I bought my first house in August of 2007. It was the peak of the housing bubble. There were signs all around me that the bottom might be falling out, but I didn’t listen. For example, on the date I was to close, the mortgage company went bankrupt. They had to fund over $3 million in loans that day and had no cash on hand. I’ll get into the other issues throughout this post, but I learned a lot from this mistake and more as I have bought another house. So to help you steer clear of making the same mistakes I did, I present to you this guide to buying a house.
Complete Guide To Buying A House
Regardless if you are a first time home buyer or are upgrading to a larger house (or maybe even downsizing), the process of buying a house is long and tedious and is filled with potholes. Many times you never see them coming. Other times, you are too blind to notice. The goal here is to help you stay on solid ground and think with a clear mind throughout the entire process, from beginning to end. Let’s get started.
9 Steps To Buying A House
#1. Get Your Finances In Order
Congratulations, you have decided to buy a house. While it is a fun and exciting time, there is a lot of work you have to do in order to make the process go as smoothly as possible. Your first step, before you even start looking at houses, is to get your finances in order. Doing this will pay off big time down the road.
For starters, you should be budgeting your money. You have to know where your money is going so that when you take on the expense of a house payment (along with all of the other not-so-fun expenses that come with it), you aren’t going to regret it.
So spend a couple of months figuring out where your money is going. You can download some excel budget templates for free and start tracking that way. Or you could try a program like You Need A Budget. Either one will help you to figure out your money situation.
From there, you want to pay off as much debt as you possibly can. The less you owe each month will come back to benefit you as you go further down the home buying process. For example, when my wife bought her house, she had the first mortgage and then a second mortgage to avoid private mortgage insurance (PMI).
One year, she received a nice bonus from work. After thinking about it for a couple of days, she put the entire bonus towards the second mortgage. From a fun standpoint, using all of that money for debt sucked. She could have taken an amazing vacation or bought some new clothes. But she was glad she paid off the second mortgage when it came time to sell her house.
While that example was about a second mortgage and not credit card or student loan debt, the point is the same – getting rid of the debt is going to be a benefit when buying a house. This is because the less money you owe to other people, the more money you get to keep and use as a buffer should the unexpected happen.
Finally you are going to want to get your financial documents in order. This includes paystubs, tax returns, bank and investment statements, etc. While you won’t need them just yet, having them organized will save you time when you do need them in the coming weeks.
#2. Save For A Down Payment
Once you see where your money is going, you can start to figure out how much you can save for a down payment on a house. While we don’t know yet how much we do need for a down payment (that comes later), begin saving as soon as possible.
Now, some people will question whether they should focus only on paying off debt or use a combination of paying off debt and saving for a down payment. The answer is whatever works for you. If you know the money you save for a down payment will be used for the down payment and not on something else, then start saving.
But if you will be tempted to spend that money, focus first on getting rid of the debt and then save everything you can.
Another common question here is, how do I save the most I possibly can each month? Here are some options:
- Set up an automatic transfer each month. I love using Digit.
- Find other sources of income. You can do various tasks and small jobs online to make money. A lot of the things you can do are simple and the payout adds up over time.
- Save windfalls. If you get a bonus or tax refund or win the lottery, save that money.
- Cut expenses. Find things you can go without. You don’t have to go without forever, just for now while you save for a house.
- Ask for help. Maybe your parents would give you a gift to help with the down payment. While this is perfectly legal, you will have to disclose it to the lender.
#3. Figure Out Your Number
Now we can get into just how much money we need to save and how much we can borrow. There are a few ratios here that we will use.
First is the 20% down ratio. You need to put 20% down when you buy a house. I know this can be a lot of money, but it will help you to sleep at night. You can avoid going underwater (when you owe more on your mortgage than what the house is worth) the majority of times by putting this much money down. You can also avoid PMI and you will be paying more towards principal each month as well.
Next is the 2 times your salary ratio. You can take out a loan up to 2 times your annual salary and not a penny more. So if you make $50,000 per year, you can take out a loan for $100,000. Now, I know that doesn’t look like a lot, but you have to understand that this is just the loan amount and doesn’t take into account your down payment.
