Investing in real estate has been on my mind lately. However, having never purchased any property, I feel very reluctant to start the process. So, I decided to educate myself to be more comfortable with the idea of buying a home. In the recent weeks, I’ve started to research and ask friends all of the questions that I could think of to get into the real estate game. We’ll cover finances, in this post.
Decades of Debt
My biggest fear in buying a home is borrowing hundreds of thousands of dollars and committing to a 360-month payment plan — that’s 10,950 days or 3 decades — to pay it back… with interest.
My philosophy with debt has always been, never borrow more than you have. That way, if you were to ever lose your main income stream, you’ll still have enough money to pay off any borrowed money. Unfortunately, with such a large purchase, it’s difficult to follow that rule.
Being Ready Financially
Pay off debts
Your most powerful wealth building tool is your income.Dave Ramsey
Don’t let old student-loans, credit card payments, or exorbitant car payments take away from your income. The more income you have available every month, the more house you can buy! Create a strict budget every month and stick to it! Get rid of those debts, so that you can begin saving for your dream home.
Build an emergency fund
Before you even consider buying a home, you should have 6 months worth of expenses stashed away into a high-yield savings account. No exceptions. If you’re not comfortable with 6 months worth of expenses, save more. But, not less! These days, banks are offering savings accounts with 2.20% APY! This money is for emergencies only and should not be touched otherwise! And no, guac at Chipotle is not an emergency.
Pricing your home
If you’re taking a mortgage, aim to do a 15-year conventional loan. Of that 15-year conventional loan, the monthly payments should not be more than 25% of your take-home pay. For example, if your take-home pay is $4,000, you should plan for a payment of $1,000 per month. If you’re contributing to a retirement plan, do not lower your 401K contributions, just to increase your take-home pay.
It’s customary to give a 20% down payment on the home (not including closing costs). If you don’t, you’ll most likely have to get private mortgage insurance, or PMI, added on top of the loan. This will increase your monthly payments on the home. Any money paid as PMI will not go towards the loan, and therefore will not be wise to pay. However, if you can achieve a higher rate of return than the PMI with the principle you keep (instead of putting it as a down-payment), then it may be beneficial to do so.
If you want a nicer home and putting down 20% leaves you with high monthly payments, consider saving more. The more money you put towards a down-payment, the lower your monthly payments will be. Additionally, you’ll save interest in the long run by taking out a smaller loan.
Once you’re ready financially, it’s time to start reaching out to lenders and realtors. We’ll discuss this more in the next post. For now, save, save, save!