10 Financial Factors to Consider When Buying a Home

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Though long considered a step on the path to success and the American Dream, homeownership has taken some hits in both popularity and dreaminess. Headlines tell readers everything from now's the time to buy real estate to why they should stay away from homeownership [sources: Kiviat, Tully]. So how are you supposed to know if buying a home is right for you?

Maybe you should ask yourself if owning a home is your dream or just the idea of the American Dream before you even consider whether you can afford it. Knowing what you want now and for your future is a first step toward understanding the financial -- and lifestyle -- commitment homeownership involves. And whether you forge ahead with excitement, or put the purchase on hold for a few more years, it's never too early to review all of the expenses involved.

Budget (Don't Fudge It)

If you ask your friends and family who have gone through the home-buying process, it's unlikely they will say that it cost less than they planned for. So it's often useful to over-estimate on your costs. Avoid using language -- either out loud or in your own head -- like "I can afford between X and Y" because numbers tend to climb slowly until final figures are beyond what you should be budgeting. You might hear words like "you should expect to pay" or "your monthly mortgage will be about" during meetings with financers. Get rid of the "should" and "about" and "between" words and demand real numbers.

A good way to start is with a realistic debt-to-income ratio. It can gives a clearer picture of what you can spend on housing without having to dine on peanut butter and jelly sandwiches for the next 10 years or more, and you should be able to find several online calculators and forms that will calculate the numbers based on your inputs.

Applications and Closing Costs
Buying a home will cost you for things like mortgage applications and closing costs.
Buying a home will cost you for things like mortgage applications and closing costs.

As with anything you buy and sell, there are costs for doing business when you buy a home. Some of the services and filings you can expect to pay for include the following:

  • Mortgage application fee: Lenders will charge you a fee for mortgage application. The price will vary, but can cost several hundred dollars.
  • Home inspection: Separate from the home appraisal, which establishes the value of the property, an inspection finds any problems with the house before purchase, protecting buyers from underlying issues and giving the owner time to correct problems tied to making a sale. Expect to pay several hundred dollars or more.
  • Closing costs (deeds/titles/land transfers/legal fees): Processing the papers for a home sale involves agencies at the private and government level, so check with a financial and/or real estate expert to get a list of how much each patch of dirt and piece of paper will cost. Make sure each step of the way that you know what you'll be signing and paying for when the property gets signed over. And the closing itself will run about 2 to 3 percent of the cost of the house [source: FICA]. Lenders provide truth in lending disclosure statements to detail percentages and financing fees before closing, and reviewing these carefully and asking questions can prevent charges from sneaking up on you [source: FDIC].
  • Unexpected charges and fees: This is a gray area, and asking people you know about payments they made but didn't expect is helpful. Unfortunately these "etcetera" costs can come during the final negotiations or closing, and they might just have to be paid in order to move forward.

As with other costs, expect to hear "there may be a small filing fee" or "we might encounter a separate charge for." Staying on top of the vague charges and itemizing them as closely as possible will keep the surprises to a minimum.

Move-in Ready?
If the house isn't move-in ready or requires any repairs, the costs of those may end up coming out of your budget.
If the house isn't move-in ready or requires any repairs, the costs of those may end up coming out of your budget.
©iStockphoto.com/Bob Randall

Home inspections are essential to buying a home and they most often work in the buyer's favor. Dangerous conditions found in a structure and even flaws can be repaired at the cost of the seller before the buyer takes over the property.

Other improvements are easier to take care of while a home is empty, so finishing wood floors or installing carpeting, or just adding fresh paint colors to rooms, might be an up-front cost and labor charge to consider. Timing the closing of a home sale with an end to a residential rental lease is another factor, and if you're moving into a move-in ready home, it usually works. However, if you're planning for major improvements that will keep you from moving in until they're completed, having a cushion of savings for accommodations and storage if there are delays isn't a bad idea. If a fresh coat of sealant is covering newly refinished wood flooring, for example, and humidity adds days to drying time, you can be stuck outside waiting while new tenants are already settling into your old rental.

