You may want to finally take the plunge of buying your first home, but should you?
Buying a home is a BIG financial commitment that should not be taken lightly. As with all big decisions in life, the answer to whether you are ready to buy a home is very personal. There are a lot of factors at play and only you can answer this question.
Luckily for you, I’ve already been through this and I am an avid planner. I know what it takes to buy a home, and I want to help you make sure the decision you are about to make is the right one. Answering this question is very complex and personal. There’s no simple answer, or single metric that can answer this question for you.
This guide will give you the information to make an informed decision. I detail the costs of home ownership (both common and hidden expenses), and also give you key benchmarks to help you make the decision.
If already know that you are NOT yet ready to buy your first home, make sure to read how you can prepare to buy your first home. It takes time to prepare for buying your first home.
Understanding the Costs of Home Ownership
Before you can answer whether you are prepared to buy your first home yet, you need to understand the costs of home ownership. There’s a lot of costs associated with owning your own home. Make sure that you don’t forget about a single expense when making your buying decision.
- Mortgage (Principal & Interest) Payment – Unless you are paying cash, you will have a mortgage payment and every mortgage has at least two parts. 1 – Principal, the amount that goes towards paying down your loan. 2 – Interest, the benefit to the lender for providing the upfront capital.
- Property Taxes – You may pay these directly, or may pay them as part of your mortgage payment via an escrow payment. Regardless of how you pay them, you still have to pay them as a homeowner. As a renter, while a percentage of your monthly rent may go towards the landlord’s property taxes, you are probably not used to paying for this. Property tax rates are often set at the city/town level and you can almost always find that information online.
- Insurance – Another mandatory expense that homeowners face is insurance. Your lender will often require you to have insurance on your new home in order to qualify for the mortgage.
- Utilities – Depending on how your landlord set up payment, as a renter you may or may not pay for utilities. As a home owner, you always pay for utilities. This includes not only gas/electricity (maybe both), but also sewer, water, and sometimes waste removal. Utilities are perhaps the most variable cost of a home. Things such as the size of the house, the companies supplying them, your state, and your actual usage all affect the price of utilities. All things considered, the price can be upwards of three hundred dollars a month. However, the cost doesn’t have to be a nasty surprise. You can always ask utility companies for the history of the property, and always remember that the cost usually varies from season to season.
Hidden Costs of Owning a Home
What some first-time home buyers fail to recognize is that there are many hidden costs to buying a home. The last thing that a new home owner wants is another bill that they weren’t expecting. Below are many of the hidden costs that no one talks about:
- Maintenance – This is a general term that includes many aspects. Not only is there ongoing maintenance for any home (lawn care, landscaping, etc.) but things break and other things need improvement. In my first three years of being a home owner, I probably did 30 separate DIY projects. All of which cost money. I expect to spend a couple thousand dollars a year on home maintenance, but this will really vary from house to house.
- HOA – If your property is part of a housing association, there may be additional HOA fees on top of regular maintenance.
- Transaction Costs – There are also hidden costs of buying and selling a home. Realtors charge a percentage of the sale from the seller, and lenders often upfront have underwriting costs for the buyer when you get a new mortgage.
- Extra Stuff – I’ve talked to a lot of home owners and everyone remarks at the tendency to fill their new home. When you are buying your first home, it’s often
- Private Mortgage Insurance (PMI) – Hopefully none you have to know what this is, but if you put less than a certain percentage down as a down payment, your lender will often tack on additional fees known as PMI. We’ll cover this more below.
Key Indicators that You are Ready to Buy Your First Home
One of the most basic indicators that you are prepared to buy a home is when you can afford it. You add up all of the costs of both purchasing and owning your home (including estimates for hidden costs), and make sure that it wouldn’t impact your other financial goals.
That’s the simple answer.
The more sophisticated answer is that there are many indicators to help you determine whether you are ready to buy a home. In my opinion, ignoring one of these and rushing in to buying a home could be a huge mistake.
- You’ve Ran the Numbers of Rent vs Buy – What many people forget to do is to make sure it makes financial sense. I grew up in a household where my parents owned their own home. I’ll be the first one to admit that this contributed to my strong desire to buy a home early on in my adult life. However, I refused to let the emotions of buying a home cloud my judgment. You have to make sure to run the numbers and compare the costs of continuing to rent to owning a home. See if the numbers make sense.
- You Have a 20% Down Payment Saved – Another easy indication that you are ready to buy a home is that you have a down payment saved. Most people skimp on their first down payment, putting as little as 3-5% down. The problem with this is not only are they incurring additional costs (PMI), but it’s also a sign that they are not ready to buy a home. If you can’t save money for a 20% down payment, it’s a sign that you aren’t ready.
- You have a Positive Monthly Cash Flow – Similar to the item above, I’m a huge proponent of first time home buyers having a healthy, positive monthly cash flow. This means the amount that you earn each month well exceeds your monthly expenses. The reason for this is that unexpected major expenses pop up all the time and you need a positive cash flow to deal with these items. One great example is when I had to replace my furnace and A/C unit. It was not cheap and without this spending power, I’d be in a tough situation.
- You are Already Saving 20% towards Retirement – The last thing you want to do is buy a home before thinking of retirement. If you aren’t already saving for retirement, please do that now! I recommend saving 20% towards retirement, which will mean that you can retire in 37 years. Saving any less than 20% means that you are going to work well into your 60s. Why would anyone want to do that?
- You have a Good Credit Score – Another sign that you are ready to buy a home is that you have a good credit score. Ideally 740 or above, but even 700 or above is okay. This not only confirms that you are good with managing debt, but will directly impact your mortgage rate. A higher credit score will qualify you for lower rates. Typically anything above 740-760 will make you eligible for the best rate possible. I bought my first home when I had a credit score of about 790 and I am loving my low interest rate.
- You have Job (Income) Security – No one should buy a home without a stable job. While anyone can be let go or laid off for any reason, you can typically tell when you have income stability. Have you been with your company for several years, and are you an essential part of the business? If so, check another item off the list.
- Not Planning to Move Anytime Soon (5+ Years) – Last, but not least, no one should buy their first house when they are planning to move in less than 5 years. Remember the transaction costs that I mentioned above? Yeah, they are no joke. It’s also good to remember that while real estate values trend to increase over time, it’s not always the case. The last thing you want to do is buy a home knowing that you have to move in a couple years and then be forced to sell at a loss.
If there are a few areas where you need to improve, take the time to improve your situation. The important thing is not to rush into buying your first home.
Once you are ready to buy your first home, the next question is to determine how much of a house you can afford.