Owning your own home isn’t just about creating your dream of personal space – it’s one of your largest investments and can be the foundation of your financial security. Home buying has accelerated during COVID as more households are looking to leave the city for more suburban, rural, or smaller city living. From saving for a down payment to getting a mortgage, the process is complex. We break down some of the ways you can get there more quickly, and help the purchase go more smoothly.
Key concepts we’ll cover: The home buying timeline, setting a price range, saving and how to invest your down payment, mortgage pre-approval, the target mortgage amount, and insurance.
Home Buying timeline
Set your price range and monthly costs
The purchase price of your home should be based on the mortgage payment you can afford and down payment you’re seeking. This is an excellent time to set a rule on how much you want your mortgage to take up as a percentage of income. For example, let’s say your household income is $250,000 in gross compensation. You can set up a rule for yourself such as “I do not want my monthly mortgage (Principal and interest payments – PITI) to exceed 20% of my gross income”. Well, 20% of your gross income is $50,000/year. Now you can figure out what the loan would have to be based on the $50,000/year mark. $50,000 represents a monthly amount of about $4,166.67. A 30-year loan with a 3.25% interest rate (a not-too-shabby rate in our low-rate environment) will leave you with a $957,401 loan. This is the net amount after your down payment. If you’re aiming for a down payment (discussed below) of 20%, your down payment should be about $239,350 ($957,401 / 80%) with a purchase price of $1,196,751.
Remember though, this does not include two other big expenses:
Maintenance: 0.5% to 1.0% of the annual value. This is an AVERAGE. Some years you’re going to need a roof replacement that might take up several years of your maintenance budget. In our example this would be about $8,000 / year.
Property Taxes: 0.5% to 1.5% or more): Dependent on the county, city or state you live in. In our example this would be about $12,000 / year.
Adding up our mortgage plus property taxes and maintenance, you’re annual outflow is about $70,000 / year. How does this fit in with general guidelines? A good rule of thumb is ALL debt service (liability payments – car loan, student loans, mortgage) should not exceed 36% of gross income or 28% of net income.
When setting your price range, it’s also important to note the trade-offs you may have to make, including location, school district, taxes, and size. For example, if your ideal location for a home is out of your price range, look to see if surrounding neighborhoods offer a more affordable price. Prioritizing what’s most critical will help root your price range in appropriate options.
What's the right size down payment?
Being able to put down at least 20% on a new home is extremely cost-effective. You not only save on mortgage costs, you save on the cost of mandatory private mortgage insurance (PMI), which lenders require for instances where there is less than a 20% down payment. Another advantage is that in a tight housing market where you may be competing with other buyers for your dream home, having 20% in cash may push a seller in your direction. In today’s hyper competitive market, even having 20% is not enough to persuade some sellers. The more down payment you have, the better the seller will feel about committing to you.
How do I save and invest my down payment?
Continuing from the previous example, you’re aiming for a down payment of about $240,000. If you were to save $5,000/month, that would get you there in about 4 years. The next question usually is: where do you save that money and how do you invest it? This answer isn’t very sexy or provocative but with such a short-term goal, you should aim to use high yield bank accounts and CDs. Why? Simply put, the upside isn’t worth the downside. Your investments should reflect your timeline (i.e., long term investments = more risk, short-term investments = less risk) and with such a short-time, it isn’t worth putting all of your money into the stock market or crypto.
start the lending process
Check your own credit report, and then start with a pre-qualification interview with a mortgage loan officer. They’ll help you understand all the things that lenders take into consideration besides income. Assuming everything looks good, your next step is to get pre-approved for a mortgage loan. Once you feel ready to start looking, go talk to your bank – or a few banks. Another option: consider seeking an independent mortgage lender who has the ability to shop multiple lenders for the best rate.
Go for the Gold Standard – Mortgage Pre-Approval
A mortgage pre-approval will make your realtor more comfortable and may be an advantage when it’s time to negotiate with a seller. Most importantly, getting this somewhat arduous step out of the way first may prevent potentially costly delays and disappointments.
You’ll need to put together a full financial package including proof of identity and employment, income and debt information, and savings and investments. The pre-approval doesn’t guarantee that you’ll be able to get a loan, but it does tell a seller you’re able to make a legitimate offer and have committed to making the process as quick as possible.
Review your insurance coverage
Finally, in addition to your new homeowner’s insurance, if you’ve bought the house jointly with someone else, review life insurance coverage for you and your co-owner to be sure that the survivor will have a plan to cover the mortgage and tax payments. You would be surprised at how often this part of the home buying process is neglected. Nobody thinks a catastrophe is going to strike their household… until it’s too late.
bottom line
Buying a home is a huge achievement – and a very smart step to financial independence. By saving for a down payment and being careful to stay in an affordable price range, you’ll be able to create your own haven, potentially reduce your expenses, and diversify your investment portfolio.
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