5 steps to take before shopping for your first home

Are you shopping for a new home? This article outlines 5 steps to take before you start shopping for a new home to help you throughout the home buying process.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print

When you're considering buying your first home, you're probably full of excitement about achieving the American dream. Unfortunately, this dream could turn into a nightmare if you haven't made sure that you're financially ready for the costs of becoming a homeowner. You don't want to fall in love with a house before you've done the practical thing and made certain you're prepared for home ownership. Before you call a realtor, take these 5 steps to get all your ducks in a row:

1. Calculate what you can comfortably spend

The last thing you want to do is make yourself "house poor" by spending more of your income on a home purchase than you should. The "affordability standard" for housing is that you should spend no more than 30% of your income on housing costs (including insurance and property taxes), while many mortgage lenders prefer that your housing cost is no greater than 28% of your income.

Your outstanding debts can also impact the amount you can spend on a home. Most lenders want a total debt-to-income ratio—including your mortgage payments and other debts—to be around 36% or less, although you can still get a standard mortgage with a ratio as high as 43%.

This means if your income is $50,000, you could reasonably afford about $1,170 per month for your total housing costs if you stuck to the 28% rule—assuming you didn't have a substantial amount of other debt that would push your total monthly payments above the recommended 36% of income. If we also assume you can pay 20% down and qualify for an interest rate of 4%, then you could potentially afford a home price of up to $250,000. That may or may not be a realistic price in your area, and you may want to aim lower if you have other sizable debts.

2. Save a down payment of 20%

In our example above, we factored in having a 20% down payment when calculating the price of the home you could afford. Paying at least 20% of the value of the home up front is vital because it allows you to avoid private mortgage insurance (PMI). PMI insures your lender in the event that you're unable to make payments and the lender must foreclose on you. On a $200,000 loan, PMI could cost you $100 a month or more, depending on how much you paid up front—and you could be paying it for several years.

You're stuck with PMI until you pay your loan down to 78% or less of the home's original value. Once you prove to your lender that you've reached that milestone, your lender is required to drop the PMI requirement.

If you don't have a down payment, not only will you waste thousands of dollars on PMI and additional interest payments, but you'll also put yourself at substantial risk. When you make a 20% down payment on a home, the value of the house would have to fall more than 20% for the home to be worth less than you owe on it. If you only make a tiny down payment, however, even a slight downturn in the market could mean you're underwater—i.e., your home is worth less than you still owe the bank. This makes it difficult or impossible to sell unless you can bring cash to the real estate closing for the difference between what your house sells for and what you still owe.

3. Save an emergency fund of 3 to 6 months' worth of living expenses

When you're a homeowner, you are responsible for everything that goes wrong in your house. Instead of calling a landlord when the furnace breaks or the pipes freeze, you have to call—and pay for—a repairman. If the problems are costly to fix, or can't be fixed, you're the one on the hook. If you don't have money set aside to cover maintenance, repairs, and replacements, then you'll have to use credit. You don't want to be paying interest on your new fridge for the next 10 years, so make sure you have an emergency fund to cover the many costs of being a homeowner.

Not only can an emergency fund help you pay for surprise repairs, but it can also ensure that you don't lose your home in the event that an illness, job loss, or other crisis puts a major strain on your household finances. If you cannot pay your mortgage because your income has taken a hit, you could be foreclosed on, lose your house, and end up with ruined credit. You don't want this to happen, so save up enough money to pay the mortgage for several months in case something goes wrong.

4. Get pre-approved for a mortgage loan

When you have your financial house in order, it's time to prove to the bank that you're ready for the responsibility of taking on a mortgage. You want to get pre-approved by your chosen financial institution before you start shopping for a home. Getting pre-approved means you'll have a clear idea of what the bank will lend you so you don't shop outside of your price range. You'll also be taken much more seriously by real estate agents and any potential sellers to whom you make an offer. Some sellers won't even consider offers from someone who isn't pre-approved because there's no way to know whether the financing will be available to complete the sale.

If you want your bids to be competitive and you want to know you're shopping for houses that are priced right, provide your financial information to the bank before you start house shopping and get a pre-approval letter to take with you.

5. Find a buyer's agent

Although you can technically buy a house without an agent, it's usually a bad idea to try it, especially if it's your first home. An agent can help you spot red flags that should send you running away from a prospective home. Agents know the market and can help you make a reasonable offer so you don't overpay, and they can also guide you through the steps of the buying process, like getting a home inspection.

You'll want to be sure you find a buyer's agent, rather than letting the seller's agent represent both you and the seller. A buyer's agent is focused only on your interests and has lots of experience helping home buyers find the house of their dreams. If you've already made sure you're financially ready before calling a realtor, your agent can help you make the buying process low-stress and successful.

Topics:
  • Emergency Funds
  • Home Buying
  • Mortgages
  • Emergency Funds
  • Home Buying
  • Mortgages
  • Emergency Funds
  • Home Buying
  • Mortgages
  • Emergency Funds
  • Home Buying
  • Mortgages
  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print
Article copyright 2017 by The Motley Fool. Reprinted from the August 13, 2017 issue with permission from The Motley Fool.
The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
This reprint is supplied by Fidelity Brokerage Services LLC, Member NYSE, SIPC.
The third-party provider of the reprint permission and Fidelity Investments are independent entities and are not legally affiliated.

Votes are submitted voluntarily by individuals and reflect their own opinion of the article's helpfulness. A percentage value for helpfulness will display once a sufficient number of votes have been submitted.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

831975.1.0
close
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
close

Your e-mail has been sent.
piggy

Get more insights from MyMoney

Just sign up and we'll email our latest thinking every 2 weeks.
Not sure? Learn more
We understand that privacy and security are important to you and will only subscribe you to the MyMoney newsletter. See our Privacy Policy.

Here's what we suggest you explore next

IRAs: A smart way to save for retirement

IRAs can be a great way to save -- whether you're contributing to a 401(k) or other workplace savings plan, or not. If you put away just a little every month, it can make a big impact over time. Learn about the differences between Traditional and Roth IRAs to see which one is right for you.

Open a Fidelity IRA and get more than tax benefits

Free investment help. Exceptional service. Range of investment choices.

You might also like

Are graduate programs worth the cost?

Are you thinking of a getting a graduate degree? Learn whether the finances associated with graduate programs are worth the cost.

Time to take away the financial keys?

Adult children have little knowledge about their parents' finances. Here are 7 ways to take charge when it's time.

How to survive unpaid maternity leave

Maternity leave is a wonderful and necessary benefit, but it can be financially draining. Learn how you can financially prepare for maternity leave.
Financial Checkup

Got 5 minutes? Get a financial checkup now

Answer just nine questions and we'll help you prioritize your financial to-dos, including smart moves to consider for your next dollar. Get your action plan now.