Like many veterans returning from a deployment to the Middle East, I came back flush with cash in the fall of 2014. Nine months of expense free and tax-free income will do that. Even on the salary of a lowly enlisted specialist (the rank below sergeant in the Army) this meant returning stateside with some $25k saved up in cash.
Many of us had never seen a number like that in our bank account and it was all too easy to justify spending it after nearly a year in the sandbox. However, instead of spending it, I took the money and immediately placed $10k into a retirement account. The remaining $15k I earmarked as my future down payment. Once I completed my degree, had a stable job, and moved in with my fiancée, I knew it was time to start looking for a starter home. My biggest fear jumping into the market in 2018 was losing the little nest egg I had saved up while overseas. It was my baby!
Going through the purchase and later sale of our first home, here are a couple lessons I learned as a first time homebuyer.
Know Your Budget
First things first, you need to know your budget. The most obvious reason is over-confidence or over-estimation. This avoids a scenario in which you view and bid on homes that are too expensive only to have your budget stretched paper thin or be denied funding entirely. Alternatively, it is possible to underestimate your purchasing power. The harm in underestimation is that you fail to consider homes that could fit comfortably in your budget. Ultimately this could impact your quality of life and could cause you to forgo significant increases in home equity.
Case in point: When my partner and I bought our first house we took out a 30yr mortgage for a charming 800sf 2bd/2ba home in a desirable location. What it lacked was a garage or paved driveway and we were in Wisconsin- Uff da!
This was in 2018 when interest rates rose modestly but the loan still only amounted to a 22% DTI (debt to income) ratio when only considering my income alone. A ratio up to 30% is comfortable for most people and a budget is not considered stretched until a ratio of 36%. Had we purchased a more expensive home, we might have built $100k more in equity with the recent rise in home prices. Talk about an expensive mistake!
Tip: Use a mortgage calculator like this one at Nerdwallet to get a baseline idea of what you can afford.
Consider a Pre-Qualification
A mortgage pre-qualification allows a buyer to enter their income, down payment information, and run a credit check to determine a likely amount that the buyer would be approved to borrow. The primary difference between a pre-qualification and a pre-approval is that a pre-qualification typically contains only self reported financial information whereas a pre-approval verifies information using paystubs and other supporting documents. For more information on how a pre-qualification differs from a pre-approval, check out this page published by Bank of America.
Note: A buyer might be prequalified for more than they feel comfortable spending. Consider your own evaluation of your finances, any second opinions, or affordability calculators when determining a budget.
Liquidity Comes First When Budgeting
Growing up, I heard over and over how private mortgage insurance (PMI), which is necessary when a down payment is less than 20%, is just throwing money away. When I made an offer on our second house it was tempting to place 20% down in order to avoid this charge. However, we ended up placing only 15% down and accepted the additional monthly payment of $60 for PMI. Why? Coming up with the extra cash to cover the remaining 5% would have meant selling off the remainder of our taxable brokerage account (triggering additional taxes) and dipping into our emergency savings. When it comes to making a down payment it’s important to prioritize liquidity so that you have the flexibility if an expensive repair is necessary or you face some other financial setback.
Tip: Consider leaving at least your 6 month emergency fund intact when determining what amount you will place as a down payment.
Be Aware of All Expenses
When considering your budget, make sure to account for additional costs to close beyond the down payment. These costs fall into two main categories.
The first category are closing costs which are a collection of various one time fees and expenses related to the loan and change of ownership for the property. The costs consist of individual line items like loan origination fees, appraisal fees, title insurance, flood certification, and more. The second category of costs are prepaid expenses. These are costs which must be paid annually but which are typically paid into a holding account, called an escrow account, on a monthly basis to ensure they will be met by the end of the year. These costs include homeowners insurance and taxes.
In total you can expect to spend around 3% of the loan cost in closing costs though this will vary. Nerdwallet has a calculator you can use to estimate these costs, or you can wait until a lender provides a more personalized estimate as part of a pre-approval.
Arm yourself with a Pre-Approval
Ok, you’ve got your budget nailed down, you’ve been searching Zillow for places for weeks, and you’ve spotted an open house for a place you’re really excited about. You’re ready to start taking a look at some properties right? Wrong.
When you’re ready to start making offers you’ll need a pre-approval. In today’s housing market a buyer must be prepared to move quickly and a mortgage pre-approval is what will allow you to make a serious offer. A pre-approval from most lenders, such as Chase, is valid for 90 days so you can get a pre-approval in place and begin touring properties with confidence. If your home search takes longer than 90 days a buyer can always get a new pre-approval. While a pre-approval does involve a credit check the impact of this on your credit is negligible and should not affect your decision to get a pre-approval.
Know the Market
Offers and counter offers take place quickly and you need to be able to place a number on how much you’re willing to pay for a property. Prior to making an offer you should know:
- The most you’re willing to pay
- What aspects you’re willing to compromise on eg. Closing date, inspections, etc.
- The initial offer which might be higher or lower than the listing price
A real estate agent can assist by providing insights into local market conditions and negotiate on your behalf but you’ll still own the final decision on what to offer.
Don’t Be Afraid to Break Your Lease
You might be wondering how you can possibly time purchasing a house with the expiration of your lease. The short answer is not to worry about it.
People Move All the Time
You wouldn’t be the first person to break a lease. Some people move for school, some to change jobs, and others still to be closer to family as personal situations change. Most rental agreements address how a lease can be broken early. If a provision isn’t listed in the rental agreement, then ask your landlord. Worst case scenario you can always find a subletter.
For our first home purchase we made our offer only four months into our lease and closed with six months remaining. By communicating early we were able to work with the landlord to list our unit and we only had s ingle month where we had to pay both a mortgage and a rental payment. For our second home purchase we communicated after we had an accepted offer and pre-approval and reviewed the days on market for existing units. Based on how long rentals were taking to be filled we opted to pay two months of rent to break the lease early.
Relax. This is Just a Five Year Plan
Jumping into the housing market is a big move. You’re making decisions that affect hundreds of thousands of dollars and might be bigger than any single decision you’ve made before so it’s natural to feel a need to “get it right”. While it is important to perform due diligence, this isn’t a decision for the next 30 years. The vast majority of first time home buyers do not stay in their first homes for 30 years. I couldn’t find recent data on ownership length but I’ve heard anecdotally the length of ownership for first time home buyers is closer to 5-7 years.
If you’re relatively young it can also be difficult to forecast your needs much further than 5-7 years. In that time span a job opportunity could send you packing across the country or a decision to have kids could lead you to the suburbs. For our most recent house we prioritized our needs knowing we have a one year old. This meant ensuring the home is zoned for a highly rated public elementary school for four years from now even as we were less picky about middle or high schools. Since our daughter won’t be in middle school for at least 9 years it didn’t make sense to consider this factor in our current purchase. This ultimately allowed us to afford other features like an office for WFH and a guest bedroom which otherwise wouldn’t fit into our budget.
Trust the Numbers
Once you’ve done your due diligence, trust your hard work. Nobody expects a perfect outcome on a first purchase but if you did your homework then you can rest assured that you’ve given yourself the best chance of success possible.
For more information on the types of mortgages available check out Is a VA Loan Always the Best Option for Veterans? Even if you’re not a veteran you might still benefit from the general overview of loan types which are explained.Log in or Register to save this content for later.