As I’m sure you’ve noticed, mortgage rate increases over the past year have dramatically affected the cost of owning vs. renting in America. The last time the gap between buying and renting was similar was right before the financial crisis in 2007 that saw home prices tumble and many buyers finding themselves under water.[1] "
In fact, there are just four cities in the U.S where it’s still cheaper to own than to buy: Detroit, Philadelphia, Cleveland, and Houston.[2] So what if you don’t live in one of those areas and are still considering buying a home?
It’s understandable that those looking for their first home have the feeling that the market is running away from them, starting with the skyrocketing home prices and followed quickly by rapidly increasing mortgage rates. From a square footage perspective, home buyers today get roughly 30% less home than they could get only a few years ago.[3] Becoming a homeowner, or even upgrading to a larger home, is a significant life event. For most Americans it is the largest purchase of their lifetime, so it makes sense that the decision should be made with sound financial practices at its core.
So what can we do to make sure that we are making a sound decision when buying a new home? Here are some considerations to keep in mind if you are beginning your search.
- Budgeting: Determine how much you can afford before starting your home search. Calculate your monthly income, expenses, and savings to establish a realistic budget. Remember to account for additional costs such as property taxes, insurance, maintenance, and potential repairs. A general rule of thumb is that your mortgage principal & interest, property taxes, and homeowner’s insurance should not exceed 28% of your gross household income.
- Mortgage Options: Research various mortgage options and consult with lenders to understand the terms, interest rates, and down payment requirements. Consider whether a fixed-rate or adjustable-rate mortgage suits your financial goals and risk tolerance. Compare offers from different lenders to find the best terms.
- Down Payment: Saving for a substantial down payment is essential. For those who are upgrading, aim for at least 20% of the home's purchase price to avoid private mortgage insurance (PMI). A larger down payment also reduces the principal amount borrowed and lowers your monthly mortgage payments. First time homebuyers likely won’t have enough cash to get to 20% right away, which is fine. Just make sure that the monthly payment fits within the guideline discussed above.
- Credit Score: A good credit score plays a vital role in securing favorable mortgage terms. Before applying for a mortgage, review your credit report and address any errors or discrepancies. Pay off outstanding debts and maintain a healthy credit utilization ratio to improve your creditworthiness.
- Affordability: Consider the long-term affordability of homeownership. Evaluate your current financial situation, stability of income, and future goals. Avoid stretching your budget to its limits, as unexpected expenses or changes in income could make mortgage payments challenging.
- Location: Assess the neighborhood and its potential for future growth. Consider factors like proximity to schools, healthcare facilities, transportation, and amenities. Research the housing market in the area to ensure that your investment retains or appreciates in value over time.
- Home Inspection: Hiring a qualified home inspector is crucial to identify any underlying issues or potential problems with the property. This evaluation can help you avoid costly surprises after purchasing the home and negotiate repairs or a lower purchase price if necessary.
- Resale Value: While it's important to find a home that suits your needs, keep an eye on its potential resale value. Factors such as property condition, location, and market trends can impact your ability to sell the property at a favorable price in the future. Your timeline for how long you plan to live in the home is also important here. If you aren’t planning on living in the home for more than five years you increase your exposure to the risk of markets dropping and having to sell your home after it has lost value and is possibly underwater.
- Emergency Fund: Maintain an emergency fund to cover unexpected expenses related to homeownership. Having three to six months' worth of living expenses saved separately can help you handle repairs, maintenance, or any financial setbacks without compromising your overall financial stability.
- Professional Advice: Seek guidance from professionals such as real estate agents, financial advisors, and mortgage lenders. They can provide expert insights, guide you through the process, and help you make informed decisions aligned with your financial goals.
Investment Advisory Services offered through TradeWinds Asset Management, LLC, an SEC Registered Investment Advisor.