Is it possible for you to delve into home ownership without all the facts? YES.
One of my three biggest financial mistakes was buying a home at a young age without truly considering the financial implications. Read until the end if you’re looking to purchase a home and don’t want to make the same errors as me.
I didn’t do my homework. I didn’t investigate historical housing prices to judge whether the asking price was greater than the true value. I saved aggressively as a young adult and managed to scrimp together 10% for a down-payment on a $150,000 starter home in Saint Louis at age 23. Another 10% was financed in the form of private mortgage insurance, or PMI, and 80% was a traditional mortgage. The home was old and charming – built in the 1920s – and didn’t have any energy efficient upgrades. Heating bills easily ran $300 monthly in the winter, and the tiny window A/C unit on the second floor didn’t suffice during hot summers.
At purchase, it was a 3 bedroom, 1 bath home. Two of the bedrooms and the only bathroom were on the main floor. The second floor was a single room (a converted attic) that consisted of a giant bedroom and closet. My dad completed basic renovations on his home in Wisconsin and offered to turn the second floor into a master suite with a luxurious bathroom. I took him up on the offer and had a beautiful master suite within a few months. Unfortunately, it wasn’t until the home sold a few years later that I realized none of the new master bath addition was up to code. Professional contractors and plumbers were hired in a pinch to fix the master bathroom. In total, I spent about $20,000 to improve my first home and sold it in 2009 for the same $150,000 purchase price. Ouch!
I hope you don’t make the same mistakes as me. Here are my recommendations if you’re in the market for a home:
1. Focus on your credit score prior to the purchase.
Annualcreditreport.com allows you to access your free credit report every 12 months from each of the three major credit bureaus – Equifax, Experian, and TransUnion. Review the report in detail for errors or issues. Here’s a full list of recommendations to repair and improve your credit score.
2. Plan to stay in your home at least 5 years.
The newly proposed Tax Cuts and Jobs Act stipulates that you’ll need to live in your primary residence at least 5 of the prior 8 years to exclude the gain on the subsequent sale of your home. Right now, the law uses 2 of the prior 5 years for the gain exclusion calculation, but legislators are hoping to expand the look-back period to 5 years. This should curtail flippers who move from house to house every 2 years without paying income tax. Regardless of whether this bill passes, real estate commissions and other closing costs make it very difficult to turn a profit (outside of rehabbed houses) if you spend less than 5 years in the property.
3. Hire a buyer’s agent who is on your side.
As a buyer, you don’t pay a commission to the real estate agent; that cost is borne by the seller. However, not all real estate agents are created equal. Some are focused exclusively on acting as a seller’s agent or buyer’s agent. Others run both sides of the table. Exercise caution if your agent is also the listing agent for the home you are most interested in purchasing – there’s an inherent conflict of interest.
4. Do your homework.
If you’re looking to buy in an area with young families, school districts are very important for resale value. Look at the price history on sites like Zillow to understand when and for how much the home previously sold. Pay attention to how long the home has been on the market and others like it to negotiate purchase price.
5. Consider “hidden” costs of home ownership.
Have at least 20% available in cash for a down-payment. Without that target percentage, you’ll either pay PMI until the loan value is 80% of the appraised home value, or you’ll need to take out a home equity line at a higher interest rate than a traditional mortgage. Closing costs, moving expenses, new furnishings and appliances should also be considered. Contemplate ongoing costs like real estate taxes, homeowners’ insurance, and utility bills as well.
6. Budget for home improvements early.
Make a list, prioritizing the improvements you want to make and the timeline for completion. Don’t focus strictly on aesthetics like new flooring, painting, or enhancing an unfinished basement. When will the roof and windows need to be updated? Driveway refinished? A/C and furnace updated? As a woman who spends most of her time inside the house, it’s tempting to focus on the interior. Yet the exterior and home systems are more costly projects that should not be ignored.
7. Get pre-approved for a loan.
Pre-approval for a mortgage gives you a better idea of how much house you can afford. Just because you’re pre-approved for a $400,000 loan doesn’t mean you need to go and find a home in that price range. Determine your monthly payment and see if it fits into your personal budget. Don’t forget about the hidden costs and home improvement projects discussed in the bullet points above. Give yourself some wiggle room. I encourage clients to stay under the maximum pre-approval amount to meet other saving and lifestyle goals.
This list wasn’t meant to scare you. Obviously, purchasing your first home or moving into a new home is a big decision. Let’s talk if you’re looking for a home but want specific advice tailored to your unique situation. As a comprehensive financial planner, I help clients reach their big picture financial goals, and home ownership is an important piece of this puzzle.
Deborah L. Meyer, CPA/PFS, CFP®