If you are putting 20% down, you can look at houses that are selling for $125,000. You put down 20%, or $25,000 and then take out a loan for the remaining $100,000.
Again, I know what you are thinking, “good luck finding a house that low priced where I live”. If housing prices in your area are much higher, you have a few options.
First, you can save until you have more money for a down payment. So if you are looking at a house selling for $200,000 and you are making $50,000 a year, you need to put down $100,000 on the house.
Another option would be to look in areas where houses may be less expensive or even consider buying a house that is a fixer-upper.
Next, you could look to see if there are any offers for home buyers. Maybe your state is offering an incentive to move to a certain area or region. While not common, it doesn’t hurt to look.
Finally, another option would be to find a higher paying job so you could afford a larger loan.
You may be wondering why the recommendation for a loan with a limit of 2 times your annual salary. The reason is because of flexibility. You want to have as much cushion in your budget as possible. What this means is that if you are paying $500 a month on a mortgage as opposed to $1,200 a month, you have a $700 buffer.
While this might not sound like a big deal now, it is when you buy your house. For example, when I bought my house, the air conditioner failed in the first 2 months. I had to come up with the money to get it fixed.
I also had to spend money to furnish the house as well. Coming from my parent’s house, I didn’t have a kitchen set, living room furniture, etc. All of that costs money.
In addition to this is looking at the long term. The less you have to put towards a mortgage each month means more you can invest in your 401k at work. It means more money to take a vacation each year. It means being able to upgrade sooner because you can save for a new down payment. In other words, it gives you more options, now and in the future.
Take it from me as someone who has been there before, you want as big of a monthly buffer as possible. By only taking out a mortgage of 2 times your annual salary, you ensure this.
#4. Shop Around For Loans
Now that we have your mortgage amount, which is 2 times your salary, we can begin the process of shopping for a loan. You will want to check your credit score before shopping to make sure it is high and you will want to check your credit report as well. In fact, you may want to do both of these during step one above.
You want to get pre-approved for a mortgage. This tells the seller you are serious and you can actually afford to buy their house. Nothing is worse for a seller than to get an offer and then find out the buyer was not approved for a loan.
Be sure to get quotes from a few different mortgage brokers. They will want all of the financial documents you collected in step one, so make sure everything is up to date.
Make sure you are comparing apples to apples here in terms of the length of the loan (20 years, 30 years, etc.) as well as paying points.
You also want to look at closing costs as well. There are some closing costs that you can negotiate and you should. At the end of the day, your closing costs should come in around 2-4% of the amount of the loan.
The chart below shows you current mortgage rates and you can click through any one of them to get pre-approved.
In addition to knowing what rates are currently, it is important for you to see what impact they will have on your monthly payment. In the cool interactive chart below, you can play around with loan amounts and interest rates to get a better feel for how much you will owe each month. You will also see the impact of changing your interest rate on your monthly payment. And the best part, you will see how much you can save by getting a lower interest rate, both in terms of monthly payment and over the course of your loan.
#5. Make A Must-Have List
Now that you have a pre-approval for a loan, the fun part begins. But before you run out to look at houses, you need to make a list. Write down everything you want in a house. Think about things like a yard, a garage, where you want it to be located (city or suburb), etc. Write it all down.
Once you have it all written down, break it out into two columns, a must have column and a nice to have column. Place each thing you wrote down into the corresponding column. This will help you when you are out looking at houses to make sure you are getting what you really want.
Of course, this list isn’t set in stone. Maybe you listed a garage as a nice to have but after looking at some houses, you realized you need a garage. Just switch it over to the other column.
#6. Find An Agent
Don’t hire the first agent you find and don’t rely on the sellers agent to buy a house. You need to make sure the agent is the right fit for you. Be honest with them upfront and tell them that you are interviewing a couple of agents.
