Are You Ready to Buy a Home? The Ultimate Checklist
The English language borrowed the word mortgage from French, in which it literally means “death pledge,” alluding to the long-term nature of such a commitment. Not to mention if you get in over your head, your home loan will surely feel like death.
A mortgage is also a place where you can royally mess up your finances for the long haul. You can clip coupons, shop at ALDI, do a shopping ban, and drive an old car, but if you over-do it on the house, it’s hard to ever get ahead. This is one of the big areas to get right as it’s likely going to be your top living expense.
Fortunately there is a way to buy a home without killing your financial future. It’s all about going in financially prepared. Use the checklist to determine if you’re ready to take a mortgage, rather than a death pledge.
I know how much money I spent last year. You must know where your money is going, or you don’t know whether you can afford a house. If you base mortgage affordability solely off what you pay in rent, you may be unprepared for the extra costs of home maintenance and repairs and increased utilities.
I’ve recorded a budget for this year. You must know where you want your money to go in order to save a down payment, cover closing costs, and be sure you know what you can afford to buy.
I have no credit card debt. Ideally, you’d want to go into buying a home with no debt, since a mortgage is the largest debt most people will take on. At the very least, you wouldn’t want to be paying high interest on credit card debt. That’s a financial emergency you must get out of before you start saving for a house down payment or getting into another loan commitment.
What about car loans? It doesn’t make much sense to keep an auto loan around (and paying interest on a rapidly depreciating liability) while trying to purchase a home, either. It would be wise to pay it off ASAP, thus minimizing the interest.
What about student loans? In a perfect scenario, you’d want to have student loan debt out of the way. Especially if you have a mortgage-size student debt, why not wait? You don’t need two death pledges! But as long as you have a plan to pay off student debt and factor this into your budget for a home, you should be fine. We had a modest amount student loan debt remaining when we purchased our home, but purchasing an affordable home and having a plan to pay off the debt meant it wasn’t a big burden.
I have six month’s living expenses saved. That’s nice you’ve saved $20,000. But what is it for? Emergencies such as job loss or illness? A down payment? Closing costs? Incidentals and furnishings? You need to separate these categories, at least mentally. Write it all down, total it up, and save that much, not a random round number that sounds good. What if you buy your house and unexpectedly get laid off? Having a cushion to fall back on is more than ever once you have the major financial commitment of a mortgage.
I have determined a budget for the price of my home, and the mortgage, taxes, and insurance will not exceed 25% of my monthly take-home pay. As mentioned before, please base your budget on the lowest income you expect to earn while paying off that house. If you’d like on parent to stay home with future kids, base it off of one income rather than two. You can always save, invest, or pay down debt with the other spouses’ pay while you’re still a dual income household.
I have saved a 20% down payment. Again, this is in addition to my emergency fund (6 months’ expenses). Putting 20% down will:
- Avoid PMI which is money down the drain for a homeowner with insufficient equity to secure the property.
- Ensure some equity when you need/want to sell. Early mortgage payments are almost entirely interest meaning you don’t gain much equity in the first few years.
- Make your mortgage smaller and monthly payments more affordable.
- Indicate you have the financial discipline to handle a mortgage.
I’ve saved an additional 5-7% for closing costs, inspections, appraisal, and setting up the home. For a $100,000 loan, you’ll spend around $5,000 or more just on the home-buying process. Additionally, you may need a lawnmower, furniture, appliances, and other tools to set up your new pad. The cost can add up even if you purchase secondhand. If you buy below your budget, the difference from your down payment savings can cover this. If you buy at the top of your budget you’ll need some extra cash on hand.
I am saving for retirement. At the very minimum you should be earning your employer 401k match. If not you’re essentially allowing your employer to keep part of your paycheck. But investing 6% is only going to inch you toward solid retirement savings. Dave Ramsey recommends investing 15% to build a solid nest egg for the future. Don’t ignore your future in order to purchase a home.
The difference between a death pledge and a mortgage lies in your financial readiness for home ownership. If you’re free of high-interest consumer debt, have sufficient savings, and live in area where home prices are reasonable, home ownership can be a solid choice. Just don’t sacrifice other goals like retirement, staying home with kids, or paying off other debt to do so. It’s worth the wait to avoid the death pledge.
Homeowners, what would you add to this list? What do you wish you’d done to prepare for buying a home?