factoring in the tax benefits.
“Realtors and mortgage lenders often assume buyers want the most house possible. It is up to the buyer to decide how much they actually want to afford,” adds Weil.
He suggests sitting down with a financial planner, buying budgeting software, or going online to sites like Fannie Mae’s, the government-sponsored corporation that supplies a secondary market for mortgages, or Choose to Save, the financial literacy Web site to access calculators that answer the question: How much can I afford without choking?
“Once you know what that number is, you can work backwards to determine the maximum amount you can borrow. Add that number to your down payment, and that tells you what price home you can afford,” explains Weil.
Figuring out what is available for a down payment is not as simple as looking at a savings account balance.
“Have you priced drapery recently? What about furniture? Congratulations on your new lawn — now you need a lawn mower,” reminds Weil.
Then there are closing costs on the real-estate transaction. “Often the extent of these extra fees, which can add roughly 1 to 2 percent to the transaction, is not realized until the closing,” he adds.
All of these add-ons need to be factored into the decision of not only how much to put down on a home, but how much home will be affordable.
“If you do not have an account with the Bank of Mom and Dad, you need to save like crazy,” says Weil. He advises new homeowners come up with at least 10 percent: “Otherwise, you are just speculating that things will work out.”
Beyond saving or hitting up relatives for cash, another option for funding a down payment may be an employer-sponsored 401(k) plan.
“If the plan offers loans it will typically allow up to 50 percent to be borrowed often with a limit of $50,000 — not a bad way to get creative," says Weil. "The interest paid on the loan is not deductible — but you are paying yourself the interest."
The biggest risk in doing this is triggering immediate and full repayment of the loan by accepting a job at another company. “If going this route, be sure you will be staying with your company for a while,” he adds.
“A lot of people have gotten into trouble recently by going into loans they ultimately could not afford,” says Pete Bonnikson, a senior vice president with online lender, E-Loan in San Francisco.
Esoteric loan products, such as those with options that adjust the rates or payments upward or defer interest payments, help get a person into a home but can easily go wrong. If home values stall or decline and interest rates rise, a homeowner can suddenly owe more to the mortgage company than the home could be sold for, transforming the American dream into a financial nightmare.
To ensure borrowers enter into mortgages only after understanding how any changes might impact their finances, E-Loan devotes a section of its Web site to understanding loan options.
Bonnikson also recommends homebuyers get pre-approved for their loans before contacting a Realtor. “This empowers a consumer when they make their offer, since it signifies they have the financing to back it up.” It is best for buyers to get pre-qualified for a specific loan amount.
The Department of Housing and Urban Development offers a number of assistance programs to first-timers, including affordable loans through the Federal Housing Administration. The Veterans Administration also provides assistance, as do many local governments and agencies — teachers in particular are frequent beneficiaries of these programs. The HUD site offers a gateway to each state’s programs.
Raysbrook cautions first-timers not to try to buy their dream home.
“This is a move-up process. They should not expect to buy into Mom and Dad’s neighborhood first time out,” he says. Instead young buyers should understand “that even if they end up out in the suburbs accepting a commute for a few years, their home will appreciate with the rest of the area along with their incomes. This will allow them, in time, to trade up until they live exactly how and where they want.”