High mortgage rates and home prices this decade continue to make the housing market difficult for first-time buyers. But for those who have the financial wherewithal, buying that first home can be a key part of the foundation for a solid financial future. Usually, a home is an appreciating asset that can grow significantly in value the more years you own it.
The fundamental question is: How can you make sure you can afford your first home — and not get in over your head? While the typical age for a first-time home buyer in the U.S. has risen to 36 — a clear reflection of the housing affordability problem for young adults in particular — some people still get into homeownership before they are on consistently sound financial footing. They may technically have the funds for a down payment and the recurring costs, but barely. Then emergency costs or other unpleasant surprises like job loss come up, and they feel squeezed.
Making the decision to buy your first house is indeed a significant one, a potentially pivotal life decision. It is often intertwined with factors such as career stability, a sense of being rooted in a desirable location, disposable income and considerations of starting (or expanding) a family. Typically, a plan to stay in the home for a minimum of three (preferably five or more) years is considered practical.
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There isn’t a one-size-fits-all age for first-time homeownership. In fact, as the new average age for first-time buyers shows, it behooves many people to be patient and wait until the time — and the price — is right for them. That’s not to say younger homeowners wouldn’t benefit from purchasing earlier. After all, money spent on rent is gone forever. However, before anyone — regardless of age — seriously considers buying their first home, it’s imperative they don’t overextend themselves. To make sure they can afford it, they need to check the following boxes to show they have a strong financial foundation.
1. Have you saved enough money?
There are numerous upfront and other costs to consider when saving to buy a home:
- Down payment. A first-time home buyer needs to have saved enough money for at least a 20% down payment, which allows you to avoid paying for private mortgage insurance. With today’s higher interest rates, down payments of 30% would be optimal. The difference between a 20% down payment at a 3.5% interest rate a few years ago vs a 20% down payment at a 6% interest rate today is massive. If you want to have a lower monthly mortgage payment, you’re going to have to put more money down.
- Closing costs. These usually range from 2% to 6% of the loan amount and go toward finalizing your mortgage. Closing costs can sometimes be negotiated by asking the seller to pay a portion of them.
- Savings for moving and move-in expenses. Moving costs alone can run over $2,000 for a local move and can be much higher for a long-distance move. While the cost of preparing a new home to your liking (painting, flooring/carpeting, furniture, etc.) can vary widely, a general rule of thumb suggests budgeting at least 10% to 20% of the home’s purchase price.
- Maintaining an emergency fund. It is vital to maintain an emergency fund equal to six to 12 months’ worth of your expenses. Even though you may be confident in your employment situation, even the best-laid plans sometimes go awry.
2. Can you afford the monthly mortgage payments?
You need to do the math regarding your mortgage affordability in terms of how the monthly payments fit in or don’t. It’s crucial that you determine your comfort level or if, in fact, a comfort level exists given your annual income and monthly bills.
- The salary rule. If you’re single or the only one in the family who works, your mortgage shouldn’t be more than three times your annual salary. So if you make $70,000 a year, a $210,000 mortgage would be the maximum you should take on if following this formula. If your partner makes $50,000 to go with your $70,000 for a combined income of $120,000, then $360,000 would be your high-end loan amount.
- Drill down on your monthly budget. As another general rule, your monthly mortgage payment shouldn’t be more than 25% to 28% of your gross monthly income. Therefore, it’s essential to take a close, honest look at how you spend monthly, including for your bills, other expenses, necessities and luxuries. A lender will tell you the maximum mortgage you can afford, but somewhere beneath that max is your comfort level — or not. It depends on how a mortgage payment of a certain amount will affect your total monthly budget, including your disposable income and ability to save for retirement. If there isn’t sufficient room in that new budget for all those things, plus emergencies, then you better think twice about buying your first home until you’re really ready.
3. Is your credit good enough?
An excellent credit rating and no other significant debt are paramount for first-time home buyers. Your credit score goes a long way toward determining your mortgage qualifications and the interest rate you’re offered.
- Check your scores on Equifax, TransUnion and Experian. You can get free copies of your credit reports and dispute errors that might be hurting your score.
- Avoid opening new credit accounts. When applying for mortgages, opening new accounts could lower the overall average age of your credit accounts and hurt your score.
- Practice discipline and slash credit card debt. If your credit score is so-so — say, average or slightly above — having a plan to get rid of most or all of your debt and raise your score is essential for getting more favorable terms from a lender.
- Pay your bills on time. It’s never too early to improve your payment history. After all, showing a long history of paying your bills on time has the single biggest positive impact upon your credit score.
Those are some of the key steps toward building a solid foundation to comfortably afford your first house. Once you’ve checked those boxes, you’ll have a clearer idea of the price and long-term commitment that makes sense for you while making a solid investment for your and your family’s future. Given all of the above, regardless of whether you are 25 or 45, having your financial and lifestyle ducks in a row prior to picking out the new door knocker is key.
Dan Dunkin contributed to this article.
The appearances in Kiplinger were obtained through a public relations program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Bleakley Financial Group, a registered investment advisor. Amwell Ridge Wealth Management conducts advisory business under a “doing business as” (d/b/a) name; however, Bleakley Financial does not hold itself as conducting advisory business through Amwell Ridge Wealth Management. Bleakley Financial Group and Amwell Ridge Wealth Management are separate entities from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision. Investing includes risks, including fluctuating prices and loss of principal. No strategy assures success or protects against loss. Past performance is no guarantee of future results. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Asset allocation does not ensure a profit or protect against a loss.
LPL Financial, Amwell Ridge Wealth Management, Bleakley Financial Group, and Kiplinger are not affiliated.
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