A Financial Guide to Buying a Home
The real estate market isn't what it used to be. Our financial guide will help you make the right decision for your family.
Deciding whether to buy a house -- and when -- ranks as one of the most important decisions your family will ever make. To make the best decision, you should investigate a wide range of options. Parents need to recognize that traditional strategies for home ownership no longer apply, says Barbara Steinmetz, a Burlingame, CA-based certified financial planner.
Consider the big picture: According to the U.S. Census Bureau, home ownership is at an all-time high: 68% of Americans, compared to 64% in 1990. (Since many people can't -- or won't -- ever buy a home, every percentage-point increase is huge to economists.) It may seem surprising, given the number of people who've lost their jobs in recent years, but home buying has been proceeding at a frantic pace. The cause: historically low interest rates. Yet purchasing a home, especially in a seller's market, is still a challenging process. So let these new rules guide you.
Look Before You Leap
Old-Think: Prices are always going to keep rising, so you should buy something, anything, as soon as possible. Fail to act quickly and your dream house will only become more unattainable.
New-Think: Don't feel pressured. Instead, make a decision based on your current financial picture. If you're bogged down with too much debt or if today's paycheck is stretched so thin that you can't save for emergencies or retirement, you may not be ready to buy a home yet.
While it may not be possible to pay off every cent of debt before buying a house, do take big steps in that direction. "It's not unusual for me to see parents with $100,000 in student loans," says Linda Patchett, a financial adviser in Chapel Hill, NC. "They might want a house today, but it will be much easier for them if they pay off as much debt as possible before they buy."
What about that old saying "It's just as cheap to own as to rent"? "That is one of the biggest misconceptions around," says Greg Van Wyk, a certified financial planner in Austin, TX. "When you look at the tax benefits of ownership, most people still need to pay $1 in mortgage interest in order to get 28 cents back. And there are all kinds of expenses that people never think about in advance, like the garden hose you don't own, the extra furniture you need to buy, and the repairs you've got to make on your furnace." Higher heating and cooling costs are also huge factors.
To determine the right time to buy:
- Make a list of the advantages you'll gain from buying a house vs. the hardships and downsides.
- Evaluate your family's likely income over the next three to five years. Is there a strong risk of layoff in your field? How probable is it that one parent will eventually decide to stay home with the children?
- Take a no-nonsense look at where you are financially. Ideally, you'll have saved three to six months' worth of living expenses for emergencies and started your retirement nest egg. You should also have little or no credit-card debt and have made real progress in reducing your student loans.
Skip the Starter Home
Old-Think: Always begin with a starter, something small you can easily afford. You can trade up later.
New-Think: Buy a home that works for your family right now -- and will do so for years to come. Maybe you'll want to upgrade at some point, but you shouldn't absolutely need to. "It's impossible to describe how much better off you will be at every step along the way if you wait to buy a desirable home in a good school district instead of a starter that has no advantage except that it's cheap," says Steinmetz. Starter-home prices rise only when the real estate market is strong, and they can be hard to unload during economic downturns. If you buy such a home when prices are still at or near historic highs and the market weakens, your family could find itself sitting on an asset that's losing value.
Are there situations when a starter house makes sense? Yes: when it's a truly great deal. Maria Ibanez, a telecommunications administrator, and her husband, Alberto, a sales representative, just successfully traded up from their one-bedroom co-op in New York City to a three-bedroom Tudor in Palisades Park, NJ, where they now live with their two children, ages 3 and 1. Their secret? They bought their first home out of foreclosure proceedings. (In cases of foreclosure, a bank or other lending institution takes possession of a home, usually because the owner has failed to keep up with mortgage payments; the bank then sells the property, often at a deep discount, to minimize its losses.) A starter may also work if your rent is so high that you're able to find a comparable deal on a small house.
Opt for a 30-Year Fixed-Rate Mortgage
Old-Think: The most important thing is to pay off your mortgage as quickly as possible.
New-Think: Never mind 15-year mortgages; stick with the traditional 30-year plan. Many of us can relate to Mia Brush's confusion about 30-year vs. 15-year mortgages. "I grew up hearing my parents talk about paying off their mortgage as soon as possible," she recalls. When interest rates dipped in 2003 to historic lows, Brush, a fundraising consultant, and her husband, Jason, an advertising agency professional, figured it was time to switch to a 15-year mortgage on their three-bedroom home in Los Angeles. With plans to have a baby within the next year or so, the couple wanted to get their house -- and their finances -- in tip-top shape.
