A friend of mine recently purchased his first house, and it got me thinking.. How do you plan for purchasing your first home to ensure financial stability and maximize long term growth potential? When looking to buy a house for the first time there are a few points that need to be evaluated carefully: 1) location 2) affordability 3) down payment 4) saving 5) timing.
Location is everything when purchasing your first home. It will be the factor that determines whether your house appreciates in value or depreciates. Highly desirable housing locations will always appreciate in value over time. So what makes a location highly desirable? We want a house that will appeal to a large demographic. First and foremost, school districts. Owning a home in a great school district appeals to people with kids. Next, we want to look for proximity to amenities and entertainment. This isn’t as crucial as school district, but will help with appealing to a larger demographic.
Unlike the traditional personal finance mind set of looking ahead, you want to look at what you can afford now. Doing so allows you to live comfortably and continue to progress towards your savings goals in other areas. If we planned ahead, purchasing a house that we could “grow into” we open ourselves up to needing roommates, or taking cash away from other areas (i.e. saving). In general, your housing costs should not exceed one third of your monthly income. A quick and easy way of determining what you can afford now is to use Zillow’s affordability calculator. This calculator also provides a great breakdown of expected monthly costs such as taxes, principle and interest, insurance, and mortgage insurance.
- Down payment
Some banks will allow as little as a 3% down payment on a house. However, we suggest having a minimum of a 10% down payment on the house. For your first home, expect to pay PMI, or Premium Mortgage Insurance. This will increase the monthly payments to the mortgage company be a small amount. Essentially, PMI means that we weren’t capable of putting a 20% down payment on the house. Once 20% ownership of the house is accomplished, PMI can be dropped from payments.
- Saving for a down payment
There are a few ways to save for buying a home. The first way is a conservative approach is collecting through a savings account. The benefit to this method is that there is little variation from growth. Meaning you can pull and use this money whenever you decide to place the down payment. The downside to this option is that it will take a while to save a significant amount. The second option is more aggressive in that you save through investing in a low cost index fund. This introduces more risk due to market variation. Though it also has the potential to grow with the market, reducing the amount of time needed save for a significant down payment. Utilizing this method means you need to know how the market is performing when you are ready to place a down payment. Our preferred method would be to save through investing in the market. Although its riskier due to market variations, history shows that more time invested in the market equates to less risk of loss.
Obviously, purchasing a home is expensive. Multiple fees come into play when proceeding through the closing process. Based upon the costs associated with buying and selling a house, we recommend that when purchasing a home you plan to live there for at least 5 years. This timeframe should be considered the time it takes to break even. Depending on the market, selling before this timeframe risks potential loss. If you plan on moving or making big life changes in a 5 year period it may make sense to rent rather than buy. The New York Times offers a great rent vs. buy comparison to help determine whether or not renting may be a better option.