The Reality of the American Dream (the How & the Cautions)
According to our parents’ generation, owning a home will be the biggest investment we ever make. It’s the American dream to own a home with a white picket fence where you and your significant other can raise your two kids and the golden retriever. However, there are responsibilities to home ownership that become mystified, and often forgotten, when the rush of purchasing your new home takes over. It happened to me!
When I purchased my first, and only, primary residence I had little idea what I was getting myself into. All I knew was I didn’t want to rent, which blinded me from other things that may have deterred a logical person.
I’ve owned my home for just over a year now and already I have rented out a room to a coworker, refinanced, and made home repairs (some of which we’re due to my ignorance). I’ll share with you the often overlooked responsibilities of home ownership so you can make an informed, intelligent buying decision.
Let’s step back to when I first purchased my home. I had been employed by BP for just over four months when I started looking for a home. I knew I didn’t want to rent forever but I was living with several college friends in a house to save money while I pay down student loans. I believe my rent was $308/mo at that time.
After I paid down my debts to manageable level I wanted to take the leap into home-ownership.
I was sent a few pieces of mail from various companies (discover, chase, wells fargo, etc.) about these historically low interest rates. I began doing the math and it was astonishing to see just how much a few percentage points on your loan can have a huge effect on your payment.
The table below shows the monthly principle and interest (P&I) payment and the interest paid over the life of a 30 year fixed $200,000 loan for several interest rates.
|Interest Rate||Monthly Payment (P&I)||Interest paid over the life of the loan|
As you can see, lowering your interest rate from 4.5% to 3.5% can save you almost $40,000 in interest and about $115/mo over the life of the loan. But why did I put 7% interest in the table? Because it’s the historical average since the 1970’s. This is why refinancing your old, high-interest loan to a new, low-interest mortgage is so popular in today’s environment. You can check out my nightmare refinance story here.
“Interest rates are rising,” shout the CNBC analysts. It seemed like everywhere I turned I heard something about the Fed slowing quantitative easing (QE) which would drive interest rates up. I knew I wanted to own a home so why not act sooner and have to pay less interest? That was all I cared about, paying as little interest as possible. So I began the pre-approval process.
The pre-approval process is fairly standardized and can usually be done online. What the process does is see how much of a loan you can “afford”. I write afford in quotes because the pre-approval process, much like the qualification for a car loan, is a cookie-cutter process.
The pre-approval asks about your debt, income and your job. The largest factors, gathered from various sources, are; job history, down payment, credit score and debt-to-income ratio. The rule of thumb for debt-to-income is 43% meaning if you gross $10,000/mo then your debt payments should not exceed $4,300/mo. For more information on the new mortgage rules click here.
After you have the pre-approval for X dollars, carefully use a mortgage calculator to see how much of X you want to use. In other words, just because the bank gives you pre-approval for $400,000, doesn’t mean you have (or can afford!) to purchase a home for $400,000. Use the mortgage calculator to see if the monthly payment of the $400,000 loan makes sense for you.
I used less than half of what I was pre-approved for.
Once, I had pre-approval it was time to start looking at houses. I was referred to a real estate agent and we began our house hunt.
I knew the area and my price range, which really helped my realtor. Daily I would get emails from her of houses that had just been put on the market and when I found one I was interested in, I would schedule to go see it.
The most important thing to remember when you’re looking at house prices is that just because house A is less expensive than house B doesn’t mean it’s a good buy. House B could be in an area with better schools, lower taxes or an overall nicer area. Which is why after I found the place I liked, I would ask for the comparables (comps).
Comps show the prices of all the houses in the area that sold in the last six months that are similar to the house you, or me in this case, want to buy. This is helpful for determining the purchase price. The realtor should have all this information.
I found a house that was $56/SF. The comps showed the price was similar to what other houses were selling for in the area. The Houston market is extremely competitive when I was purchasing my home so I didn’t make a lowball offer.
I offered him $5,000 under asking to leave some room for negotiating, and it worked. I ended up with the fridge, all the TVs and an expensive projector for the theater room. And all for bringing my offer up to the full asking price ($189,000).
So, why did I negotiate the fridge and other items? Because I would have had to buy those items with cash out of my pocket anyway. Instead, I added $5,000 to my offer, which will be added to the mortgage, that I put 3.5% down on. I essentially purchased those items with the home loan. Yes, it added a few dollars a month to my payment but it saved me from coming out of pocket thousands.
After the negotiation everything is fairly routine. You sign a written offer with earnest money. You get an inspection (then can negotiate more if they find any issues). You wait till the title company checks the history of the title. Then you go to closing, where you sign about 100 pages.