They consulted Eileen Freiburger, president of On Your Side, Inc., a financial-planning firm in El Segundo, CA. Her advice: Stay with a 30-year fixed-rate mortgage, which requires lower monthly payments and offers more flexibility. "A 30-year mortgage can be paid off more quickly if you find yourself with extra cash," she says. Simply include an extra principal payment, whatever you can afford, with your mortgage check each month. Even $100 extra will make a big difference. During months when other financial demands prove pressing, you don't have to make the extra payment.
If a family signed up for a 15-year mortgage instead, it would be committed to paying higher bills each month, despite the lower interest rate. Freiburger calls that "an unnecessary burden at a time when the family's income may shrink and its expenses will rise." (Mia wasn't sure when and how much she'd want to work after the baby's birth.) The bottom line: It's more important to pay off your credit-card bills and save for college and retirement than to opt for a quick 15-year mortgage.
That's just what Mia and Jason did. They refinanced their home with another 30-year fixed-rate mortgage. Thanks to the house's appreciation in value and low interest rates, they were able to borrow enough money to pay for renovations to make their house more kid-friendly.
Protect Yourself With a Home-Equity Line of Credit
Old-Think: Wait until there is an emergency and you really need the cash before you apply to a bank for money.
New-Think: The best time to safeguard your finances by securing a line of credit is when you've just bought a new house. Todd Shepherd, a financial adviser and certified public accountant in Leawood, KS, signed up for a home-equity line of credit -- even though he hopes to never use it -- as soon as he was ready to move into his new house with his wife, Vicki, and their 9-month-old baby, Jake.
A home-equity line of credit is based on how much equity exists in your home on top of your mortgage. For example, if your home's value is $200,000 and your mortgage is $125,000, a bank might allow you to borrow another $35,000 through a home-equity line of credit. Your total home borrowings would add up to $160,000, or 80% of the house's value; the interest you would pay on the $35,000 would be tax-deductible, just like mortgage interest. But -- and this is the best part -- because it's a credit line and not a loan, you don't take the money from the bank unless you need it. It's an emergency line of defense.
There are three simple reasons why this strategy is smart for home buyers. First, it's easy: If you apply at the same time or soon after you qualify for a mortgage, you'll minimize paperwork and may be able to reduce or eliminate fees. Second, it's painless: If you don't use the credit, there's minimal impact on your family's credit rating. (Make sure you don't apply for a home-equity loan, which is a different matter.) Third, it's far safer to have this credit line than not.
"I'm in California, where the layoffs have been huge," says Freiburger. "You need to be prepared for an emergency, whether it's a job loss, a disability, or an aging parent's illness. That's why I tell people to sign up for a home-equity line of credit as soon as they buy a home."
Plug in to the Internet
Old-Think: There's no substitute for home visits and neighborhood tours when looking for a house that's right for your family.
New-Think: Computers can be great time-savers for early-stage shoppers. The Internet can help you research home styles and prices, brokerage firm specialties, school district quality, mass transit availability, and other factors that may be important to families, such as proximity to religious institutions or availability of special types of childcare.
Take a lesson from Alberto Ibanez. When he and his wife decided they were ready to move out of New York City, they had plenty of questions. So Alberto narrowed their house hunt by using the Internet to compare the cost of houses in towns with strong school districts. (To check out different districts, go to www.greatschools.net.) Alberto also looked into costs for preschools to be sure they'd choose a town with affordable programs. Best of all, he was able to conduct his research at his own convenience, after work and when his children were asleep.
You may ultimately decide to work with a mortgage broker or apply directly to your local bank, but the Internet is also a good way to comparision-shop for interest rates and closing fees. However, there's a caveat: Watch out for too-good-to-be-true offers, such as 120% financing and interest-only mortgages. In addition, never provide confidential data unless you're familiar with the
company, its site is secure (the Web address will begin with "https"), and there's a good reason why you're being asked this information. For example, there's no justifiable reason for a site to ask for your Social Security number, bank account specifics, or credit-card information unless you're actually applying for a loan online.
Few life experiences offer a greater reward than buying a home your family will be happy in. But house-hunting, especially in today's economy, requires patience, careful attention, and perseverance. "If you commit yourself financially in ways that are clearly risky and something goes wrong, your family will be in trouble," says Steinmetz. "So the most important rule to remember is the most simple: Put your family's financial health first."
Copyright © 2004. Reprinted with permission from the May 2004 issue of Child magazine.