Historically, young adults in their 20s and 30s were at the best age for buying their first homes. Nowadays, people ranging in age from 25 to 40 are facing first-time home-buying challenges. At today’s high prices, is it a wise decision to buy? What planning opportunities should first-time home buyers consider?
There’s been a trend of deferred homeownership. 51% of baby boomers owned a home by age 30, 48% of Gen Xers owned a home by age 30 and 42% of millennials owned a home by age 30. According to Zillow Group’s economist Jeff Tucker, this may represent “… a potential indicator of enduring housing demand to come.”
However, it isn’t easy to buy a home right now. Financial and emotional factors come into play. Emotionally, it’s a big part of the American dream; your home is supposed to be your refuge and sanctuary and where your kids grow up, play and sleep. Financially, it is one of the most expensive purchases you will make in your lifetime.
Unfortunately, current conditions of low inventory, steep new construction costs, high home prices and stiff competition reduce affordability and create limited opportunities for buyers to succeed. This leads to hasty decisions, including buying homes sight unseen with significant concessions. Is rushing the purchase a good idea?
Before you go house shopping
Build a budget and be prepared to fork out money for these expenses:
- Down payment: Conventional loans typically require 20% down, but FHA (Federal Housing Administration) loans can demand as little as 3.5%. Keep in mind, though, the less you put down, the more you may pay in the long run.
- For example, take a $400K home and compare the two loans using 30-year mortgages at 3% interest (excluding Primary Mortgage Insurance or PMI). You’ll pay about 20% more in cumulative interest, and you miss out on about $280,000 of savings (the opportunity cost of higher monthly payments assuming a 6% return). PMI protects the lender in case of default and cost is determined by loan to value and credit score. If the PMI premium is 0.5% (of original loan amount) on the 3.5% down payment example, your monthly payment may increase by another $160 and continues until equity reaches 20%. Also, a bigger down payment may protect you if you need to sell your home in a rush. If prices drop below 10%, you may have to fork over funds to cover selling costs and negative equity.
- Closing costs: These are the costs you pay to finalize the financing and purchase transactions. They may run between 2-5% of the price or mortgage amount. Sellers may be willing to cover some expenses, but you may have less room to negotiate in a hot market.
- Property taxes and insurance: Be prepared to pay up to a year’s worth of taxes and fire insurance premiums upfront. Taxes depend on location and value, but 1% of property value is a starting estimate. Homeowners’ insurance may cost $1,200 to $2,000 based on property value, location and risks. Are your life and disability insurance sufficient, and is additional umbrella liability coverage advised?
- Move in, improvements and maintenance costs: You may have expenses even if the home is “move-in-ready” (e.g., renting a moving truck, buying a garden hose and plants for the yard, etc.). You should hire a home inspection company to identify potential issues and expenses from the foundation to the roof so you can plan ahead. If it’s a fixer-upper, get some estimates to confirm that it will not be a money pit. If it is, I recommend looking at other options.
Picking your first home
The U.S. Census estimates the average American will move 11.7 times in their life. A 30-year-old may have five to six moves left in their lifetime, and a 45-year-old will have about three more moves left. Based on this, you may have more opportunities to find and buy the “perfect place.”
Defining and aligning personal and emotional preferences may help you “get close” to your first home. Seek support and guidance from people who know you and about homeownership, including parents and a skilled realtor.
Reducing Your Costs
- Is it better to wait? If improved financial stability is needed (e.g., improving your credit score, getting a new job that pays more, saving for a larger down payment, etc.), it may make sense to wait.
- On the other hand, will home prices be the right price for you if you wait? It’s emotionally hard to “buy high,” and no one wants to make a mistake that could heavily impact their financial security. However, the real estate market is not homogenous - pricing is subject to location, supply and demand. What if prices drop or stabilize, but mortgage rates rise? How does affordability change for you if you wait or move to a less expensive area? Finally, don’t confuse your home to be just an “investment.” It’s a necessity. You need a roof over your head.
- Check assistance programs: Perhaps you qualify for first-time home buyer programs. Check regional agencies and the U.S. Department of Housing and Urban Development (HUD), the Veterans Administration (VA), the Federal Housing Administration (FHA) and others.
- Pre-funding inheritance: According to a recent Zillow Group Consumer Housing Trends Report, buyers may need an additional year to save for a down payment due to rising prices. COVID-19 allowed people to be more aggressive with their savings, and low mortgage rates improved affordability. However, with soaring home prices, what about additional assistance with your down payment? If family members can help you make a hefty down payment, use them.
Planning to buy your first home has always been challenging. There are many factors you need to consider, not to mention, saving can take many years. However, today’s first-time home buyers have unique opportunities to capitalize on in this realm. May this sage advice help you to make money-wise decisions in your home-buying endeavors.