By Julie Anderson Bray, CFP®
Most people reach a point in their early adult lives where they want to buy their first house. Being a first-time homebuyer can be a scary and overwhelming process, even for those who are employed full-time. Committing to purchasing a home, making mortgage payments and keeping your finances afloat is a large commitment. I hit a lot of bumps while I was buying and selling my first home, which I'm sharing in the hopes that others can learn from my path to homeownership.
First Home Purchase and Renovation Struggles
I didn't own property until I was married. We purchased our first condo in 2011 for $432,000, using a gift from my in-laws and a $10,000 distribution from my IRA for the down payment. I had to pay income tax on this distribution, but there was no penalty because it was for a first-time home purchase.
As time went on, we were not managing our credit cards or debt very well and there was tension in our marriage as we struggled to communicate about our finances. Still, I kept pushing forward and forged ahead in my career. We decided to add a loft to our condo because we thought it was wise to make improvements to our home to increase its value. (For related reading, see: 7 Renovation Projects That Improve Your Property Value.)
Unfortunately, we underestimated the costs of remodeling by about $10,000 because we didn't include the cost of necessities such as paint and furnishings. About two years after the renovations were complete we decided to sell our home. We were very fortunate, and it sold for $575,000. If this had been 10 years earlier, or we didn't have a financially savvy member of the family (me) to help, this could have ended very differently.
Buying a Second Home With a Wish List and a Budget
When we decided to purchase our second home, we thought we could avoid the mistakes we made with our first home. We had a budget and a wish list, and we wanted to buy our dream home. The first item on our wish list was a pool, but the home we decided to buy did not have a pool. We thought that by buying a home that was less expensive, we could afford to put in a pool ourselves.
We were wrong. After moving in, we determined that at one time there was a pool, but it had been covered over. Because of the slope of the backyard, there was a problem with leaking, and we would never be able to put in a pool. We came to the conclusion a pool would not have been a smart investment anyway. This led to the decision to take out a home equity line of credit (HELOC), refinance our debt and complete some improvements and small projects. The return on investment of this decision was roughly 7%, which was much better than the pool.
Consider the Current Market Before Buying or Selling
We should have considered the market at the time. If we had invested the money my in-laws gave us, what would the return have been? We may have ended up in a better place financially, but it's also important to consider that we received an interest deduction, didn't pay rent and added two kids over the time period that we would have needed additional space for. (For related reading, see: To Rent or to Buy? The Financial Issues.)
We still don't have a pool, and just when we thought we might be able to finance one, the new tax bill says our state income tax isn't going to be deductible, and our property tax is going to use up most of the bucket. This means moving to a bigger house with a pool is no longer in our foreseeable future.
My husband thinks we should refinance to a 15-year mortgage. This would sweep up our existing loan at a 4.125% interest rate and HELOC at a 6.99% interest rate into a 15-year mortgage loan at 3.99%. We will muddle through the next 15 years, but the house will be paid off by the time the kids enter college, which we hope will give us more financial flexibility.
What would I go back and tell my younger, first-time-home-buyer, self? Buying a home can have a ripple effect on everything else in your life for a long time. You need to seriously sit down and list out your priorities. If you are married or are making this decision with someone else, they need to be included as well. You must be on the same page.
There are going to be non-negotiable items, like the number of bedrooms and bathrooms you need, or the general location of where you purchase your home. There are going to be things you would really like to have but might be willing to give up for the right house. For you, this could be a big kitchen or garage. There will also be some things that would be nice but not deal breakers, like having a house that is move-in ready. These could be things that you are willing to add later if you are financially able to. (For related reading, see: Top Tips for First-Time Home Buyers.)
Remember priorities are different for different people. If you don’t plan to have kids, schools aren’t that important. If you own a large dog, you need a backyard and a fence to accommodate your pet. One thing to always keep in mind, however, is resale value. If you know this isn’t your forever home and you are going to sell it at some point, think about what others will be looking for.
You must also consider your lifestyle. Is there a wedding on the horizon, children, or more children? You need to think somewhat long-term. Can the house grow with you, or will you need to move?
The Financial Aspect
Now that you have an idea of the things you are looking for in your first home, do you have realistic expectations of the expenses associated with buying a house and being a homeowner? Do you know how much you can really afford? Have you looked at your household income and expenses on paper and done the math? Also, consider if your finances are going to change soon.
While most people assume as their careers progress over time their income will go up, this is also true of their expenses. New car, kids and paying off student loans are all expenses that you might need to add to your monthly total when buying a house. Most people don’t realize their income to expense ratio is often much lower when they are younger. That is why it is so important to start saving early.
When looking for a home, you must also look at more than just the listing price to see if it will fit within your budget. Things like property taxes, utilities, homeowners insurance, and homeowner association fees will increase the monthly income needed to buy a home. There are always fine print add-ons so beware!
Are You Ready?
Finally, are you financially ready for the cost of purchasing a home? Do you know your loan limits and how much you are approved for borrowing? Do you know what rates you will be offered? This is often dependent on your credit score and credit history. How much can you afford to use for a down payment, and where is that money coming from? Have you realistically looked at fees and closing costs, are you going to roll them into the loan or pay for them at closing? While it may seem easier to just wrap it all up into the loan and not worry about it, that is not always the case. A larger loan, or higher rates, means more interest paid over time. All of this can add up quickly.
Take your time, weigh your options and have a firm and realistic grip on your finances. This is a huge life decision, emotionally, physically, mentally and financially. Make sure that you are doing it right the first time to avoid buyer’s remorse and financial strain early in life. (For related reading, see: How to Buy Your First Home: a Step-by-Step Tutorial.)
This article was originally published on Investopedia.