First Person: Financial Planning as a First Time Home Buyer

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First Person: Financial Planning as a First Time Home Buyer
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Maple tree in my first house

Buying my first home as a young single required serious financial planning. Although the government site HUD offers many resources for first time home buyers, I developed some specific plans that allowed me to figure out if I was ready to buy a home, how much I could afford, save up for the downpayment, maintain a credit score essential for low mortgage rate, and finally get mortgage financing to fulfill my dream of home ownership.

Understand what I can afford

I wanted to buy a home I could afford to 1) pay 20% down, and 2) pay monthly mortgage. I imposed upon myself a 50-30-20 budget that allocated my take home pay 50% to fixed costs, 30% to discretionary costs and 20% to savings. I set a maximum for my housing expense, whether it was rent or PITI mortgage payment. Using a simple mortgage calculator, I reverse calculated my target mortgage amount, factoring in both downpayment and a cushion for taxes, insurance and closing costs. Since my calculations were with my take home pay (post-tax), I found I could afford less house compared to lenders' standard affordability calculators that were based on the standard 28% monthly housing payment (front end) ratio and 36% debt to income (back end) ratio.

The FHA has an even more generous home affordability calculator, but I wanted to choose a more stringent affordability calculator so I had enough cushion to absorb unexpected repair costs, property tax increases, or a change in my income. I also wanted to have funds left over for furniture, home furnishings and housewares that would go in my new house, as well as maintain an emergency repairs fund.

Buy or rent?

I had heard that home ownership offered significant tax advantages. However, for buyers who do not itemize their tax returns, the benefits are less clear. In many cases, even after taxes, homeowners "break even" only after they live in their homes for 5-6 years. I itemized, but I still crunched the numbers to see if it made sense for me. My favorite buy vs rent calculator is on the New York Times website.

Yield not to temptation, and start saving!

Like most American consumers, I was bombarded with special offers by mail and email. I opted out of catalog mailings through the "Do Not Mail" list and unsubscribed from promotional emails. These helped curb impulse shopping. Thankfully, I never had much time or inclination to shop aimlessly in stores, and when I did need to buy something specific, I went alone and set a time limit (15-30 minutes) after which I needed to leave the store. I also brown bagged lunches and reduced expensive nights out with friends. My goal was to exceed my minimum 20% savings plan.

Don't open or close credit card accounts

My credit score was excellent, so I needed to continue to pay my credit card bills on time to maintain it. Since a 30-year mortgage loan was my holy grail, I had to turn a blind eye to other credit offerings. According to myfico.com, new credit contributes to 10% of the credit score, and opening new accounts could lower it. I read that closing card accounts actually did more harm than good since it reduced the credit history, and in case I carried balances on my cards, made the credit utilization ratio look worse (same balance over lower credit limit appears riskier to lenders).

Shop around for a mortgage

While maintaining my credit score was a priority, I learned from myfico.com that credit inquiries within a short amount of time for a specific purpose, say mortgage loan shopping, was not viewed negatively by the credit agency algorithms. Since getting the lowest possible mortgage rate was a key factor in home affordability, I used Bankrate.com to keep an eye on mortgage rates. I got pre-approved, a practice that is now offered less by lenders, but is viewed favorably by buyers. Once I started househunting, I called around for detailed rate quotes. I asked questions not just about the APR, but also about any buy downs or points, application and underwriting fees, and any penalties for prepayment. I found my employer had a relationship with a lender that offered a 0.25% discount on the rate.

With these financial planning measures, some good luck and a bit of help from family, I was able to buy my first home in my mid-20s.

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