Let Me Clarify
Buying a home can seem overwhelming. From costs and inspections to insurance and taxes, you will likely have plenty of questions along the way. Luckily, there are many professionals involved in the process that will help you through it. However, as a financial planner, I want to shed some light on a few areas that are often overlooked.
Let me clarify.
Pre-qualification is the first step in buying a home. In this process, some basic calculations are done to give you an idea of how large of a mortgage you may qualify for. At the center of these calculations are two numbers: 28 and 36. The 28/36 Rule provides guidelines that no more than 28% of gross monthly income should be spent on total housing expenses, and no more than 36% of gross monthly income should be spent on all debt (including housing).
While this gives you a ballpark estimate for where to begin your future home search, I highly suggest avoiding shopping for homes at the top end of those ranges.
Like most other “rules of thumb,” quite a few pieces of your financial situation are ignored. For instance, basing your housing costs on gross monthly income does not factor in your tax situation that directly impacts what you have available to spend. At the same time, closing costs, renovations, and other expenditures involved in buying a home may end up stretching you past what you can really afford.
In some cases, this can turn into a “house rich” situation, where a family may have a beautiful home, but is struggling overall financially. To prevent this from happening, remember the considerations below:
Determine What You Can Actually Afford – Again, the 28/36 rules will provide a ballpark estimate to get you started, but only considers your income and the debt you have. Plenty of individuals and families have other non-debt expenses that can throw a wrench into things. Because of this, you should start with outlining an accurate budget to look at what your housing costs are currently and what your overall monthly cash flow situation looks like. This will help you determine what you can afford from month to month, to hopefully avoid a situation where you need to change your lifestyle in order to pay your mortgage.
With an appropriate cash flow-based payment estimate, average current mortgage interest rates, and the amount you plan on paying as a down payment, there are plenty of calculators available online to give you a better idea of the home value to shop for.
Factor in Your Down Payment and Emergency Fund – A common mistake that home purchasers often make is to spend all their available cash on the down payment. Of course, making a larger down payment can reduce overall financing and additional insurance fees (called “PMI”), but what happens if something needs to be fixed, or replaced, shortly after becoming a homeowner? What if there is a loss of employment or a medical emergency? Unfortunately, not all home repairs are quick or cheap and life does not always go quite as planned. This adds to the importance of having an adequate emergency fund at this stage of life.
Although we all want to keep up with the Jones’, it might make sense to wait a little longer or to consider a cheaper home if it feels like you’ll have to spend everything you have upfront.
In my experience, much of the stress of buying a home comes from surprises throughout the process. I may not be able to eliminate all of the anxiety you might have, but hopefully these few tips can help make the home buying process a bit more manageable.
As we embark on this clarifying journey together, I encourage you to submit any ideas, topics, or questions to firstname.lastname@example.org. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. “Let Me Clarify” is a weekly blog containing Chad Baxter’s insights and thoughts about a variety of topics. To learn more about Chad, click here
All performance referenced is historical and no guarantee of future results. All investing involves risk including loss of principal. No strategy assures success or protects against loss. This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding your specific situation. Clarify Wealth Management and LPL Financial do not provide legal advice or services. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. 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. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.