If buying a home fills you with anxiety and fear, you’re not alone.
A new home is one of the most significant purchases you will ever make. However, using these first time home buyer tips should make the experience a little more pleasant.
I remember when my wife and started the home buying process. We had no idea where to start. We looked at every home within a 15-mile radius. After a rigorous search and driving every realtor in town crazy, we finally purchased our first home.
Looking back, having more guidance would have made the process less stressful and a lot more enjoyable. Getting started can sometimes be the hardest part of any process. So, if you need a little jump-start, here’s how you can prepare for your new purchase:
Tips for Buying Your First Home
1. Obtain a copy of your credit report
Your credit report plays a significant role in receiving the best interest rate on your mortgage. Lenders want to be sure you are not a high-risk when lending you funds to purchase your home. Your credit report demonstrates your ability to manage your debt.
This may seem like an unlikely first step; however; credit repair and improvement can be a slow process. The credit bureaus move very slowly when disputing discrepancies. It is best to understand your credit report as early as possible; improvements in credit score could save you thousands of dollars over the life of the loan.
2. Sign up for Credit Monitoring
Unlike auto loans and credit cards, personal loans mortgage lenders pull all three of your scores. I have found the most comprehensive monitoring service available is myFICO. By monitoring all three of your scores, you can make sure no errors are reported, and all information is correct. If there are discrepancies, you will need to contact the specific credit bureau immediately.
3. Know Your Debt-to-Income Ratio
Several lenders will look at is your debt-to-income ratio. This is the combination of all your expenses and your monthly pre-taxed income. Anything below 36% is considered “workable.” Calculate your ratio and determine if you need to lower your percentage.
It’s easy to forget to print documents when you’re doing your banking or taxes online. However, when you apply for your mortgage, the lender will likely require a significant amount of paper documents for review. These documents can include:
• W-2’s or 1099s
• Tax returns
• List of debts
• List of assets
• All account bank statements
• Profit and loss statements if you are self-employed
• Paycheck stubs
• And more…
The more organized you are, the easier this process will be. Try creating a filing system to keep all of your documents. Organize each document depending on the category.
Then every month, print a copy of your statements and put them in a folder for the mortgage lender. I also like to save a PDF version of essential documents on a password-protected USB flash drive on my key ring. If you’re ever meeting with a lender and need the materials, it can be handy to have.
Note: If you have frozen your credit, make sure you wrote down your pin and any answers to security questions.
4. Find a Good Realtor
“The commission from the sale of the home comes out of the seller’s proceeds so, there is no reason for a buyer not to get representation,” says Mike Hrubos, founder of The Avalon Life.
Mike adds, “ a good realtor can help buyers save money by, negotiating, knowing the market precisely and not backing down.” Realtors can also show you neighborhoods that may represent a good value and mimic the lifestyle you desire.
Ask your friends and family for referrals. There are hundreds of realtors. It is crucial to find one that can understand your wants and needs.
5. Join the Down Payment Movement
Saving any amount of money can be challenging, let alone a down payment for a house. Lenders prefer a down payment of 20% of the purchase price of your home. But not to worry, there is a group of people that are willing to support you with your efforts. Join the Down Payment Movement and receive a 12-week home buying course in your mailbox every week. You will pledge a savings amount and be encouraged by a community with a similar goal.
Saving for your first home doesn’t have to be daunting when you have a group of people rooting for you.
Purchasing your first home doesn’t have to be stressful or leave you feeling anxious. Get organized, know your credit score, and surround yourself with a community of people who have a similar goal. In no time, you will realize your dream of buying a home.
There’s no shortage of time, energy, and effort spent when buying a home, especially your first home.
For most people, this represents the single largest purchase of their financial lives and, for obvious reasons, they want to make sure it’s perfect. The problem is your first-time home is rarely your last home.
Meaning, your first home is not just a roof over your head, but it’s a financial opportunity and should be considered as such during the process. This is the story of Woodstock’s first home.
