As a homebuyer, learning the financial responsibilities of buying a home can be quite challenging. Searching for homes and buying advice online doesn’t always paint a complete picture of what buyers need to know. Besides finding a good value in a home when buying, there are financing considerations that are just as important to consider.
Most first time homebuyers and even some repeat buyers are unaware of all the costs associated with buying a home. If you haven’t purchased in a few years you may be surprised at how costs have increased. Even with the help of a real estate agent, it can be easy to make serious mistakes in terms of your finances when buying a home if you don’t educate yourself. The following are five common mistakes that homeowners often make when buying their home.
1. Focusing on buying foreclosures because they think they’re going to save lots of money. Many first-time homebuyers will explore distressed properties (think foreclosures or short sales) in search of a bargain. One thing that you MUST understand if you’re thinking of buying a foreclosures – these homes almost always sell at market price, not below.
Wait, don’t foreclosures sell below the typical market price of similar homes? Absolutely. Why? Usually because of condition. A true purchase below market price is fairly rare. Most of the time there are two factors that ensure foreclosures sell for market price (what a typical buyer is willing to pay).
- Often investors are locked out of the bidding process for the first week or two of the listing. This keeps savvy investors from buying low & selling high, giving owner occupants first choice. Owner occupants are less likely than investors to lowball an offer and make more reasonable offer.
- Many sellers (banks or their representatives) will not look at any offers until the home has been on the market for several days. This encourages a representative sample of buyers likely to make offers rather than the 1st buyer to see it coming in low in hopes of picking up a steal. Also, this encourages multiple offers which almost always means a higher sales price.
If you’re looking to invest your money, then a distressed property can be a great deal. But you need to have plenty of time on your hands and hire the right agent with a LOT of experience with foreclosures to guide you. The greatest odds of making money when buying a foreclosure come from owners who can do the repair/remodel work themselves. Profits going to contractors eat into your ability to gain equity when you resell. If you’re actually looking for a home to move into, then you may not want to spend your time looking at distressed properties. There are exceptions, but for the most part foreclosures are sold “as-is” and will not be in move-in condition.
Deals for distressed properties can take months to close (particularly short sales), and the amount of money you may have to put into renovations may not be worth it. Be realistic when estimating repair & remodeling cost for your distressed property. Thorough inspections up front, getting multiple bids, and allowing for at least a 10% contingency will help avoid surprises.
Spending all of your time looking at distressed properties could also result in missing out on well-priced homes that may have been better-suited for all of your needs. As a homebuyer, keep in mind that you are looking for a new home first and foremost — bargains are nice, but you shouldn’t be focused on finding a deal just for the sake of feeling better about yourself and ability to make money. Focus on finding what you love and need.
2. Borrowing the full amount that your lender qualifies you for
Just because your lender approves you for a certain mortgage doesn’t mean you have to borrow the full amount. A general rule of thumb is to borrow around 20 percent less than what the lender is offering (if you will be happy with the resulting homes).
So if the lender has approved a $250,000 mortgage, you should consider only looking for homes priced at $200,000 or less. This will help to protect you financially. How? To guarantee the loan, lenders charge PMI, a significant addition to your “normal” payment which would usually cover just the principal and interest on the loan. Borrowing only 80% of a home’s appraised value will save you PMI. The amount offered by the lender is typically the most that they are comfortable lending to you in terms of what they think you can pay back on a monthly basis. This means that you could barely end up affording the mortgage payments if you take out the full amount — and you may not want to be financially uncomfortable for the length of your mortgage.
3. Getting a short-term adjustable-rate mortgage
A short-term mortgage (less than 15 year term) is going to require significantly more of your cash flow each month. Yes, you will end up paying off your loan sooner, which will help relieve your debt that much more quickly. But is it worth the financial discomfort? That decision is up to you of course. Carefully weigh your long term plans with the short term ability to comfortably make your payments.
An adjustable-rate means that you’ll never know how much your mortgage payments might be — it could vary significantly during the life of the loan. A longer-term fixed-rate mortgage is a much safer play. With a fixed-rate mortgage, you’ll know exactly what you’ll be paying monthly, making it easier to budget. A long-term mortgage isn’t as bad as it might sound either. You may be making payments for 15 to 30 years, but remember those payments aren’t going to seem like that much after a decade or two since they will remain constant throughout, even with inflation. Also, with rates near historic lows the penalty for taking a longer term loan are much less.
4. Using all of your cash in order to buy the house
Make sure that you set aside savings for the potential costs associated with buying a home as well as owning. Besides the down payment there are other costs incurred when buying. There are appraisal fees, pro-rated taxes, money required to start your escrow account (hazard insurance for example), title insurance, home inspection fee, closing fees, attorney fees and more.
When saving money in preparation for your purchase, keep all of these costs in mind. Your agent can always negotiate on your behalf to get your closing costs paid by the seller, but this will figure heavily into the discount off of the purchase price you can expect. You don’t want to end up emptying out your savings account by your very first day as a homeowner, as this can end up putting you in a difficult financial situation. You’ll always want to have a reserve set aside for repair contingencies and/or purchase a home warranty to protect you again breakdowns.
5. Not speaking to the neighbors first
In most cases you are going to be living next to your neighbors for a long time (the average is 5 – 7 years), so you’ll want to make sure that you don’t end up regretting the decision of buying a home where you can’t stand your neighbors. There’s not much you can do if you end up buying next to a fraternity that throws loud parties multiple times a week or if your neighbors have dogs that bark throughout the night. This is not a situation you want to put yourself in as a first-time homebuyer since you may not be in a good financial situation to be able to move.
Being a first-time homebuyer can in particular be both exciting and daunting at the same time. Even repeat buyers make mistakes. Because there is so much financially at stake you should strive to make sure that you perform your due diligence and speak in detail with your real estate agent in order to prevent yourself from making any potentially costly mistakes.
Remember, in almost all cases, the use of a buyer’s agent is 100% free. There’s very little to lose but so much to gain.
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