BUYING A HOME MAY STILL BE the American Dream. But is it your dream? Even though home values are continuing to recover, one legacy of the housing downturn of a few years ago is that home ownership is no longer the holy grail it once was. First-time buyers in particular are asking themselves whether investing a large chunk of their savings in a down payment will pay off for them in the long run.
To help you think through this big decision, we turned to Neil Stikeleather, a financial advisor for Merrill Lynch who helps clients become homeowners. Here, he shares seven questions that he asks first-time buyers, and offers up some thoughts on the issues you should consider as you answer each one.
1. Is owning the roof over your head your No. 1 priority?
"Your answer is going to depend on the other things you've got going on in your life. Are you trying to sock away funds for a wedding or graduate school? Have you started saving for retirement, or are you planning to begin soon? Buying a home should mesh with the rest of your priorities. Having other financial goals doesn't necessarily prevent you from buying a home, but it could help narrow your price range or lead you to consider postponing the purchase for a few years."
2. Do you expect any big changes in your life in the next few years?
"Could your career make it necessary for you to move? Are you thinking about starting a family? If you've got major short-term plans, you might think twice about buying now. In most cases, you should stay in a home for at least five years to recoup your upfront costs."
3. Will you qualify for a mortgage?
"For many first-time buyers, sitting down with a bank representative to discuss mortgage options is the moment of truth. Before you get to that point, I advise taking a few minutes to calculate your debt-to-income ratio. That figure compares the amount of debt you have against your overall income. Banks often use it to assess your ability to handle a mortgage. Generally, to qualify for a mortgage, monthly payments on your debts should come to no more than 43% of your monthly income. It might also be wise to go through the loan prequalification process at your bank. It's a relatively easy way to find out whether you'll qualify for a loan and, if so, how much you can afford."
"Don't feel pressured by the conventional wisdom that now is a good time to buy because real estate prices and interest rates are still relatively low." — Neil Stikeleather, Merrill Lynch Financial Advisor
4. How's your credit?
"Your credit score factors heavily into your ability to get the best interest rate available. Before you apply for a mortgage, take advantage of your right to a free credit report from each of the top credit bureaus to find out where you stand. (You can see all three reports at AnnualCreditReport.com.) Request corrections right away for any inaccuracies you find—updates can take time."
5. Have you saved enough for your down payment?
"The traditional practice is to put down at least 20% of the purchase price of a home in cash. There are, however, many exceptions to this rule. In some cases, you can provide investment assets as collateral to help reduce your down payment. Another option is to ask a parent or family member to cosign a loan or pledge their investment assets as collateral to reduce the down payment. There are also a number of mortgage programs available today (VA, FHA, etc.) that require little or no down payment.
"While 100% financing may be possible, it may not be wise. It's important you are comfortable with the monthly mortgage payment, which will include the principal on the loan, plus interest, as well as the amount put aside monthly to cover real estate taxes and insurance. It's also important to have sufficient emergency savings set aside so that you could comfortably make the mortgage payments for several months in the event your income was suddenly reduced."
6. Are you aware of all the expenses of being a homeowner?
"Costs like heating and insurance are often higher for homeowners. You may also have to pay for things you currently get for free, such as waste removal and lawn care. And when the hot water heater breaks or a storm damages your roof in the middle of the night, you won't be able to simply call your landlord. Because home expenses vary widely by region—a heating bill in Maine looks very different from one in Virginia—your best bet is to talk to either a real estate broker or homeowners in the area where you hope to live, just to get a sense of what you're in for."
7. Now that you've thought through what becoming a homeowner might mean for you, do you want to continue renting for awhile longer?
"Don't feel pressured by the conventional wisdom that now is a good time to buy because real estate prices and interest rates are still relatively low. That way of thinking makes more sense for someone who is investing in real estate. You don't want to get caught up in the noise around real estate when you're making a decision about your family and your future.
"Even when you can afford to purchase a home, it may not be the best move for you right now. Look at your take-home pay and living costs—and how those numbers will change when you move into a home. Even when you factor in the mortgage deduction you'll be able to claim on your taxes, in some areas renting may still be more economical than buying.
"The point here isn't to discourage anyone. But home ownership is a big life decision, and you need to be fully aware of the commitment it requires before you sign on the dotted line."
3 Questions to Ask Your Advisor
- Does buying a home fit in with my other financial goals?
- How can I make sure I have enough for a down payment?
- Will my debt-to-income ratio make it easy for me to get a mortgage at a favorable rate?
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