For many of us, buying real estate is one of life’s biggest milestones.
Whether it’s purchasing your first home, a bigger home or an investment property, it’s critical to have your financial ducks in a row before you dive in. Or as someone who handles real estate for a living puts it:
“Buyers should carefully assess their finances before beginning their home search,” says Steve Brown, president of the National Association of Realtors. “By looking into their income, savings and credit reports, and collecting documentation of income and cash available, they can help avoid future problems when they’re trying to qualify for a mortgage.”
Want to know how much house you can potentially afford—and what pitfalls to avoid when you begin looking?
LearnVest spoke with four couples from across the U.S. who are looking to purchase real estate in the near future, as well as David Blaylock, a CFP® with LearnVest Planning Services, who weighed in on how each couple can better prepare for this important next step.
The First-Time Homeowners
Who: Steve Thomas*, 28, a software salesman and his wife, Sally, 29, who is looking for work as a Korean translator.
Location: San Jose, Calif.
What They Want to Buy: We’re looking to buy our first home together sometime in 2016. Ideally, the house will have two bedrooms, two baths and be located in a safe, quiet neighborhood within ten miles of work (preferably five so we can ride our bikes, save on gas and get some exercise).
The home doesn’t have to be turnkey, but we don’t want to have to do many repairs either. We have no children and aren’t planning on having any—but things could change, who knows.
Because of the high cost of real estate in San Jose, we’re considering moving to an area with similar weather and a lower cost of living. Sacramento, Houston, Austin or somewhere in Florida are all in the running.
We’re looking at spending $200,000 or less on a house. If we do get a mortgage, we’d like to pay it off in no more than 15 years. We don’t buy anything unless it’s on sale, and our house won’t be different. I actually blog about my frugal ways at Steveonomics.
Where They Stand: We should have $100,000 liquid at the end of next year. Our rent is reasonable—we have a great deal on a one-bedroom through a friend—so I don’t feel there’s a huge rush to jump into a big mortgage. If we save aggressively, we should have enough cash if we spot a great deal.
I should make about $70,000 this year (close to half of my salary is based on commission). When my wife starts working, most of her salary will go toward savings. We’re aiming to spend around $20,000 this year on living expenses. We currently have $50,000 saved for a down payment.
Outside of retirement accounts we only hold cash. We don’t want to risk a market crash a few years before we’re planning to buy a house. After we own a house, I can see us taking more risks with stocks.
We have no debt whatsoever. Our modest student loans were quickly paid off and we bought our car with cash. I use credit cards for almost every purchase to earn miles and fly for free throughout the year.
I plan to max out my 401(k) and have already maxed out my traditional IRA with my tax refund. This lowers our available cash, but makes it so I pay very little tax. My wife maxed out her traditional IRA with Vanguard last year even though she didn’t work. She will probably max it out this year and put at least some money in a 401(k) if it’s available to her. We currently have $20,000 in retirement accounts.
If I were to lose my job tomorrow, we could support our current lifestyle for close to three years without any assistance. Our emergency fund would be our bank accounts (which is also our housing savings).
What the CFP® Says: What an exciting time; plans to buy a first home and a possible move to a new city. I think it’s a great idea to consider buying in a location that may provide more bang for this couple’s buck. I do recommend they consider purchasing a home that has at least three bedrooms, especially if they’re considering possibly starting a family. It could also help increase the home’s desirability when it comes time to sell.
The couple’s desire to have around $100,000 in liquid savings is a great goal. They currently have about $50,000, which should give them at least a 20% down payment and six months worth of living expenses for their emergency fund. With mortgage rates being very reasonable at this time, I recommend they consider a 15-year fixed mortgage for the remaining part of the purchase price instead of paying cash (while a 30-year fixed mortgage is OK, a 15-year is typically ideal).
I also suggest that any extra money they’re able to save should be added to their retirement account balances to help make sure they’re on track in that area as well. At their income level I would also recommend that they use Roth IRAs instead of Traditional IRAs to create tax-free dollars at retirement.