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5 Questions for Potential Homebuyers

Posted: 1/21/2013 5:15:00 PM
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Are you ready to buy a home? With housing prices and mortgage rates as low as they are, many are tempted to take the plunge and become first-time homeowners. But how do you know if you're truly ready?

1 - Can you afford it?

Being able to afford a home is more than simply having enough income to cover the mortgage payments. You also have to be able to afford the upkeep on the property, which tends to be more costly than first-time homeowners expect, and have enough of a reserve to handle occasional major expenses - such as a new furnace or roof - which can crop up unexpectedly.

You also have to be able to afford other unexpected expenses as well. Many foreclosures occur after the homeowner was hit with medical bills or other major expenses. A slow drip of lesser bills - like auto repairs, plumbing calls, a worn-out appliance - can also accumulate into a financial crisis when you have a mortgage to pay.

Most people with a steady job can afford the mortgage payment on a home of some sort. But can you afford the payment on a home that's adequate for your needs? Beware of getting caught-up in bargain deals - that fixer-upper could need a lot more work (and additional money!) than you anticipated or the neighborhood around that little gem could be much less desirable that you initially thought.

A home is something you'll have for a long time - you don't want to scrimp on one, but you don't want to stretch your budget either. If you have to do one or the other, you're probably not ready for home ownership.

2 - Can you make a down payment?

Coming up with a down payment is a major obstacle for many potential homebuyers. Fortunately, it doesn't have to be as big a hurdle as you may think.

The conservative approach is to make a down payment of at least 20 percent of the price of the home. That will get you the best interest rates on a mortgage, will allow you to avoid paying additional monthly fees for mortgage insurance and will provide a financial cushion against possible declines in the value of your home.

Most first-time homebuyers would be hard-pressed to come up with 20 percent down, however. That's ok. You can still get a conventional mortgage with 5 percent down if you have good credit and the home you've selected is in a neighborhood with stable property values, or 10 percent down if your credit is less than perfect. And you can get an FHA home loan with as little as 3.5 percent down, even with blemished credit.

The downside of buying a home with a small down payment is that you'll end up paying more in interest and mortgage insurance than you would if you put 20 percent down. But if it still makes financial sense, it's perfectly ok to buy a home with a small down payment.

3 - How's your credit?

A big issue for prospective homeowners is what kind of credit they have. While you can certainly qualify for a mortgage with flawed credit, a lower credit score means you'll pay a higher interest rate - sometimes, quite a bit more that someone with perfect credit.

These days, perfect credit usually means a FICO credit score of 740 and above. A score of 700-720 means you shouldn't have much trouble qualifying for a loan, but will probably pay a bit more in interest - maybe an additional one-eighth to one-quarter of a percent on your rate.

Once your score drops below 700, however, things start getting more difficult and expensive. You can still qualify with a score of 680, depending on other factors, but your interest rate will be significantly higher than for borrowers with unblemished credit. Interest rates climb rapidly as your score sinks below 680 and qualifying gets much harder. You may be able to get a mortgage from some lenders with a score of 620, but expect to pay a fairly high interest rate if you do.

To check your FICO scores, you can order them through ; there is a cost involved in getting the actual scores. Before doing that, it's a good idea to get your credit reports that the scores are based on and check them for errors - you're entitled to a free annual copy from each of the three major credit reporting companies and can order those through , the official web site.

If your credit scores are weak, you may want to wait for your credit to improve before buying a home. The impact of minor blemishes, such as an occasional late payment, begins to fade after two years; more serious ones can stay with you for four to seven.

4 - Will it fit your lifestyle?

This is something that surprisingly many people overlook. Are you cut out to be a homeowner in the first place? This isn't a question about finances, it's about your lifestyle and how you want to spend your time.

Owning a home takes a lot of work. When something breaks, you have to fix it or make arrangements for a professional to come in and fix it. You're responsible for mowing the lawn, cleaning the gutters, shoveling the snow and all the other chores that apartment dwellers typically don't have to worry about. Even if you hire someone else to do these tasks, you still have to take on a managerial role in deciding whom to hire, when these tasks will be done and which ones take top priority.

Many people simply don't want to deal with this, even if they can afford it. They'd rather spend their free time playing golf or in some other activity, rather than devoting it to home maintenance.

If you're looking for a low-maintenance lifestyle but still want the advantages of home ownership, a condominium can offer a good compromise. With a condo, the homeowner's association takes care of most of the outdoor maintenance tasks that are required, in return for a fee you commit to paying at the time of purchase. However, it still usually falls on the owner to handle any maintenance issues that occur within the unit itself, such as appliance or plumbing issues.

5 - Are you going to stay put?

This is a major question - how long do you expect to live there? Buying a home requires a significant up-front investment in terms of the fees you pay at closing. If you're not going to stay in an area for at least five years, that's just going to be money down the drain.

You also need to stay in a home for an extended length of time before you accumulate any equity. Because of the way compounded interest works, you build equity very slowly during the early years of a mortgage - you may pay down only 10 percent of the balance during the first seven years of a 30-year loan. But after 10 years, you can begin to build equity rapidly as interest payments take up a progressively smaller portion of your mortgage payment.

Building equity is a major reason why people buy a home. But if you're not going to stay put for more than a few years, you may not build very much, particularly if home values increase only slowly.

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