Question 1. Is It A Place That I Really Want?

Let’s say your friend is thinking about getting a dog. They love the idea of having a four-legged friend to take walks with and have around the house.

But…

They’re not so sure how they feel about cleaning up after it. Nor, are they positive they can afford the dog food, let alone the trips to the vet. 

Well, they need to figure that out, right?!

Well it’s the same thing with your first home. The responsibilities of ownership need to be considered alongside the reasons for buying. A new home can serve as an appreciating asset, a new beginning, or a family-friendly environment to raise children.

But it’s also a place that will require repairs, maintenance, property tax, and monthly mortgage payments. Not to mention potentially higher expenses like utilities and HOAs. And unlike a month-to-month lease agreement on an apartment, a home may not be something you can exit quickly. It’s much more dependent on current market conditions in your area. 

But if you're sure, and it’s a home you're looking for, you can go forward. 

Question 2. What’s My Present Financial Situation Look Like? 

Before checking the foundation of a home, you should check the one under your finances. Run through the following before going any further in the purchasing process.

Establish An Emergency Fund: Make sure you have 3 to 6 months of living expenses on hand. You need to be able to sustain yourself in the event of the unexpected. If a sudden job loss or car accident could completely derail you, it’s not time for a home yet. 

Review Your Budget: If you don’t have a budget, you’ll need one before moving forward. If you do, it’s time for a review. Is there enough cash left over to take on new expenses for a home? What’s your gross monthly income? That’s going to come in handy in just a minute...

Check Your Credit Score: Your credit score matters for a lot of reasons. And, in terms of home ownership, it matters when getting a loan. You might need to improve your credit score, if it’s going to scare off any and all quality lenders. 

Question 3. What Homes Are In My Price Range?

We can calculate your maximum monthly payment on a house based on your gross monthly income. That’s the amount you take home before taxes. And that figure will be based on your budget. 

There’s debate over how much of your gross monthly income is appropriate to put towards putting a roof over your head. But some experts recommended a maximum of 28%. [3] 

And remember your home expenses will include more than just your mortgage. They’ll extend onto things like property taxes and home insurance payments. 

Below is a breakdown example applying the 28% recommendation. We’re assuming a gross income of $102,500, which the U.S. Census Bureau found as the median income of Seattle in 2019. [4]

Breakdown:

$102,500 (gross annual income) / 12 (months) = $8,542 (gross monthly income)

$8,542 x 0.28 (max % for home expenses) = $2,548 (recommended maximum cost for all home expenses)

A simple fact is that Seattle’s cost of housing is very high relative to some areas. We have noticed that single income households have a much harder time affording the purchase of real estate when compared to dual income households. Singles who would otherwise have to restrict their price range and not live in their desired neighborhood may need to consider sharing their residence with roommates. 

Of course not everyone earns the same amount. But the math will stay the same (28% of gross income). Look at your budget and work the above formula to find out what you can afford moving forward in the process. 

Question 4. What Kind of Mortgage Makes Sense For Me In the Long-Run?

Typically a mortgage is structured along one of two time frames. You get a 15-year one or a 30-year one. And the interest paid on that mortgage will either be fixed or variable.

Which you should get is highly dependent on your situation. And there are a few things you should consider before deciding. 

Current Interest Rates: Interest rates are hugely important in making your mortgage decision. If interest rates are low, which they are right now, it may be wise to get a fixed mortgage. This locks you in at a low rate permanently, whereas a variable rate is subject to change. It’s also worth noting that interest rates are lower on 15-year mortgages than 30-year mortgages.

Overall Cost: A 30-year mortgage can be an attractive option due their lower monthly payments. But it’s important to consider the overall cost of your new home. Since the interest payments are higher on the 30-year mortgages, you will end up paying substantially more on a 30-year mortgage in the long-run than you will on a 15-year mortgage. 

Time Value Of Money: Those looking to buy their first home may not be able to afford the 15-year mortgage option. And while you’ll pay more with a 30-year mortgage, it can make sense when you take the time value of money into consideration. Money spent on a 15-year mortgage may actually be put to better long term use in an investment vehicle like a 401k.

You can see an example of the time value of money at play here.

TVOM Example:

Let’s say you’re looking to buy a house that costs $200,000 dollars, and you’re able to put a $40,000 (20%) down payment on it. And you’re given the option of a 15-year mortgage with a fixed interest rate of 2.75% and 30-year mortgage with a fixed rate of 3.5%. Below is a cost breakdown of those options. 

