October 10, 2019
Life events to consider – buying a house
Whether it’s your first house, you are relocating to a new area, or you are upgrading to your “forever” home, buying a house is one of the most significant purchases you will make. Properly budgeting for the costs to buy, finance, and maintain the new home can help set you up for financial success and keep you from feeling “house poor.” While there are many considerations that go into finding the right house for you and your family, reviewing the points below will start you off on a solid foundation (pun intended!).
How much can you afford? – 3 primary rules of thumb include:
- Maximum purchase price is 3x your gross household income.
- Housing-related payments (mortgage, taxes, homeowner’s insurance) should be less than 28% of your monthly gross household income.
- Total debt payments should be less than 36% of your monthly gross household income.
What type of mortgage to get and how much to put down:
- The most common types of mortgages are conventional mortgages. Conventional mortgages have a fixed interest rate and vary in duration, with 15 or 30 years being the most common.
- A 30-year mortgage will generally have the lowest monthly payment but a higher interest rate.
- A 15-year mortgage is the opposite. Your interest rate (and therefore the overall cost of the mortgage) will be lower, but your monthly payments will be much higher.
- Regardless of the term length, lenders typically require you to make a down payment of 10% to 20% of the purchase price. If you put less than 20% of the purchase price down, you will likely be required to pay Private Mortgage Insurance (PMI). This insurance protects the bank in case of a home mortgage default and is typically between 0.5% and 1% of the loan amount each year.
What are some of the other costs to consider?
- Property taxes and homeowner’s insurance – Property taxes can add a significant amount of cost on a home. Taxes vary by state and by county; however, it is not unreasonable to assume that if you are targeting a $1M+ home, you should estimate paying $25K to $40K a year in property taxes. Property taxes may be included as a portion of your monthly mortgage payment, or you may need to pay them directly during the year. Don’t forget to take advantage of state programs, like New York’s STAR program, which can reduce your property tax burden. While not nearly as expensive, homeowner’s insurance goes up as the purchase value of the home increases. It may be advantageous to bundle your various insurance policies together through one carrier. Often insurance companies will provide discounts for having homeowner’s, car insurance, umbrella policy, etc. with them.
- Closing costs – Most mortgages will have some form of closing costs associated with them. The fees cover the loan recording and processing, attorney costs, title insurance, appraisal and various other new mortgage requirements. Expect closing costs to be approximately 2%-5% of the loan value.
- Maintenance and upkeep expenses – Homes can be expensive to maintain. Routine repairs and improvements on an older home can be a few thousand dollars a year. Major repairs such as replacing the roof, or damage from a weather event, can cost tens of thousands of dollars and can be unexpected. Plan on budgeting about 1% of the home value for annual maintenance.
How to title the property?
- Tenants by the Entirety (TBE) – For married couples, this is typically the default titling option. Advantages of TBE include creditor protection in certain circumstances and probate avoidance when the first spouse passes away. Just like with owning property as joint tenants with rights of survivorship (JTWRS), the deceased tenant’s share passes to the surviving tenant via operation of law and not through the decedent’s Will or revocable trust.
- Tenants in Common – In some instances, it will be advantageous to own the property jointly as tenants in common. The main difference between tenants in common and TBE or JTWRS is that each tenant can direct the passing of their interest through their Will or revocable trust. This is advantageous if real property is needed to fund a testamentary trust, such as a credit shelter trust.
- In Trust – For those using a revocable trust (or trusts) as part of their estate plan, making sure to title the property in the name of the trust(s) is essential. Usually the attorney who drafts the trust will also draft a deed to transfer existing property into the trust(s). If a trust is already in place and you are purchasing new property, the new property should be purchased directly in the name of the trust(s).
So, whether you are purchasing a first home, a forever home, or perhaps a second (or third) property, there are a number of considerations (financial and otherwise) that should be reviewed beforehand. Proper planning will not only help you acquire the house of your dreams, but can also help make sure that dream does not end up in a financial nightmare down the road.