Buying a house is exciting! The thing is, whether you’re a first-time homebuyer or you’ve purchased homes before, you’ll need to be prepared before buying your dream home. When buying a house in the next year, you’ll have lots of options at your disposal, including how much to put down, how much house to buy, and what type of mortgage to take out.
In this post, I’ll talk about how much to save to buy a house, what mortgage options to consider, and what to do if you’re buying a house next year.
1. Save for a 20% Down Payment
I always recommend putting 20% down on a house. It’s possible to get loans where you put less down, including a VA loan and an FHA loan. When you put less than 20% down, unless you have a VA loan, you must pay PMI, which private mortgage insurance.
A second reason to save up a 20% down payment is if the housing market shifts unfavorably, you could find yourself underwater. Here’s how:
- You put $5,000 down on a $300,000 house.
- The market drops the value of your house 5%.
- Your house is now worth $285,000, but you owe $295,000 on your mortgage, minus what you’ve paid currently.
- You now owe more than the value of your house, severely limiting refinancing options, and if you sell the house, you will still owe money to the bank.
A third reason for putting 20% down is a practical one. You lower your monthly payment by putting more money down because you lower how much money you’re borrowing. This, in turn, also lowers how much interest you pay over the loan’s terms.
In short, when you're buying a house next year, make sure you're saving as much as you can.
What is Private Mortgage Insurance (PMI)?
PMI stands for Private Mortgage Insurance, and it’s an added insurance policy that you pay for when you make a down payment on your home that’s less than 20%. It is designed to protect the lender in case you can no longer pay your mortgage.
The cost of PMI varies based on your credit score and how much you put down on your home. Typically, you’ll pay between $30 and $70 per $100,000 borrowed per month. This continues until you have 20% equity in your home.
If your house has risen in value such that you have greater than 20% equity in your home, you can contact your lender about removing your PMI payments.
The Benefits of a 15-Year Mortgage
The monthly payments of a 30-year mortgage may be enticing due to the lower amount versus a 15-year mortgage. That said, a 15-year mortgage generally has a lower interest rate, sometimes up to half a percent, and over the course of the loan, you’ll pay less than 40% in interest when compared to the 30-year mortgage.
When you get a 15-year mortgage, you’ll pay it off twice as fast as a 30-year, leaving you many more years where you’re not in debt.
The downside of a 15-year mortgage is that the monthly payment is higher, which means you can’t afford as much of a house, and if you incur a financial hardship, it will be more difficult to make payments.
2. Make Sure You Can Afford Your Home
Homeownership is one of the most expensive purchases you'll make. There’s something to be said about how much house you can afford. A bank may be inclined to preapprove you than you can actually afford.
Your monthly mortgage payment can’t be higher than 28% of your gross monthly take-home pay. So if you make $5,000 per month, you would not be able to have a mortgage payment greater than $1,400.
Additionally, your total debt-to-income ratio must not be greater than 36% at most banks. That is, if your mortgage payment plus all other monthly debts combined add up to greater than 36% of your gross take-home pay, then you will not be approved for your mortgage.
Here’s what to look out for, though. While the lender will make these considerations, you must also consider your savings rate and how much you spend on everyday expenses and bills. If you have a lot of monthly expenses, then you might not be able to afford 28% of your take-home pay for a mortgage payment.
When determining how much house you can afford, make sure to review your budget after you’ve received a maximum borrow amount from your lender.
3. Avoid Big Purchases
In the two to three years, leading up to purchasing a new home, avoid big purchases. You’ll need as much money as you can saved up for both the down payment and any moving or unexpected expenses that you incur after you buy your home. By avoiding big purchases, you’ll also keep your credit card balances paid off more easily. If you're buying a house next year, bank as much money as possible.
Your lender will pull your credit report and check your score when you first inquire about a mortgage and right before you purchase your home. If you have made recent major purchases and are carrying a high credit card balance, your credit score may be lower, which might worry your lender or have them change the terms at the last moment.
4. Check Your Credit Score
Check your credit score before inquiring at a lender for rates. You can get your free credit report once per year here. Additionally, some credit card companies offer regularly updated credit reports and scores. If you notice anything incorrect on your credit reports, reach out to the credit bureaus and correct them.
Having a higher credit score generally means you'll qualify for lower interest rates. This can save you tens of thousands of dollars over the life of your mortgage.
5. Avoid Applying for Credit
Applying for credit has a minor impact on your credit score, however, once you’ve applied for a mortgage, you’ll not want to apply for credit at all until after you’ve successfully purchased your new home. Most lenders want a clear picture of how much debt you owe, and when they are drafting up mortgage papers with you, they will generally tell you not to take on more debt.
If you need to apply for credit, do so at least 12 months before applying for a mortgage. This will also allow the lender to see that you aren’t applying for a lot of credit over a short period of time.
6. Have Extra Money Saved for Closing Costs
Some lenders will roll your closing costs into your mortgage, but this raises your monthly payment. It’s always a good idea to pay your own closing costs when you find a home you plan to purchase. With extra money, you may have the option to lower your mortgage rate by buying points.
When you buy points, you pay money upfront to lower the rate of your mortgage. This has the potential of saving you thousands of dollars of interest over the lifetime of your loan.
7. Work with a Real Estate Agent
A real estate agent will guide you through the process of home buying. They will give you comparable homes in the area, take you to different properties, assist you in making an offer, and help you prepare for the closing. A real estate agent can also offer to help you negotiate the purchase price of the home you’re looking to buy.
Wrapping It Up
It’s easy to get caught up in the excitement of buying a house. When taking the plunge, ensure that you think long-term, as a mortgage will last you many years. Think about your long-term plans, your career path, and potential upcoming expenses.
The last thing you want is for your income or expenses to suddenly change out of your favor and your mortgage payments becoming troublesome. If you're buying a house next year, make sure your income and expenses are as stable as possible.
If you're a first-time homebuyer, check out these first-time homebuyer tips to help you land your dream home!
Are you in the market for a house? What have you done to prepare for your purchase?