Tips for First-Time Homebuyers
Many Americans are choosing to relocate right now, with the boom of work-from-home culture making it more feasible. Professionals who were once tied to office buildings in expensive cities now might have the option to move wherever they desire—around the corner or across the country—without leaving their jobs. Many are migrating to more affordable areas and less dense populations.²
Homebuying can be an exciting but anxiety-provoking process, exacerbated by this already taxing period in time. We, at Wealth Architects, aim to support our community by making the homebuying journey a little bit easier. Below, we offer some tips to help you prepare to buy your first home.³
1. “To Buy or Not to Buy”
Buying a home is a big commitment. You should first evaluate the costs of renting versus buying, which should include a review of your taxes. For example, mortgage interest and property taxes are tax-deductible expenses. Also, consider where you see yourself in the coming years: might you change jobs (or job locations), start a family, go back to school, etc. How might the economy and COVID-19 pandemic affect your plans? Think of all the things that might lead you to sell your home down the road. Home prices do fluctuate, i.e., they can lose value, especially in the short run. These factors will help you determine if now is really the time for you to buy a home or if it’s better to wait. Buying (and selling) a home is a time-, money- and energy-consuming process. The timing will rarely be perfect, but in being honest with yourself, financially, personally and emotionally, you will determine if now is the time.
2. CIA: Credit, Income, Assets
Credit, income and assets are three financial pillars to purchasing a home. Lenders, mortgage professionals and sometimes realtors will extensively evaluate your personal finances in these three areas.
Credit: Your credit report and scores will determine your creditworthiness, which in turn will impact a lender’s willingness to provide you a loan. A credit report is a record of your credit activities. It lists any credit-card accounts or loans you may have, the balances and how regularly you make your payments. It also shows if any action has been taken against you because of unpaid bills. You can obtain your credit report free online at AnnualCreditReport.com. A credit score is a three-digit number generated by a mathematical algorithm using information in your credit report. The higher your scores the better. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits. There are three credit bureaus—Equifax, Experian and TransUnion—that each provide their own score. Your three credit scores typically are not included in your credit report, but you can often obtain your scores online for free or a mortgage professional can help get them. If your scores are unsatisfactory, you can improve them by, for example, paying your bills on time, getting current on missed payments, increasing credit lines on current credit cards, etc.
Income: The lender will review your income (past, present and future) to determine your ability to repay the loan and other housing payments: property taxes, homeowner’s insurance, flood insurance, mortgage insurance and homeowner’s association dues, if applicable. Typically, for a lender to approve your loan, your projected total housing-payment ratio cannot exceed 28% of your gross income and your total debt payments (e.g. student loans, car payments, etc.) cannot exceed 40-45% of your gross income.
Assets: Your assets will determine the down payment you can afford and what remaining assets you will have in reserves. Depending on the loan, lenders often require that you have assets in “reserves” equal to at least 6-12 months of housing payments. Usually, lenders will consider 60% of retirement assets (IRAs, 401ks, etc.) when calculating your available reserves.
If you do not know where you stand in these three areas, find out now. Review your credit report and scores, calculate your income and build a balance sheet. The key: know your finances in and out. It will provide clarity about what you can afford, alleviate stress and reduce uncertainty. Lastly, have your financial documents in order. Lenders will request a litany of documents, such as W-2s, tax returns, account statements and perhaps even official undergraduate or graduate school transcripts.
3. Family Matters
First-time homebuyers often get financial (and emotional or practical) help from parents and close family members. This can come in the form of a direct gift, private loan or joint ownership. Naturally, the “giftor” should consult a tax attorney to learn the gift-tax rules, but under current tax law any individual can gift another individual $15,000 ⁴ per year (called the annual gift-tax exclusion amount) without it counting against her lifetime gift-tax exclusion amount. Parents will often gift to their children over a period of years to avoid reducing their lifetime exclusion amount and to prepare for a future home purchase.
If you receive any meaningful amount of money shortly before the purchase of a home, the lender is going to ask you where it came from and if there are strings attached. For example, if a gift is actually a loan, the lender will add the repayment of that loan to your housing and debt obligations. Lenders will often require a “gift letter” signed by the giftor, clearly stating that their gift is, indeed, not a loan. Also, lenders sometimes exclude “gift assets” for meeting loan and reserve requirements if the funds have not been “seasoned,” i.e., in your bank, savings or investment account for a length of time, which can be multiple months.
If you anticipate getting assistance, begin with the end in mind and work backward. Be sure to talk the process through with the person(s) who plan to offer assistance so to help determine the most appropriate gifting or loaning method.
