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While the dream of home ownership may have taken a beating during the recent recession, a majority of Americans still say that buying a house is in their life plan.
And with good reason: home ownership is a key part of many individuals' long-term financial strategies, plays an important role in improving the health of the economy, and can provide much-needed space for growing families.
But if the recent collapse of the housing market made one thing clear, it's that home ownership is not for everyone. It's a significant, long-term commitment that requires strong financial standing and the right timing.
We spoke with Merrill Edge Financial Solutions Advisor Wesley Gunter and Trulia real estate expert Michael Corbett to get a sense of what first-time home buyers should consider before taking on a mortgage. They recommend that prospective buyers ask themselves the following questions:
1. Why do you want to purchase a home?
Both Gunter and Corbett say that figuring out why you want a home is absolutely critical before you begin looking at options. "What's the purpose of the home?" asks Gunter. "What do you want to do with it? Are you going to live in it? Are you going to rent it? Know where you are in that life cycle." Answering those questions will determine what kind of loan structure you'll need and what size house makes the most sense given your short- and long-term family plans.
2. What can you reasonably afford?
Before you even think about whether you want a two- or three- bedroom , you need to figure out what you can actually afford. That means taking an inventory of your income, expenses, assets, savings, and debts. Once you know where you stand, Gunter suggests sitting down with a financial advisor and saying: "Here's an example of our cash flow on a monthly and quarterly basis. Is it reasonable for us to buy a $500,000 home or a $200,000 home?"
The last thing you want is get your sights set on one kind of home only to discover later that it's way outside your price range.
3. Have you factored in all the hidden costs?
The mortgage and down payment aren't the only numbers you need to consider. "You hear people say all the time: 'Well, my rent right now is $2,500 and the mortgage would be $2,300. I should buy a house,'" Corbett says. "Well, the problem is, you're not taking into consideration all the ongoing costs of home ownership."
Costs like property taxes, home owner's insurance, realtor fees, closing fees, utilities, and maintenance can really add up. If you're buying in areas like California, Corbett continues, you'll also have to pay hazard insurance against natural disasters like earthquakes. "So that $2,300 is not $2,300," he says. "It may end up being $3,500 or $3,700 when all is said and done."
4. What kinds of loans do you qualify for?
Just like applying for a credit card, whether you qualify for a particular home loan depends on your financial history. Lenders will look at your pay stubs, employment forms, and tax returns going back two years, as well as your credit score to determine eligibility. F irst-time homebuyers can apply for Federal Housing Administration (FHA) loans, which require just a 3.5% down payment.
But if you can't put down 20%, says Corbett, you should seriously think through whether you can afford a house. In the latest housing crisis, he says, "the majority of the collapsed mortgages and a majority of the defaults were homes that were purchased with very little money down." Gunter agrees, saying: "Every mortgage is set up differently, but the more you can afford to put down the better, because it will reduce your payments as you get going."
5. What will your life look like in five years?
While you might be financially ready to buy a home, it might not make sense given your current career path or relationship. Is there any chance you'll be transferred to another office? Are you or your partner, if you're looking with someone else, considering grad school in the near future?
"Just because interest rates are low, and it might be a great investment right now," says Gunter, "is it something that you want to go in on? One of your most expensive assets that you're ever going to invest in in your entire life, besides your retirement, is your home. It's a major decision, and it can't be jumped into foolhardily."
6. Are you ready to stay put for the next few years?
If there's a good possibility you might move within five years, says Corbett, now is probably not a good time to buy. "Right now we're seeing some nice stable appreciation in home prices," he says. "However, coupled with all the costs of closing [the house] and then selling again, it ends up being cheaper for you to stay renting for this same time period if you're going to be moving any time under five years." While appreciation rates vary by region, Corbett says staying put for three to five years is a good rule of thumb.
7. What kind of neighborhood do you want?
If you're young, being in a major metropolitan area might be the most important factor in your decision right now. But if you're thinking about starting a family in a few years, you might also consider the quality of your local schools, access to public parks, and the safety of your neighborhood.
Locate a few areas you're interested in and start checking out homes in your price range. Corbett and Gunter recommend starting to look at least a full year in advance so you have time to check out as many options as possible.
8. Are you working with the right realtor?
Your relationship with your realtor is just like any other financial relationship; it's important that you mesh well and that they'll go to bat for you when you find the house you want. Gunter suggests doing mini interviews with a few realtors to compare their commission structures and availability. "Doing that due diligence right off the bat is going to save you a lot of time," says Gunter.
One mistake many people make, says Corbett, is using a realtor because they're a friend or a relative, not because they're familiar with the right area. "You really need someone who has the knowledge and the expertise and reputation," he says.
9. Is the rest of your financial house in order?
The last thing first-time homebuyers need to consider is whether they'll be able to stay on top of all the other financial commitments in their life without going under. " When it comes down to it," says Gunter, "you don't want to sacrifice your retirement just because you really want to get this home right now." By the same token, you shouldn't put yourself in a situation where you're struggling to pay off your car loan or credit cards. "So make sure you can manage all of your finances when you step into a major decision like this."
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