Your realtor will help you through the majority of this process so you should have a realtor that you like and trust. However, remember how they’re incentivized. They get paid a percentage, usually 3% of the sales price, by the seller of the home. Keep this in the back of your mind and never tell your realtor exactly what you’ll pay.
Remember, everything is negotiable; the realtor fees, home price, furniture, closing costs, closing date, even the big screen TV.
Now that you know the process, it’s time to learn about the “dark side” of home-ownership.
When you see your mortgage payment of $1,000/mo that typically includes principle, interest, taxes and insurance (PITI). Side note: if you don’t have a 20% down payment don’t forget to budget for private mortgage insurance (PMI), which is about $100/mo per $100,000 home value.
Maintenance and repairs, which can be a hefty burden if you purchase an older home, are like the redheaded step child, you just don’t talk about them and hope they go away. They are hard to quantify but they need to be accounted for when doing the arithmetic of home affordability.
So what kind of continual maintenance am I talking about?
- Yard and landscaping care (this can be a big time suck)
- Replacing and checking air filters for the AC unit
- General cleaning
- Appliance checkups
- Test smoke and carbon monoxide detectors
- Flush hot water heater
- Clean gutters
- Add caulking around bathtubs and showers
- Get carpets professionally cleaned
This is a lot of work, and time consuming. You can hire these things out but that’s another expense you’ll have to budget for.
On average I spend about 10 hours a month doing general maintenance I described above. I set myself reminders on my iPhone for the routine items like; replacing air filters, testing smoke alarms, and flushing the hot water heater.
I also had to buy a mower, weed eater, gas cans, ant and weed killer, fertilizer, fertilizer spreader, and hedge trimmers to properly care for the landscaping and yard. Thanks to an old friend I purchased most of the list at an extreme discount but it could have cost me nearly $1,000.
So, with general maintenance, if you’re going to do it all yourself, it will cost several hundred dollars for all the proper tools with a variable cost of $35-50/mo and about 10 hrs/mo of your time.
At least the general maintenance is a known and expected cost, unlike repairs, which can really be a surprise to your wallet. Inevitably something will go wrong, whether it’s inside the house or a tool you just purchased for lawn care, you will have repairs that need to be made.
But, forget the unexpected expense, who’s going to fix the AC unit, the mower, the refrigerator, the dishwasher, the oven, the plumbing, the leaky roof, the washer, the dryer, the window, the siding, the drywall, the ceiling fan, etc.?
So, there are two heads to the repair snake; the cost of the repair and the quality of the work. Do you know a good repair man that you can call for X, Y, Z? Maybe you live close to home where your Dad can help, or you live in a small community where you know the local handy man? If you live away from family and hardly know anyone, what do you do? Get a home warranty.
According to Cost Owl, an average home warranty costs between $300 and $600 per year. When something breaks, you get online to your home warranty company and fill out a request form. They will contact you usually within 24 hours and have a repair man at your house within two days. I use American Home Shield and they have already saved me hundreds of dollars.
I purchased a home that was five years old from the original owners. With a five year old home, I expected minimal repairs. I was wrong. I have already had to repair the AC unit, the garage door opener, a ceiling fan, and a toilet. Thankfully, each time I had an issue the only thing I had to do was request the service and pay the $75 deductible. I didn’t have to find and vent the proper repair man for the job or worry about the quality of the work. This is a big relief that I gladly pay $475/yr for.
I don’t mean to paint a gloomy picture for people who are looking to buy their first home but I want you to make an informed, intelligent decision. I don’t want you to be the one struggling to make a mortgage payment because of unexpected expenses. And remember, when you buy a home, unlike a lease, you’re stuck with it until you decide to sell.
To summarize the do’s and don’ts of home buying;
- Do take advantage of low interest rates.
- Don’t let mortgage rates be the deciding factor when looking to buy a home.
- Do use the mortgage calculator to see the monthly payment of your loan.
- Do budget for maintenance and repairs.
- Don’t forget to add PMI to your monthly mortgage payment.
- Do negotiate price, terms, furniture, etc.
- Do wrap large expenses, like the fridge, washer dryer, etc. into the mortgage.
- Do use your iPhone to set monthly maintenance reminders.
- Do look at recent comparables.
- Don’t tell your realtor what you’ll really pay for the house.
- Do purchase a home warranty.
- Don’t be afraid to live with friends to pay down debt and save for a down payment.
- Don’t be afraid to rent out a room to a colleague or friend.
- Do have an exit strategy.
- Do research your market, realtor, interest rates, etc.