Most importantly, I recommend that you think about the non-financial aspects of getting a gift or loan. Will it change your relationship? What are their expectations? What are yours? Do they want to be involved in the home-selection and purchase process? If yes, are you OK with this? Even if financial strings are not attached, are there emotional strings? Also, are they really in the financial position to gift you the money? These are important questions to ask.
4. There is no “I” in Team
Buying a home usually involves you, the seller, a mortgage professional, a lender, two realtors, an insurance professional, an inspector, a title company and, hopefully, a financial planner. Although it may feel like it is all about you, it’s not. Building a team that will serve your interests is imperative. If buying a home is new to you, I recommend that you work with experienced professionals who enjoy educating first-time homebuyers. Also, I’d urge you to speak with a mortgage professional first. That way you will not waste time and energy looking at homes you can’t afford. Buying a home is emotionally demanding. The last thing you need is a logistical nightmare on top of it.
Although online resources abound, I believe it’s important to build your team by asking for referrals from people you trust. Next, get to know your team and develop a strong rapport with those professionals. Be yourself. The more you connect with them, the harder they’ll work for you. Lastly, when you submit an offer to buy a home, it could be one of many. Whom do you want to represent you? Who has the experience to close the sale?
5. Tradeoffs, Tradeoffs, Tradeoffs
Buying your first home is a dream come true, but most likely you are not buying a “dream” home. To me, it comes down to tradeoffs. Where are you willing to compromise and where are you not? I encourage you to write down your need-to-haves, nice-to-haves and can’t-haves. What is more important to you? Granite countertops or square footage? Single-family home or good school district? Also, how might homeownership change your lifestyle? Ask yourself these questions because chances are, you will need to make a tradeoff. Also, I recommend that you look past aesthetic sticking points, e.g. paint, wallpaper, carpet. Instead, focus on the bones: foundation, roof and quality construction. For those do-it-yourselfers, be realistic about the time, cost and energy of potential renovations and remodels. Lastly, READ the seller’s disclosure package before making an offer—you will be astounded by what you learn. What looks good on the outside may not be on the inside. If the seller accepts your offer, hire an experienced inspector and follow them step-by-step through the inspection
6. The Bottom Line
The numbers are important and you should never overextend yourself. However, when it comes to buying a home, it’s not always about the bottom line. Some view a home as the quintessential investment, but I view a home as something much greater. A colleague mentioned “pride of ownership” and “knowing that you own this unique piece of dirt and wood and stone and that you can shape it however you want provides a tremendously satisfying feeling.”
A home is a place to share with family and friends. A place to build memories. Ask yourself, is this a place that I see myself entertaining family, sitting at the dinner table, taking out the garbage? These things will never show up on the bottom line. That said, I recommend that you keep your emotions and excitement in balance. Remember, thousands of houses are out there—be careful not to fix yourself on just one.
Also, keep in mind the seller. They could be selling a home that has meant more to them than any number. This could lead them to overprice it but, often, they simply want to find an owner who will care for the home as much as they did. If you have the opportunity to meet the sellers, do it. Get to know them, too. You will get a sense for their “pride of ownership.” It’s not unheard of for sellers to leave money on the table because they feel one buyer would take better care of the home over another.
Buying your first home is one of those “once-in-a-lifetime” experiences. Cherish it because it’s a milestone you will remember forever. But stay focused on the essentials so you make an informed decision. Please let us know if you, your family or your friends would like to discuss buying a new home. We are here to help you build a plan toward this goal.
[1] Source: https://www.travelers.com/resources/home/buying-selling/pros-and-cons-of-buying-a-house-now
[3] Sources: https://www.politico.com/news/magazine/2020/05/13/how-coronavirus-could-upend-human-migration-251715 and https://www.thedenverchannel.com/news/national/coronavirus/more-people-are-moving-during-the-pandemic-heres-where-they-are-going
[4] Sources: https://www.northerntrust.com/united-states/insights-research/2020/wealth-management/wpi-lifetime-exclusion-amount#:~:text=The%20annual%20gift%20tax%20exclusion,U.S.%20couple%2C%20in%202020). and https://www.natlawreview.com/article/now-good-time-to-make-gift#:~:text=The%20Gift%20Tax%20Exemption%20is,Tax%20and%20the%20Estate%20Tax.
Copyright © 2020 Wealth Architects, LLC
Wealth Architects, LLC does not provide tax or legal advice. Please consult with your tax and/or legal advisor for such guidance.
Note Pat Phillips and Wealth Architects are not licensed Real Estate Brokers or Agents.
Wealth Architect