Recipe for Success: Your First Home Purchase
Woodstock and Dr. Linus share their recipe for success in buying real estate correctly
My first blog was inspired by my first home purchase, which was a tiny, new construction: 2 bed, one bath condo in a high rise building. I was single and living alone, but excited to get a place I could call my own. I spent money on upgrades that I considered valuable, like bamboo flooring, fancy fixtures, and custom window treatments.
Like many, I thought because I could afford my payments I was okay and that eventually, the condo would appreciate after 5-6 years and provide equity for my next purchase. Coming out of law school, I wanted to establish myself as a professional and what better way to do it than with a bachelor pad in a high-rise.
I left the condo after six years, and it wasn’t until recently that I truly recognized the error of my ways and appreciated the money lost with this investment.
Dr. Linus and I contracted the real estate itch with an investment opportunity that forced us to put on our nerd glasses and educate ourselves on the financials of what we hoped was a good purchase. This first purchase led to another, and eventually, some level of clarity on the differences between a good and bad deal.
Through our purchases, Linus and I have come up with an approach to real estate investing that I think could be applied to any real estate purchase, whether it be an investment property or a personal residence. Had I assessed my first home purchase knowing what I know now, I may have made different choices.
Here’s our approach applied (retroactively) to my first home purchase:
Making The Math Work
6. For Starter Homes, Consider the Rental Market
If we’re viewing the first time home purchase through the lens of an investment, then the analysis starts with rentability and the return on investment (ROI). For this analysis, we will use the 1% Rule and the 50% Rule, which were discussed by Dr. Linus on our site previously.
(Quickie: House price x 1% = rental of the house. $100k house = $1,000/month rental.)
The expected rent should be at least 1% of the purchase price. This is a quick and dirty way to assess the income potential for a rental property. If it’s greater than 1%, then you have a good chance of being cash flow positive. Not all purchases will net you a full 1%, and the further you are from that number, the more you’re relying on the appreciation of the property value to close the gap.
This estimates the expenses of a property (not including mortgage) to be 50% of the gross rent. This will account for property taxes, Homeowner Association (HOA) dues, insurance, repairs, unoccupied months, and other misc. expenses. This also helps the budget for one-time expenses like a new HVAC unit or a new roof, which will not happen every year but should be budgeted for in advance.
So Let’s Do the Numbers
Below, we look at the scenario with the 1% rule (ideal) and with market rates (actual) at the time of purchase. As you can see the “actual scenario” is not an investor’s dream, but luckily Woodstock was not renting the place from day 1.
|At the time of purchase|
|Expenses||$1,375||$1,375||Based on 50% rule|
|Mortgage||$1,100||$1,100||20% Down ($55,000) @ 4.5%|
|NOI (Annual)||$3,300||($11,100)||Net Operating Income|
|Cap Rate||6%||Ouch!||NOI / Purchase Price|
Let’s fast forward ten years and look at the most recent data. The unit has been rented for three years with the same tenant and other than an individual assessment for some building repairs it’s been smooth sailing as you can see, the market rents have improved but still not up to the optimal level.
|Expenses||$1,000||$1,000||Based on real expenses|
|Mortgage||$1,100||$1,100||20% Down ($55,000) @ 4.5%|
*Cap Rates are not the best rate to use ten years after purchase. Instead, I will use Return on Equity (ROE)
7. Overspending on Amenities or Upgrades
The ROI of any investment is based on maximizing revenue while minimizing cost and expenses, but first time home buyers are rarely looking at ROI. The excitement is the ambition and desire that everything be the absolute best. Homebuyers (first-time or repeat) will always try to justify upgrades at the time of purchase by thinking it will improve resale value. Sure that might be true, but it won’t increase resale value in proportion to the increase in the purchase price. The developers and real estate agents are incentivized to push up the sale price via upgrades because it results in higher profits and commissions.
From a rental perspective, hardwood or laminate is negligible, ¼” v ½” granite is irrelevant, and fixtures are functional, not decorative. When buying your first home, keep an eye on the big picture. Leave the custom cabinetry, fancy built-in’s, and designer fixtures for when you are in your forever home because the value of those upgrades is in their usage, not the resale. In this case, if Woodstock had gone with the base features offered and passed on the updates, then he would have had a lower purchase price and helped close the gap to the 1% rule.
