As you begin searching for your first home, you’ll more than likely have plenty on your mind. Unfortunately, it’s not uncommon for people to forget to make a comprehensive financial plan for their new circumstances. It’s important to keep in mind that your new situation will bring about significant changes to your finances. Your mortgage payment will generally be greater than the rent you were paying, you’ll have higher utility costs, and you won’t be able to call the landlord anymore if something goes wrong. You’ve got to create a plan that accounts for all of the new expenses you will have.
What Can You REALLY Afford?
Many experts will offer you advice about the portion of your income that you should commit toward your monthly mortgage payment, and I’m no different. What’s the difference between their advice and mine? I recommend that you dedicate a lower percentage, for several important reasons.
First, the “affordable” monthly mortgage payment recommended to you by lenders is almost always based on your gross income, that is, your income before taxes and other deductions are taken out. Since that money is never going to reach your pocket, you shouldn’t consider it available to help pay your mortgage or any of your other expenses, either. Instead, you should think in terms of your net income--what you actually bring home. Experts say that you should spend no more than 33% of your gross income toward your housing costs, which include your mortgage payment, property taxes, and homeowners insurance. My organization generally advises consumers that they shouldn’t spend more than 35% of their net income on all costs associated with the home. This includes the items I previously mentioned, as well as your utility bills and groceries.
Many people will tell you that you would be crazy not to take out the maximum loan that they say you can afford according to their calculations. The truth is, they don’t know what you can afford. Remember, they’re using your gross income. They don’t know that you may spend $50 a month on wireless Internet access for a laptop, $70 a month for dry cleaning, $150 a week for day care, or whatever your unique expenses are. Only you know where your money goes. Therefore, only you can determine just how much you can afford as a monthly mortgage payment.
Living Space
Since this is your first house, the available space will probably be larger than your former accommodations. You may need to buy appliances, window treatments, lamps, rugs, or additional furniture to make your new home livable. And since this is your new space, you’ll naturally want to decorate it according to your tastes. All of these items can really add up, so try to set aside an amount in advance, or create a buying strategy to make your house a home.
Energy Costs
Again, because your new home will more than likely be bigger than your former living space, you can expect higher energy bills. Be sure to ask the current occupants what their monthly averages are so you can plan accordingly.
Utility Fees
Utility companies may charge you to establish service with them. These fees vary depending on the service provider and area. Before you move, contact the utility providers in the area to see what these charges may be. Certain service providers routinely advertise free installation deals, so be sure to inquire.
Auto Insurance
What you pay for auto insurance is affected by where you live. Moving from one community to the next, even if only a few miles away, can have a tremendous impact on your costs. I once moved to an apartment just five minutes away from my old place, just one town over, and my monthly payment rose 75%! Contact your insurance company to receive an updated quote based on your possible new address.
Closing Costs
The day you’re scheduled to receive your loan and actually take possession of your new house is known as the closing. On this day, you’ll be expected to write a check for a number of expenses, typically including attorney’s fees, taxes, title insurance, prepaid homeowners insurance, points, and other lender’s fees. Together, these are known as closing costs, and the total can be anywhere from 2% to 7% of the price of the house.
You can plan for closing costs by getting a good-faith estimate from your lender early in the loan process. It’s also a safe bet to add an additional 1% to the good-faith estimate you’ve been given because, simply put, it's only an estimate. The last thing you’d want is to be caught short on the day your dream of homeownership is supposed to come true.
Create an Emergency Fund
Now that you’ve sacrificed to save money for your down payment and closing costs, you may have no funds set aside for emergencies. According to Murphy’s Law, “if anything can go wrong, it will.” Just imagine: It’s your first night in your new home. As you settle into bed, you hear a noise from the basement. You examine the situation and discover that your hot water heater has sprung a leak. Wishful thinking on your part may have led you to believe that this wouldn’t happen to you, but alas, similar disasters have come to pass for many new homeowners who thought the same way. With this in mind, it’s a good idea to set aside an emergency fund equal to three months’ worth of expenses, before you buy your new home.
These are just some of the items you need to take into consideration. Be sure to do your homework. Talk with friends and family members about their home-buying experiences, and do some research on the Internet, as well.
The last thing you want is for your American dream to turn into a financial nightmare. With preparation, you can make sure that doesn’t happen.
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Thom Fox is a public speaker and personal finance author who has helped to develop numerous programs for both young people and adults. As an expert in the field of personal finance, Mr. Fox has served as a guest lecturer for the Bruce Wells Scholarship Upward Bound program at Clark University and a panelist for both the Nichols College “Cycle of Debt in America” student Q & A and the California JumpStart Coalition “Innovative Financial Literacy for Youth” conference.