15-year mortgage:

$40,000 (down payment) + $160,000 (total principal) + $35,442 (interest payments) = $235,442 (total cost)

And you would have $1086 in monthly payments.

30-year mortgage: 

$40,000 (down payment) + $160,000 (total principal) + $98,649 (interest payments) = $298,649 (total cost)

And you would have $718 in monthly payments. 

That’s a $368 difference in monthly costs and $63,207 in total costs!

But wait a second, let’s consider the TMOV.

What if you took that $368 a month you were saving with the 30-year mortgage, and invested it in a solid growth stock mutual fund that compounded at 9% annually over the same time frame?

You know what you’d have?

$609,934.09!

More than a fair trade off, huh?

Suffice to say, the mortgage you choose depends on your unique situation. Do your due diligence to understand which option best suits you. And don’t hesitate to contact us for help. 

Now...

Question 5. How Can I Hit The Ground Running On The House Hunt?

Okay, now you know you want a house, and you know you can afford one. AND you know how much of one you can afford. Now...

Start Prepping for the Down Payment:  The less money you need to loan out the better. The more you can pay in cash, the better. If you could put down 10-20% in cash you’d be in GREAT shape. And higher down payments often translate to lower interest rates.

Get Prequalified: You need to get prequalified for a mortgage. This is where you communicate with a lender (i.e. bank or mortgage broker) regarding your income, debt, assets, and credit history to determine if you qualify for a mortgage. And if so, how much you'll be able to borrow. A properly made budget will make this much easier. [1]

Get Pre Approved: After getting prequalified you can get preapproved for a mortgage. This is where a bank extends you a conditional, written offer to loan you a certain amount. The offer usually expires within a set period of time (ex: 3 months), and does not guarantee you will be secured a mortgage. Losing a source of income or failing to pay bills can break the conditions of the offer. But, if maintained, it can show sellers how serious you are and might just jump you to the front of the buying list. [1]

Save for Closing Costs: This one sneaks up on plenty. First-time home buyers can be unaware of the fact that there's also a fee to finalize a purchase. But you’re not one of them. Anticipate a closing cost of 3% - 6% of the total purchase price, though for buyers it averages closer to 3%. [5]

Question 6. What Real Estate Agent Should I Work With?

Choosing the right real estate agent is huge. After all they’re the ones hunting down your optimal house at the optimal prices and negotiating with the sellers.

Or at least they should be…

It’s worth meeting with multiple agents or getting referred to one by someone you trust. And if you’re looking for guidance, feel free to contact us and get pointed in the right direction.

An agent should be walking you through negotiations and the closing process smoothly. They can guide you towards quality home inspectors and serve as a second set of eyes to make sure it’s done properly. 

Lastly, going back to negotiations, the right agent can provide sage advice when it comes to price leverage. Depending on their knowledge of the market and the intentions of the seller, they can advise you whether or not to ask for a better deal. 

In a bad market, with few bites on a house, asking the sellers to take on repair costs can make a lot of sense. But if it’s hot, and the buyers are biting, they can talk you out of a request that could lose you the opportunity.

Finally...

Question 7. Where Do I Sign?

This one’s the fun one!

You’ve run through these questions, and have come up with a solid set of answers. Now you’re at a place where you can confidently close.

You’re ready to sign on your first home. You did your due diligence and feel assured as you step into the rewards of your new decision. 

Running through these questions can be tough. And initially, they might reveal that you’re not ready yet. Or, they might make you uncomfortable. But don’t worry…

You’re not alone.

At Crafted Finance we help clients work through these questions. If you’re looking to buy your first home, we will guide you every step of the way. And put you in touch with the right people to service your needs. Reach out to Crafted Finance at 650-336-0598 for further guidance or fill out a contact card here, and we’ll reach out to you. 

References

  1. https://www.nerdwallet.com/article/mortgages/how-to-get-a-mortgage-preapproval
  2. https://www.forbes.com/advisor/mortgages/15-year-vs-30-year-mortgage-calculator-how-to-decide/
  3. https://www.cnbc.com/2021/07/14/how-much-of-your-income-you-should-spend-on-housing.html
  4. https://www.seattletimes.com/seattle-news/data/seattles-median-income-soars-past-100000-but-wealth-doesnt-reach-all/
  5. https://www.rocketmortgage.com/learn/closing-costs#:~:text=Closing%20costs%20can%20make%20up,t%20include%20your%20down%20payment.