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Buying your first home can be a confusing and frustrating journey, but it doesn’t have to be. We recently spoke to Century 21 New Millennium to demystify the home buying process, but what about the financials of the transaction? Do you really need that coveted 20% for a down payment, and should you buy a starter home?
In honor of National Homeownership Month, we reached out to Robert Mascia of Green Ridge Wealth Planning to find out the financial steps to buying a house for the first time – and being able to afford the mortgage payments, too.
How much house can I afford?
“If a home is primarily on their mind in terms of what do we need to do, that’s such an emotional decision,” says Mascia, who started his financial planning firm in 2014. “It’s not always a monetary decision.”
Start with the logistics of the home you want – the location, the type of home, and the style. Once you know those answers, it’s important to discover the size you should be buying. Potential homeowners need to answer this imperative question –
“What do the next five years look like?” says Mascia. “You have to understand who’s going to be living in the house for the next five to ten years. Once you get a view of what that life looks like for yourself, you almost need to fast forward five years and say, ‘Based upon my earnings trajectory, what’s the type of house I can afford?'”
Mascia has been a financial analyst for more than 20 years and started Green Ridge Wealth Planning to help individuals and business owners to create and live meaningful lives for themselves and loved ones. This includes helping them through life challenges, such as buying and maintaining their homes.
Mascia explains that there is always a level of uncertainty when venturing into the world of real estate. The current pandemic serves as a reminder of that fact, as did the Financial Crisis of 2008. Therefore, Mascia cautions to plan for uncertainties when buying a first or any new home.
“You don’t want to get yourself caught in a spot where you say, ‘I bought a house, and this is my starter house,'” says Mascia. “Then three or four or five years later, go, ‘I’m already grown out of it. I could afford more now, but in order for me to get out of this house, I need to take a loss.”
Some homeowners need to sell their “starter home” for what the price they brought it, but after the closing costs, moving costs, and agent commission, the homeowner actually sees a loss on the sale.
The risk of buying only an asset
If homeowners are planning to build an asset from a smaller home, they need to understand the risks, especially during times of low interest rates.
“You can buy a home for $700,000 with a 3% interest rate,” says Mascia, “but if the interest rates are 6%, you might not be able to afford that same home at that same price.”
The discrepancy derives from the way mortgage lenders assess a home price. The overall selling price isn’t as important as the number a homeowner owes on a monthly basis. Can the buyer afford to pay that amount back?
When interest rates rise, they provide less of an opportunity for people to spend the extra money on that $700,000 home. In the event of an adjustable-rate mortgage, in which the interest rates change over a period a time, either the homeowner has to make more money to afford it, or the mortgage rate will come down to be affordable. If neither of these issues occur, the homeowner may have to get out of the house.
“If there’s ever a time where you’re going to be reliant upon that, you might find yourself in a really bad position that could set you back dramatically,” says Mascia. “That’s why planning is so important from our perspective.”
Mascia says it’s imperative to take “today’s snapshot” and “a snapshot five years from now,” marrying a plan of the two, so you’re getting the home you want and can afford.
Do I need that coveted 20% down?
You may be asking, “What do I need to buy a house?”
When it comes to landing a mortgage, a bank or mortgage lender typically looks to supply 80% of the loan with at least 20% of the down payment coming from the buyer. This transaction is called a primary mortgage.
If a buyer has less than 20%, the bank charges a primary mortgage insurance (PMI). This amount will cover the difference between the actual down payment (3% or 5%) up to that 20% for a short duration. A homeowner doesn’t pay the PMI for the life of the loan, just until the owner amasses the total 20% down payment.
“It sounds a lot scarier than it is,” insists Mascia. “When buying the house that you can afford five years from now as opposed to the house that you can buy today – it’s good to keep the extra money on the side.”
Another avenue to buying a home without the 20% down is a Federal Housing Association loan, one of the federal assistance programs. A FHA loan helps low-to-moderate income home buyers to put down as little as 3%, though the monthly mortgage payments will be a bit more. However, the homeowner will have more in reserves for home maintenance and other issues that may arise.
“Using some basic planning techniques will help to prepare,” says Mascia. “You have to save the money. You shouldn’t have just 3% and get an FHA. You should have a buffer, so you can afford more on a monthly basis because that’s what the banks value.”
How much do I need to budget for housing expenses?
Homeowners don’t always take into consideration the small issues that can surface when house hunting.
“Most of the time you’re buying someone else’s problems,” says Mascia. (This is also why you absolutely need to hire a home inspector and get a home inspection!)
Even if the house looks functional and recently renovated, a homeowner needs to be prepared for inevitable repairs.
Explains Mascia, “All of a sudden, the HVAC goes. That could be in a fairly new home, but homeowners don’t always take care of these mechanical components. They say, ‘Oh, I was supposed to change the filter?'”
Mascia suggests homeowners (and buyers) have six months of expenses in liquid savings account. While there are utility insurances that homeowners can buy to help with large appliance expenses, having a six-month account helps to manage most unexpected home projects.
“If you can keep that account replenished at all times, you’re in a good spot that if something does go wrong,” says Mascia. “You won’t feel totally pinched.”
Having a savings and checking account can help to achieve this stability. The checking account can extend the monthlies – utilities, water, mortgage, groceries, and take-out expenses. The savings can act as a reserve for those home maintenance expenses. Mascia suggests using bank digital platforms and apps to keep the savings replenished.
For larger projects, such a roof or a kitchen remodel, a micro-savings account can help to accrue the money needed. This technique will prevent homeowners from conducting emergency withdrawals or applying for a home equity loan.
Once you buy a home –
It’s time to take care of it! Learn more about the finances of the home, including taxes and insurance, by subscribing to vipHomeLink. Our home management app provides tailored recommendations for home improvement, such installing an automatic water shut-off valve, and even send personalized reminders for home maintenance. Plus, our Money Meter will help you to see how much value you’ve added to your home – just by taking care of it!
Subscribe to vipHomeLink now with a monthly or annual membership.
Looking for asset management advice? Connect with Robert Mascia at Green Ridge Wealth Planning now.