The largest and most important investment for most people is their home. It is your shelter, a tax benefit and, after you have paid down the mortgage, a source of wealth you can tap in your retirement.
If you are a first-time home buyer, here are six guidelines to assist you in your financial preparation. Determining your housing expenses is a critical step in your budget planning. You will need to figure out if you can afford to buy the house and afford to own it on an ongoing basis.
1. Establish an emergency reserve to cover three to six months of living expenses. As you transition from a renter to a home owner, the chance of having unexpected expenses increases. Establish a cash reserve to cover your non-discretionary expenses, such as food, clothing, utilities and insurance, if your income takes a sudden hit or if you need to make a large home repair. If you are a two-income family with stable employment, a three-month reserve is adequate. However, if you are self-employed or if only one spouse works, a six-month reserve is advisable.
2. Calculate your total housing costs carefully. Reputable lenders employ a housing debt ratio to determine the cost of a home that you can afford. Total costs should be no more than 28 percent of your gross annual income. For example, if you have monthly income of $6,250 ($75,000 per year), your housing costs could not exceed $1,750 a month. Housing costs include mortgage payment, home owner insurance, taxes, and association fees if applicable.
3. Take into account on-going maintenance expenses. On average, you will spend 1 percent of the value of your home on maintenance expenses. For example, for a $175,000 home, you should plan for maintenance costs of approximately $1,750 per year. However, this does not mean that you may incur this expense every year. Some years you may spend more on maintenance costs than others. Other factors include the age of your home and costs of labor and materials in your geographical location.
4. Plan to make a down payment of 10-20 percent of your mortgage. For example, if your mortgage is $175,000, your down payment is $17,500 to $35,000. If you make a payment of less than 20 percent, some lenders may require you to purchase private mortgage insurance (PMI) to protect themselves against loan default. On average, PMI costs approximately a .5 percent to 1 percent of your total mortgage. With a $175,000 mortgage, your PMI would cost about $875 to $1,750 a year. Lenders typically require you to keep this insurance for at least two years. You can drop the insurance after five years if your home equity is 20 percent or more. Lender requirements may vary so consider comparison shopping.
5. Consider taking a 15-year mortgage with a fixed interest rate. Consider buying a home that allows you to afford a 15-year loan. For example, if you purchase a $175,000 house and make a down payment of $17,500, your mortgage would total $157,500. With an interest rate of 3.13 percent, your mortgage payment would total $1,097.54 a month. As long as your total housing costs do not exceed 28 percent of your annual gross income, you remain within the comfort zone.
6. Estimate the costs for furnishing your home. You may spend up to 25 percent of the purchase price to furnish your new home. For example, furnishing a $175,000 home may cost up to $43,750. Another estimate suggests furnishings may cost $50-$100 dollars per square foot. Make sure you get estimates of furniture and other items, such as appliances, before you purchase your home. If you already own furniture, you may spend less.
Purchasing a new home is one of the most important decisions that you will ever make, and your success as a homeowner depends on getting the budget right. Consider working with a CFP® professional to help you set goals, decide what you can afford and design a sustainable plan.
Marty L. Reid, CFP®, CFP Ambassador
214 South Academy St., Lincolnton, NC 28092
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
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