7 Financial Must Haves for the First-Time Home Buyer
Buying your first home can be one of the most exciting events in adult life. In many ways, it's our society's primary marker of adulthood, a symbol of financial prudence, and the ultimate sign of stability. But without the right planning, buying your first place can be fraught with stress, fear, and way too much guesswork. Here are seven financial prerequisites that, in my book, are musts before you sign on the dotted line and start picking out curtains and countertops. (See also: Buying a Home Without the Money)
1. Bank a Large Enough Down Payment
Ask 12 people what an acceptable down payment is, and you'll get a dozen different answers. Common ranges are 5% to 20%, with anything less than 20% requiring buyers to carry private mortgage insurance (PMI) to protect lenders against loan default. Your down payment should be large enough to make the resulting mortgage manageable month-to-month, even if there's a temporary financial hiccup. Remember, every dollar you save toward your down payment is one less dollar you'll need to borrow and one less dollar you'll be paying interest on for the next 30 years.
2. Understand How Much You Want to Afford
Lenders are great at telling us exactly how large a mortgage we can afford based on factors like our down payment and debt-to-income ratio. But I think there's a second, much more important equation — how much do we want to afford?
Ask yourself, "What kind of lifestyle would I like to have after I purchase my home? What level of mortgage debt am I comfortable with?" Consider your other financial goals and calculate just how much money you're willing to devote to your mortgage, mortgage insurance, property taxes, and association dues.
3. Know Your FICO Score
Lenders use FICO scores to determine if buyers qualify for a loan and help calculate the mortgage rate for those who do. Typically, anyone with a credit history has three FICO scores, one from each of the three credit reporting agencies: Experian, Equifax and TransUnion. It's a good idea to know your credit score before you apply for a mortgage and, if necessary, correct any errors that might negatively affect your chances of getting the best mortgage rate. By law, credit bureaus are required to provide consumers with their scores free of charge once every 12 months.
4. Gauge Your Job Stability
Knowing that your income is relatively secure is an important but often ignored prerequisite to buying a home. A few times over the course of my career, I've initiated candid conversations with my boss whenever I'm on the cusp of making a large purchase. I like to check in and see how the company is doing and how I'm doing, and I base at least part of my purchasing decision on the answers I get. I try to be as direct but as discrete as possible and explain why I'm asking.
Usually the conversation begins something like this, "Hey, Chris, I'm thinking of putting an offer in on a condo and just wanted to touch base with you about the company. Off-the-record, is there anything I should be concerned about or any potential bumps in the road that might make this a bad time to make a big financial commitment?"
Of course there are no guarantees with any job and not all employers will welcome this approach or be forthcoming with their answers. But it helps to put it out there and try, as much as possible, to get a clear sense of your short-term and long-term employment realities.
5. Cut Your Consumer Debt
Did you know that, according to NerdWallet, the average credit card debt per household in the US is $15,216? That's a lot of unsecured debt, a lot of interest, and a lot of stress.
Regardless of what debt-to-income ratio your mortgage company allows, strive to drastically reduce or entirely eliminate consumer debt before you buy a home. And after, resist that nagging temptation to use easy credit to remodel or furnish your new digs. The quickest way to sour on home ownership is to stack a bloated credit card bill on top of new expenses like mortgage payments, homeowners insurance, property taxes, and maintenance costs.
6. Build a Healthy Emergency Fund
A well-funded emergency account not only protects you from financial and employment hiccups — it protects your assets. Having six to eight months' worth of income squirreled away and available for withdrawal penalty-free is a must before you commit to buying your first home. If stashing cash seems impossible, especially after you've just scrimped and saved for a down payment, consider some creative strategies on how to build an emergency fund.
7. Fund Your Retirement
Don't let the home buying process distract you from solid retirement planning. Contribute to your 401(k) at a rate that lets you take full advantage of the company match and then add a Roth IRA to your investment mix. Young savers who start early and stay consistent can benefit from a longer investment horizon (and that sure beats playing panicked catch-up later).
For first-time homebuyers, taking the financial leap can be daunting. But there's real power in understanding our financial realities personally — well beyond what the mortgage lenders tell us (and sell us). And when we're empowered enough to truly know our financial pictures, we can make better choices and "own" the homeownership process.
Did I leave anything out? What else should first-time home buyers do before they buy a home?