Meet with them and talk about what you are looking for in a house and then have them email you some houses that fit your criteria. Then go out and look at some houses with them. You need to make sure you are a fit together. While it might not seem like it, you really are building a relationship with the person and it need to fit the needs of both parties.
For example, when we are looking to move, we interviewed two agents. The first one was good and was a top seller just about every year. While this was nice, we realized they were the top seller because they were strictly transaction based. It was all about getting a deal done. They segmented their practice so we would visit houses with one person and then if we closed on a house would be there with someone else, etc. It just wasn’t right.
We settled on the second agent because she was about the relationship. She listened to what we liked and didn’t like as we visited houses and modified her searches. She wanted to make sure we found the right house for us, and wasn’t driven by making a sale as fast as possible.
When you find a house you want to buy, it is time to negotiate. Depending on where you live and the type of market you are in will determine how you go about putting an offer in. Typically you start out with a number less than the asking price, but not so low you insult the seller. Usually this means making an offer that is 10-15% below asking price.
From there, you go back and forth until you reach an agreement or you end negotiations and find another house. The key to remember here is to keep a level head. It can get stressful negotiating and you don’t want to get caught up in the moment thinking you need to come to an agreement. You can walk away. There will be and are other houses. A good agent will remind you of this.
After you agree to a sales price, you have to get the house inspected. You can rely on your agent to find someone they use and trust or you can use someone you know and trust. The key here is to be present for the inspection.
A thorough inspection will last a few hours depending on the size of the house. Walk with the inspector and ask questions – lots of questions. Remember, this could potentially be your house, so you want to know everything there is to know and not find any surprises after you bought it.
When an agreement is reached, the inspections are complete and you are at the closing table, your work is not complete. Unfortunately there is a mountain of papers you have to sign. Before you sign, make sure you understand what you are signing. It can become overwhelming with the amount of papers, but take your time. This is a serious transaction you are entering into and you want to make sure you understand what you are doing.
When the final paper is signed, you will get the keys to your new house and will officially be a homeowner!
Traps To Avoid When Buying A House
There are some more tips that you need to be aware of when buying a house. They tend to be traps that can easily get you into trouble, so be sure to read through these and take notes.
Don’t Listen To The Bank: When you are getting approved for a loan, the amount the bank says you can borrow will be more than the 2 times salary formula I provided above. While on the surface it appears that you can easily afford the loan amount, remember this: when the bank calculates how much you can borrow, they base this off of gross income, not net income. This means they are looking at your income before taxes and retirement plan contributions are taken out. They make a big difference as I am sure you know.
For example, when I was single and dating, I was going to buy a house with a girl I was dating. Combined we made roughly $90,000 a year. The bank approved us for a $500,000 mortgage! How we would ever cover the monthly payments I’ll never know. Thankfully we didn’t move forward with buying a house.
Don’t Fall In Love: This is hard to do, but you have to avoid falling in love with a house. It will cause you to pay too much for it thinking there aren’t any others out there. There are. While it is good to want a house, don’t become so obsessed with it that it clouds your judgment.
Don’t Confuse Needs And Wants: I make you list out wants and needs for a reason. It is very easy to see some features in a house and think we need to have them, when in reality we don’t. Make the list and refer to it often. When you want to move something over to a need, give it a few days and see if you still feel the same way.
Don’t Level Up: If you can afford a house with a price of $150,000 then don’t start looking at houses selling for $200,000. I did this and paid the price. It doesn’t seem like a big deal, but there is a huge difference in features and square footage when you go up in price. Once you do, you will never look at the less expensive house (the one you can actually afford) again. This will result in you taking out too large of a mortgage and becoming house poor.
So there is the step-by-step process to buying a house. It is a fun experience and also can be exhausting. As long as you can keep your emotions in check and think with a level head, you should be fine. Don’t let your agent or others talk you into a bigger house or paying more than you are comfortable with.
At the end of the day, those people will be nowhere to be found when the mortgage bill arrives in the mail. It will just be you paying for it. So be smart and take your time.
[Photo Credit: Flachovatereza]