Memberships and Utilities

When shopping around for a rental, most factor in the cost of monthly utilities as a major part of choosing where to live. Shopping for a home should be no different -- except you should take an even closer look at what it will cost to live in comfort. Researching the average utility bills per month for the prior owners or renters can be helpful, especially if you compare their average consumption to yours. If the previous homeowners kept the heat really low to save on gas bills, for example, you know you can estimate a bit higher if you prefer toastier temps during cold months.

Utilities aren't the only fees to consider. If your new home has homeowners association (HOA) and condo dues for lawn care, administration and other upkeep, those can add up. Your closing packet should include exactly how much these cost annually, but if you're able to talk to potential neighbors to determine how often the HOA dues have increased, or what other charges you could expect to incur, that could be helpful in budgeting.

Equity and Interest

Building equity isn't what it used to be, and at the close of 2010, an estimated 23 percent of homes in the United States lost value [source: Ellis]. Equity is the amount of money you've paid toward the value of a home by lessening the amount owe on a home. For example, if you purchase a $225,000 property and the loan (or principal balance) goes down to $100,000 after 10 years, then your equity is $125,000 -- in a perfectly working system. Unfortunately, with the housing bust of the early 21st century, a home you bought for $225,000 may now only appraise at $150,000 after 10 years and a considerable re-evaluation in the real estate market. Your equity then becomes negative despite all of the money you've paid toward the principal loan. This level of risk is a big factor in buying a new home, even at more affordable selling prices.

Getting a loan at a fixed rate means that no matter the change in market interest rates, your mortgage payment will remain the same month after month and year after year. These fixed rates stay the same, but if a home's value drops significantly, payments are overvalued because the equity gets farther and farther behind as home value declines. An adjustable rate mortgage, or ARM, goes up and down with interest rates and can save home owners in the short term as interest at the start is usually very low, but in the long term interest rates are only partly predictable based on economic factors and trends. Long term payments might increase even as a home's value drops. Refinancing on either type of mortgage is unlikely when the equity is negative, and the mortgage itself is then "upside down" or "underwater" [source: Armour]. Owners are pretty much sunk in with their properties until home values rise again.

Insurance and Taxes

Of course you want to insure your home against disaster and major damage, but did you know that banks and lenders want to insure themselves against you, in a way, too? You can add your homeowners insurance to a plan you already have in place like your auto or life insurance for example, and it even can be paid as part of the mortgage payment and managed through a separate escrow account under your main loan.

Property taxes can be paid as part of your mortgage payment through the same escrow account too, but if they're underpaid, you might owe a lump payment after the property taxes are assessed each year. If the taxes are overpaid, you do get some money back, but this isn't necessarily a great thing: It could mean that your property value went down.

Banks require you get insurance on your actual mortgage, as well. Private mortgage insurance (PMI) is necessary if you don't put down at least a 20 percent or more down payment to make sure you are good on your obligations. This added insurance for the lender can cost you .5 to 1 percent of the loan amount each year, or about $500 or $1,000 on a $100,000 home [sources: CNN Money, Kiplinger's].

Down Payment Options

Coming up with a 20 percent down payment might seem daunting, but it's more expensive without it in the form of extra fees like PMI [source: Kiplinger's]. And options for obtaining a mortgage without a hefty 20 percent down payment might be dwindling [source: Goldfarb].

Using a piggyback loan, or a second loan taken out at the same time as the principal mortgage loan, has made it possible to get into a home sooner, but this type of arrangement, often called an 80/20, generally means that the 20 percent going toward the down payment will have higher or variable interest charges and won't add anything to the bottom line equity that goes into the home loan repayment. However, as the housing market crisis drags on, many lenders are pulling back on offering these types of loans and are raising credit score and income requirements for buyers, and U.S. legislators are following suit by proposing restrictions on lending that may become law [source: Goldfarb].

