3 Important Things to Consider When Buying a Home

Buying a home is not as risky when you follow three key principles of prudent investing.

Aug 24, 2014 at 10:00AM


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Being able to afford your own home is part of the American Dream. Living rent-free is liberating and certainly can fill homeowners with a sense of accomplishment after making mortgage payments month in and month out for many years.

Investing in your own home can make a lot of sense if you indeed plan on settling down. Home ownership is not only a political goal, but is also a viable, long-term financial goal that can make your retirement so much easier: Building and increasing home equity can be one of the pillars of your retirement wealth.

Nothing is more liberating and more contributing to a peaceful state of mind than not having to put up with endless rent payments. This, of course, is particularly valuable during retirement, when many people don't make and probably don't need as much money as they did during full-time employment.

There have been various studies out there, including this one, which suggests future retirees need to plan for only about 75-85% of their pre-retirement income in order to uphold their living standard.

In the long run, the real estate market will likely continue to do well driven by ongoing population growth and increases in household formation.

Buying a home can be a complex process and is not without risk. Following the three steps below will materially reduce your risks associated with home ownership.

1. Make a down payment a.k.a demonstrate your credit worthiness
Obviously, when you want to buy a house, you need to put up with some cash in order to entice the lender to lend you the remainder of the purchase price.

Down payments were often not required during the housing boom of 2004-2007, when literally everybody received a loan, but they are essential for both the prospective homeowner as well as the lender.

Why? Because a down payment means that a borrower has skin in the game (something lenders like) and that he is less likely to just walk away from the loan commitment if times get tough.

Being able to come up with a down payment signals that you know how to manage your finances and are more trustworthy, which often translates into a lower risk assessment and lower financing costs as a result.

Many big banks including Bank of America, for instance, advise that prospective homeowners put up 20%  in equity in order to avoid having to pay up for private mortgage insurance. The 20% 'rule' is not set in stone though: Depending on market and lending conditions you might be able to put down a lesser amount.

Understand, however, that the more you put down, the lower your mortgage payments will be.

2. It's all about the location
The old real estate adage remains true: It's all about location, location, location. It doesn't matter whether you seek a location for your business or your private residence.

You'd want a location in a safe neighborhood with easy access to schools, doctors, shopping centers, public transportation as well as other businesses.

Neighborhoods that are part of a vibrant economic ecosystem will increase your chances of sustainable real estate appreciation. If a neighborhood is in decay, property values will surely reflect it.

3. Home inspections
Before buying a home, make sure you inspect it personally. Bring along your spouse or a knowledgeable friend and check out the property yourself. Don't buy just on speculation with a walk-through.

Also, if you intend to buy a second-hand home, it might make sense to hire a home inspector who can point out potentially critical issues with the property's building structure or roof. Unforeseen repairs can cost enormous amounts and can be avoided by hiring a professional to appraise the soundness of the property before you buy.

Replacing the roof on your house costs an average of $7,226 while structural work such as the repair of a foundation could set you back up to $10,000 according to HomeAdvisor

The Foolish bottom line
Buying a house and increasing home equity is a valid strategy for building wealth even though the recent real estate crises might cause you to think otherwise. Over the very long term, real estate has proven to be a solid investment.

Home purchases can be tricky territory and often include a healthy amount of emotional situations. If you can put up some decent cash for a property in a safe neighborhood and are willing to shell out a few dollars for a risk-mitigating home inspection, your chances of failure are greatly reduced.

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Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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