You may finally feel that now is the time to step onto the property ladder but wait! You have to make sure that you’re 100% ready or risk losing it all later down the line. The good news is that the rate of foreclosures has dropped significantly. According to Business Insider, foreclosures were at their lowest rate in the 18-year history of the data in the second quarter of 2016. The bad news? There were still 83,000 foreclosures.
Reasons for the drop include better interest, more competitive mortgages, bad loans from the previous crisis are out of the system and the labor market, along with wages, is improving. Nonetheless, you don’t want to fall into a trap whereby purchasing your first home leads to long-term stress. Here are five first-time home buyer mistakes to look out for to avoid going underwater on your mortgage.
Overestimating How Much You Can Afford
At the time of writing, it is still possible to get an interest rate of below four percent, and since the U.S. Federal Reserve has already raised the rate with another possible rise on the horizon, first-time buyers are keen to take advantage while the rate is still low. Please remember that there is a fine line between what you can borrow and what you can afford to borrow.
As a rule of thumb, you should not spend more than 36 percent of your gross monthly income. However, the true amount you can afford depends on a number of factors including:
- Down payment
- Annual income
- Marital status
- Monthly debt payments outside your mortgage
- Credit score
For example, a single person living in San Francisco with an annual income of $90,000, a down payment of $25,000, an excellent credit score and monthly debt obligations can afford a home worth $408,000. This figure represents a monthly mortgage payment of $2,377. We urge you to use a mortgage calculator like this one at Smart Asset to calculate what you can afford.
Also, you must take into account your lifestyle. Someone who enjoys spending time at home can afford a more expensive property than an individual that plans to travel a lot.
Forgetting About Extra Costs
There are still some people who believe you just make an offer, have it accepted, and then you make a down payment and start repaying the mortgage. If only it were that simple! A shocking number of first-time buyers fail to understand the terms and conditions attached to a mortgage. According to a 2013 survey by PricewaterhouseCoopers, over 40 percent of bad mortgage experiences are down to misunderstandings over the loan. 61 percent of the time, the fees, terms and ownership costs are the points of contention.
Take into account closing fees such as loan origination fees, home inspection costs, appraisal fees, moving costs and upfront repairs. While certain costs such as loan origination fees are often tied to the mortgage, you have to pay upfront repairs and moving costs out-of-pocket immediately.
Draining Your Savings & Ignoring Your Debt
The excitement of finding your dream home coupled with low-interest rates often leads to a misplaced sense of urgency amongst first-time buyers. However, if purchasing a home means you have to drain your savings accounts, it is a sign that you can’t afford the property. There is a wide disconnect between the savings of the average American and the rate of credit card debt.
A 2016 GoBankingRates survey shows that almost 70 percent of Americans have less than $1,000 in their savings accounts while 34 percent have no savings whatsoever. Only 15 percent have $10,000 or more saved. According to NerdWallet, households in credit card debt owe an average of $16,748. This figure equates to $1,300 a year in interest.
The Takeaway: If you have several thousand dollars in savings, know that this money is precious! Ideally, you’ll have enough savings to cover at least six months of your mortgage and other bills in the event you lose your job or face an unexpected and sudden expense.
Skipping the Home Inspection
Common sense would suggest that when you’re committing hundreds of thousands of dollars to property, a home inspection is a pre-requisite! Not so according to the President of the American Society of Home Inspectors, Bill Loden. He claims that 10 percent of homebuyers skip the inspection as a means of cutting costs. The average inspection costs $450, but it is unquestionably one of the best investments in the entire home purchasing process.
A home inspection expert will spot hidden problems that could become money pits if left unattended. For example, it’s possible for repairs worth several thousand dollars to go unnoticed with a cursory glance. Then there is the small matter of foundation repair which is a real wallet buster. Finally, a home inspection reveals if there are any additions or installations completed without the right permit. If a seller bribes you to avoid the inspection, either pay for the inspection or walk away.
Buying the Home with a Small Down Payment
Although homebuilders like LGI Homes occasionally offer properties with no money down, it is a good idea to hold off on making a purchase until you have enough to make a sizeable down payment. If you don’t pay at least 20 percent of the home purchase as an upfront payment, you must pay Private Mortgage Insurance (PMI). Not only will you have higher mortgage payments because you’re borrowing more, but PMI also adds even more to the payment.
PMI normally equates to between 0.5 and 1 percent of the total cost of the loan. The National Association of Realtors suggests that the average price of a home in the U.S. is $230,000. At that price, you could pay almost $200 a month extra on PMI!
It is tempting to dive into the housing market as soon as possible. However, we urge you to hold off if you don’t have the money for a sizeable down payment and lack the savings to provide you with a shield in case something unexpected happens. Instead of going for your ‘dream home’ right away, choose an affordable property first, build up equity, and in a few years, you could be in a position to get the home you’ve always wanted. You’re only a first-time buyer once; make sure you get it right!