If you're planning on buying a home -- perhaps even your first home -- congratulations! You're living the American dream, striving for and achieving home ownership. But before buying a house, be sure to ask yourself the following questions:
Are you buying the right kind of house?
For starters, think about what the right kind of house is, for you and for anyone. For example, if it's by far the fanciest house on the block, it might not be the best buy, because it will stand out and future buyers may not like that neighboring houses are not nearly as nice. Make a list of all the features you must have and the ones you'd like to have. Remember that while a wonderful view might have you about to pull the trigger, if you're settling for a house that isn't as big as you need or that has any other shortcoming, you might not be making the best decision.
Is it a major fixer-upper? If so, who will be fixing it up? If you're not a very handy person with the time and resources to fix it up, know that hiring for the job can be costly. Think about how you might use it in the future. If your parents are ill and aging and might end up living with you, will the home be able to accommodate them with a bedroom and bathroom on the first floor? Think too about how much of a commute you'll have -- and perhaps take a trial run during rush hour.
What are reasonable appreciation expectations?
Next, ask yourself what you're expecting from this purchase. If you're mainly aiming for a nice roof over your head and a comfortable place to raise a family, good. If you're looking at the home as a great investment, though, think again. Since World War II, home prices have averaged annual growth of about 5% , which, adjusted for inflation, is closer to 1.5% or 2% annually. That's not going to make you rich anytime soon. While some people do realize great gains from properties they've bought and sold, many others earn very little or even lose money on the home they bought.
If you're mainly looking for investment gains, you're better off sticking with stocks for your long-term money. They've averaged close to 10% annually over many decades, or about 7%, adjusted for inflation. If you're a big believer in real estate's growth potential, you might focus some attention on Real Estate Investment Trusts (REITs). REITs tend to pay generous dividends.
Might you be better off renting?
Consider whether you really are best off buying a house or renting a home. Home ownership has definite advantages, such as no landlords, and fixed housing costs, if you opt for a fixed-rate mortgage. (Rental rates tend to rise over time, while fixed mortgage payments, adjusted for inflation, shrink over time. $2,000 per month might be a lot when you first buy your home, but 20 years later, you'll likely be earning more, and $2,000 per month might not hurt as much.)
Renting has its advantages, too. You're not responsible for property taxes or home insurance (though getting renter insurance is smart). You don't have to pay for repairs to the home or its maintenance, either. You might not even have to mow the lawn! Meanwhile, if you're paying less overall in housing costs than you would if you bought a home with a mortgage (which is likely the case), you should have more money available to invest in the stock market or any other investment. Thus, you might be missing out in home equity growth, but you can still build your financial war chest, without paying any mortgage interest.
How much house can you afford?
Next, if you're sure that buying a house is what you want to do, only buy as much house as you can afford. And don't aim to buy as much as you can afford, either, as that can leave you strapped if your income drops or disappears or major expenses crop up. Try to determine what a reasonable, manageable monthly mortgage payment would be for you.
It's best to aim to be able to pay 20% down on your home, in order to avoid having to pay private mortgage insurance, so think about how much cash you can pull together. Keep in mind that your credit record will influence the interest rates you get and, thus, your monthly payments. And lenders will also be considering how much other debt you have, such as car loans, credit cards debt, and student loans.
A helpful rule of thumb is to aim for a home that's valued at about two to two and a half times your gross income. So if you earn $75,000, you're looking at a range of $150,000 to $187,500.
What kind of mortgage do you want?
Finally, think about what kind of mortgage will suit you best. There are many varieties, but the most common ones are for either 15 years or 30 years, and sport either fixed interest rates or adjustable rates. (Other kinds of mortgages exist, though, such as 20-year or 40-year ones.) The shorter the term of the mortgage, the steeper the monthly payments will be, but you'll pay a lot less in interest along the way and will own your home outright much sooner. Fixed-rate loans are generally preferable in low-interest rate environments such as our current one, as you can lock in a low rate for decades. But for some, especially those who don't plan to be in their new home for too many years, an adjustable-rate mortgage (ARM) might be better, offering lower rates.
If you're able to make higher payments, you might still opt for a 30-year loan, but get one with no prepayment penalty (a good rule for all loans). That way you can pay more than you owe each month and will shorten the life of the loan – while still preserving the ability to only pay the lower minimum payment.
Keep these issues in mind as you look into buying a house, and you might end up with a better home and a better deal.