8. When to Cut Your Losses
We incline to tough it out with investments that are not ideal and wait for the tide to turn rather than cutting our losses. We all make mistakes or misjudgments in our financial lives, but when those mistakes have been identified, how do we pivot?
This property does not just represent a loss of $100 a month ($1,200 annually); it’s also the opportunity cost on what the equity could have earned.
We illustrated how to get 10-12% in a Crowdfunded REIT. At $100,000 in equity, that $1,200 loss could easily be a $1,200 gain making it an actual loss of $2,400 annually when accounting for opportunity cost.
The reality is, your first home, unlike your “forever” home, is, in fact, an investment. It can be held onto to create cash flow. It can be sold to make a downpayment. It can be used as collateral on another deal. This first home purchase can be the first domino to fall in your quest for financial independence retire early but only when analyzed correctly.
A special thanks to Michael Dinich. Blogger, expert, advisor, whatever you want to call him, guys like him push this community forward. We were able to accelerate our path to financial independence through their lessons and have made wiser decisions accordingly. Thank you for inviting us to post on your great site. We look forward to collaborating in the future.
Bonus: Co-Op or Condo for the First-Time Buyer?
Before you make any decisions, it’s best to weigh up your options. We featured a calculator that can help you check the cost of buying versus renting—you can do the computations yourself, based on location and the size. If you choose to buy over renting, one of the key things you need to decide on in New York is whether you will buy a condo or get a cooperative.
A condo is a multiple unit building where you own a unit but co-own the property’s common areas with other condo owners. Everyone in the condo building has a shared responsibility to maintain the property. Meanwhile, in a cooperative, you don’t exactly own a unit, rather a share in the corporation that entitles you to a long-term property lease. You won’t shoulder the upkeep, as the corporation takes care of that.
The New York Times notes the two most common differences include the approval process and the building rules—co-ops are usually stricter but they make up a bigger percentage of New York’s housing stock. Co-ops tend to be less expensive than condos, too. Here is a more detailed look that can help you choose:
Co-ops tend to be much cheaper than condos, but condos are often easier to finance. You need to put down at least 10% of the condo purchase price, including the closing cost. For a co-op, you need to pay for 20% of the purchase price.
Condo fees are usually lower, too, as it only includes common charges that pay for services and amenities shared by condo residents, as well as, property taxes. Co-ops on the other hand charge for maintenance fees based on the number of shares the tenant owns, which is typically dictated by the apartment size and floor level. When it comes to tax benefits, the advantages are quite similar.
Condo owners often have more control over the property than co-op owners do. Rules are less stringent in condo units—there is no limit in subletting and the less financial information is required to purchase. Mann Reports details how most co-ops limit the number of times a unit can be sublet. The sublessee needs to be approved by the board, too.
The Approval Process
Acceptance in a condo is usually automatic, while co-op applicants have to go through several stages, assessments, and verifications before they are approved. Co-ops are basically guided by three documents: the property lease, which defines the shareholder and the corporation’s relationship, the bylaws, which details how the building is governed, and the house rules.
Co-op boards also closely scrutinize a potential buyer’s application, which, The Balance claims includes a buyer’s financial statement and bank balances. The board also checks the applicant’s assets and liabilities including a review of letters of recommendation from friends and business associates.
James McGrath writing for Yoreevo explains that a co-op board requires two reference letters – a personal letter and a professional letter and both need to convince the board that you’re a worthy investment. When it comes to writing both, the key is to be unambiguously safe, which means you need to leave out anything that can cause anyone from the board to be concerned or offended.
Even something as trivial as having a passion to cook pungent dishes can cost you your application. Be as tasteful as possible, better yet, put yourself in the shoes of the board, how would you convince them that you would be a good shareholder?
Whichever type of property you choose, whether it’s a condo or a co-op, pay close attention to the details; they might be your ticket to successfully buying your own space.
Michael launched Your Money Geek to make personal finance fun. He has worked in personal finance for over 20 years, helping families reduce taxes, increase their income, and save for retirement. Michael is passionate about personal finance, side hustles, and all things geeky.