You’re getting closer to being a first-time homeowner. But are you financially ready? Here are five questions to help you determine if you’re prepared to make that commitment.
1. Are you prepared for the cost of maintaining a home?
While your mortgage lender will review your income to verify you have the ability to repay the loan there may be instances where additional housing expenses will require budgeting and discipline. In fact, the down payment and closing costs are only the start of financing your dream home. You may be faced with storm damage, replacing the boiler or even losing your job. You’ll want to have a healthy financial cushion—one that covers at least six to twelve months of mortgage payments—to weather unexpected financial challenges.
According to Forbes, "a good view of annual maintenance and repair budgets for your house is between 1-4% of the purchase price … if your house is less than five years old. If your house is 25 years or older, then 4% is a good number."1 A new home should ideally require less annual maintenance, but as a home ages, the cost of repairs may increase. Methodically setting aside 2% of your new home's purchase price every year to cover any unexpected maintenance needed is recommended. You should consider both the initial and continued cost associated with maintaining a home before you sign on the dotted line.
2. Have you researched the financing options available to you?
There are a number of products available, and it's important to do your research. Fixed-rate mortgages provide a fixed principal and interest payment for the term of the loan, whereas the interest rate on an Adjustable Rate Mortgage (ARM)2 resets periodically after an introductory period. While the introductory rate on an ARM loan is generally lower than what you would obtain on a fixed-rate mortgage, once out of the introductory period the new interest rate is calculated annually unless you've opted for a one-month ARM, which would adjust monthly thereafter. What this means to you is, once out of the introductory period on an ARM loan, your payment may increase.
If you find the introductory rate on an ARM attractive but are uncomfortable with a potential payment increase once out of the introductory period, an ARM may not be the appropriate loan product for you. It is helpful to consider your level of comfort with both the immediate and potential future mortgage payment when trying to determine what loan product is best for you.
3. How long do you plan to be in your new home?
If you are having difficulty determining which loan product might be right for you, figuring out how long you plan to stay in the home is a good start. If you anticipate a change of lifestyle or moving to another house in a few years, and you are comfortable with a potential payment increase should you end up staying, a Principal and Interest ARM may be an option to consider. Since the average buyer keeps a mortgage for around eight years3, locking in to a 30-year fixed mortgage at a higher interest rate may have you paying an unnecessary premium if you don’t plan to keep the home long-term. On the other hand, if you can see yourself in the home for the long haul and you have a low appetite for risk, a fixed rate mortgage may be more appropriate.
“From a product perspective, you want to choose the home financing option that best meets your current and projected financial situation,” says Chris Kanavos, Director-Senior Wealth Management Banker for UBS Bank USA.
4. How important is owning a home to you?
You may be tempted to house-shop because your peers are reaching that milestone. But buying a home means being tied to a piece of property and all the monetary responsibility that comes with it. Making the commitment to own a home should be carefully considered. If you're not mentally and financially prepared for that, it’s probably better to rent until you solidify your plans.
5. Are you counting on home appreciation?
If you're buying for the long haul, a profit and loss analysis in terms of appreciation may not be appropriate as you wouldn't gain or lose anything until you're willing to sell. If you're buying a home as an investment to make money, it's important to note that "a reported value for your home or property is considered an estimate of what a buyer would be willing to pay at that point in time, and that figure changes as months go by, more homes sell and the property ages."4 You may not be able to get your asking price when you’re ready to put your home on the market," Kanavos warns. “Don’t assume you can flip your house. Think of your new home as an investment for the future.”