There are government options available for those who meet income limits and can't afford a down payment, but these are tied to mortgage insurance fees, too, and may also become less available with talk of proposed U.S. budget cuts [sources: HUD, NAHB]. Without this help, some low-income families would find it impossible to save enough for a down payment. If you're able to save a set amount toward a down payment while renting, you'll save thousands of dollars in fees and interest as you settle into home sweet home with the 20 percent covered, and realistically, an upfront down payment may soon become the only option.

Where's Maintenance?

People either rave about or complain about their building's maintenance man, but when the toilet is backed up, he's the first person they call. Brown water running out of the faucet? Call maintenance. Furnace not cycling on during the blizzard? Call maintenance. Large ants parading to the fridge with tiny knapsacks? Call maintenance.

But when it's 4 a.m. in your very own home on a rainy evening and a chunk of the ceiling falls onto your bedroom floor, who are you going to call, and how are you going to pay them? Would you have deep enough pockets to get a maintenance problem taken care of right away?

Sump pumps fail, basements flood, animals die in crawlspaces, ice jams thaw and leak through your wood detailing, and whether in the hundreds or thousands of dollars, these issues are your responsibility now. And while homeowners insurance covers a lot of repairs, using it can lead to increased premiums, and the cost of the repair is subject to your deductible, which is often much higher [source: IIABA, Insurance Information Institute].

Even regular wear-and-tear and maintenance comes with a monthly or even weekly price tag. Some relish this aspect of homeownership and others resent the weekend trips to hardware megastores. There's a reason the phrase "the joys of homeownership" can drip with sarcasm.

Upside-Down-Up Market

With articles ranging from advice for walking away from a mortgage to hanging in there and buying more properties for the big housing correction to come, it's not easy to make blanket statements about whether or not owning a home is a good idea. It might be better to ask if buying a home is a good idea for you. Taking out a large loan involves risk, and losing money is a real possibility for today's home buyer. You might find your much loved investment underwater or upside down, or you could have an investment that earns returns as, and if, the housing market rebounds.

If you're going into a home purchase without expectations of making money on the investment or being able to borrow against the equity but just determined to own property, then the goal and dream of owning your own house outright someday might outweigh other factors.

It remains a buyer's market, and after crunching numbers as honestly as you can -- and getting your finances to the most predictable and measurable place they can be -- take a look at the pros and cons, joys and risks, and either wait or go for it. Maybe the outcome will be finding out that you don't care about the risks or that you want to forego the risk altogether.

Going Somewhere?

Moving into a new home across town involves some costs, but it might be a joy to pay them if you have the keys to your new home in hand. Some can even envision a move as their last, or at least the last they'll make in a long time. Going somewhere you love, whether to a new city across the country or a new condo a few miles away, might cost several hundred to several thousand dollars, but this is cash that usually hurts less because you planned for it. But what about the costs of when you have to move from a property you own and can't sell?

In the not too distant past, Americans bought homes with the idea that they would start families, pay off the mortgage and live there rent-free after retirement. More recently, buyers have lived in homes for the short-term, with a five- to 10-year plan for selling and moving up or out to another region.

Today, though, it's common for people in the United States to move about 12 times in a lifetime, with around nine of those moves occurring after age 18 [source: U.S. Census Bureau]. Whether relocating for a new work opportunity or to be nearer to family, when a moving checklist includes selling a home, it's not as easy as it used to be. And when you're unable to sell -- and make the payments -- the story becomes even grimmer. Short-sales, foreclosures and deed-in-lieu (turning the house back over to the bank) can cause long-term credit damage..

For every statistic and glimpse into buying, owning and selling a home, so many factors depend on the individual and as many -- or more -- depend on chance and unpredictability. Getting the numbers together is as much a science as it's ever been, and checks and balances along the way will confirm whether you've considered all of the financial factors and whether having a place of your own is worth every single penny: saved, earned or lost.


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