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By: Daniel Bortz
Financial planners don’t just help people balance their budgets or plan for retirement; they also help their clients buy homes. After all, a house is very often the biggest financial investment you’ll ever make—so, it makes sense that these professionals would have some strong opinions on just how to go about it.
Curious what they want you to know? Read on for their top, no-nonsense tips.
When you purchase a house, you have to shell out a significant amount of cash for closing costs—fees paid to third parties that helped facilitate the sale. Closing costs can vary widely by location, but they typically total 2% to 7% of the home’s purchase price. So on a $250,000 home, your closing costs would amount to anywhere from $5,000 to $17,500. That’s a serious chunk of change!
Consequently, Craig Jaffe, a certified financial planner at United Capital in Boca Raton, FL, says it’s important to calculate your break-even point—i.e., how long it will take for you to recoup those costs.
“Typically, you want to own a home for at least three years in order to recoup the initial costs of buying the home,” says Jaffe. You can use realtor.com®’s rent or buy calculator to see whether purchasing a house makes financial sense for you.
When weighing whether it makes more sense to buy a house or continue to rent, don’t focus solely on your mortgage payments—you’ll also have to pay property taxes, interest, home insurance, utilities, and other expenses.
“A lot of people don’t budget for hidden costs” such as maintenance and repairs, says Jaffe.
You should also have an emergency fund set aside in case something goes wrong with the house.
“If your roof gets damaged or a major appliance breaks, you want to have cash on hand to pay for those costs,” Jaffe says. (If you don’t have a rainy day fund in place for those kinds of expenses, you could be forced to take on high-interest credit card debt.) Jaffe recommends building an emergency fund of 1% to 2% of your home’s value.
Unless you qualify for a Department of Veteran Affairs loan or Federal Housing Administration loan, you’re going to need to obtain a conventional home loan from a private mortgage lender.
When doing so, “you want to aim to make at least a 20% down payment,” says Jaffe. Why? Because if you put down less, you’ll have to pay private mortgage insurance, an additional monthly fee that protects the lender in case you default on the loan.
PMI can be pricey, amounting to about 1% of your whole loan—or $1,000 per year per $100,000. The good news? You can typically get PMI removed once you’ve gained at least 20% equity in your home.
While it’s tempting to borrow from your IRA or 401(k) to amass a down payment on a home, “a retirement account is the last place you’d want to go for your down payment,” says Jaffe.
Indeed, if you borrow from either plan before age 59½, you’ll get slapped with a 10% excise tax on the amount you withdraw, on top of the regular income tax you pay on withdrawals from traditional defined contribution plans. Making early withdrawals also obviously prevents the money from accruing interest in these accounts, which could force you to delay retirement.
A better alternative? You could qualify for one of over 2,200 down payment assistance programs nationwide, which help out home buyers with low-interest loans, grants, and tax credits. Home buyers who use down payment assistance programs save an average of $17,766 over the life of their loan.
You need to have solid credit—typically at least a 650 credit score—to qualify for a conventional home loan, and you need to have excellent credit (think 760 or above) to qualify for the lowest interest rates.
Hence, “you want to get pre-approved for a loan when your credit is at its strongest point,” says Jaffe.
To assess where you stand, pull a free copy of your credit report from each of the three major U.S. credit bureaus (Experian, Equifax, and TransUnion) using AnnualCreditReport.com. Your report doesn’t include your credit score—you’ll have to go to each company for that, and pay a small fee—but it shows your credit history, including any black marks (e.g., missed credit card payments, overdue medical bills).
If you notice errors on your report, contact the credit-reporting agency immediately, Jaffe says.
In the months leading up to your home purchase, make sure you don’t take any actions that could hurt your credit score. These mistakes include closing old credit card accounts, opening a new credit card, maxing out your credit cards, and making a large purchase such as a new car, says Jeremy David Schachter, mortgage adviser and branch manager at Pinnacle Capital Mortgage in Phoenix.
This one might sound obvious, but a lot of people make the mistake of buying a house that’s simply outside what they can comfortably afford.
“You don’t want to stretch yourself so thin that your housing expenses are going to stress you out each month or prevent you from saving for retirement,” says Jaffe. You can use realtor.com’s home affordability calculator to determine a price range that fits your budget.