4 Rules for Buying a Home (and How Far You Can Bend Them)

When it comes to buying a home, few rules are hard and fast. Government programs have allowed people at all financial levels to realize this basic American dream. Long gone are the days when only the most affluent members of society could become landowners.

So what are the rules today when it comes to home ownership? And to what extent do they apply to you?

1. Save up a 20 percent down payment

A 20 percent down payment is a must in order to get the best terms on a mortgage. But some Americans find that putting together that much cash is an insurmountable obstacle. In fact, many would-be homebuyers can easily afford a mortgage payment – often equal to or lower than the rent they were paying – long before they’re able to save up that amount of money.

This is a rule you can bend. FHA loans are available for buyers who qualify in all other aspects but who only have enough cash on hand to make a smaller down payment. The down payment on an FHA loan can be as little as 3.5 percent of the purchase price. Know, however, that the interest rate on the loan will be higher than the rate on a loan that does not exceed the 80 percent loan-to-value threshold.

2. Save up an emergency fund

Home ownership comes with untold numbers of unexpected expenses, many of them large. Having cash set aside for emergencies is simply not optional. Experts suggest that you maintain an emergency fund equal to six to twelve months’ living expenses.

You can bend this rule a little, but only if you are on solid financial footing (reliable income, ample cash reserves, great credit score) when you start shopping for a home. Don’t make a move before you’ve stashed away at least three months’ worth of cash, above and beyond the cash required to cover closing costs, the down payment and any moving expenses you’ll incur. The more cash you have on hand, the better.

3. Be prepared to keep the home for at least five years

This rule is based on the amount of time it usually takes to recover the costs associated with buying a home (closing costs, moving expenses, and so on). In recent years, the mortgage market has been so competitive that many loans were offered at very low cost (and in the case of refinances, even no-cost). That will make the time to sell without losing money much shorter for some buyers, allowing them to break the five-year rule.

If you incur normal closing costs, you can use different strategies to reduce the amount of time it takes before you hit your break-even point, including buying a home at the low end of your price range and paying down the loan a little faster. (During the first few years, your mortgage payment goes primarily to interest and your principal balance owed goes down just a tiny trickle each month. So if values remain relatively stagnant, or dip a little, you might not be able to sell the property for what you’ve spent within the first few years.)

Of course, you can certainly plan to keep the home for more than five years. Housing bubble aside, real estate values tend to appreciate by 3-5 percent per year over time.

4. Buy the most home you can afford

Many real estate agents and mortgage brokers will encourage you to buy the most home you can afford. That’s not the best strategy for everyone. Maxing out your budget leaves you with nowhere to go if expenses rise sooner than you anticipated.

You should bend this rule if you are considering buying a more expensive home with less than 20 percent down instead of a more modest home with a full 20 percent down payment. For one thing, you’ll get a much better deal on the loan. For another, even with market fluctuations the home is not likely to be worth less than what you owe should you decide to sell in the foreseeable future.

Consider the unknowns when you plan out your purchase. Property taxes and maintenance costs will go up eventually. And you might want to stop working when children are born, or travel the world when you get burned out on your job. These and many other experiences could be severely restricted if your financial obligations are high.

If you have your heart set on a home with certain luxuries or upgrades, find a home with room to grow and plan to purchase those upgrades for yourself when you can afford them.

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Published July 25, 2013
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