The most difficult financial challenge for young adults: Buying their first home

By BOB CUNNINGHAM

We can save and invest, eliminate all our debt – especially those nasty and unproductive credit card payments – and engage in activities to increase our income.

But when and how do we go about buying a house?

That’s pretty much what many young adults and families are asking these days. As personal finance education continues to be more and more commonplace, the one major component that is often missing is information about how – and when – to secure that elusive first abode.

Signing a rental agreement is easy.  Loan and escrow documents? Not so much.

I’d love to be able to write in this space that the process for buying a home doesn’t have to be challenging or complicated.  But in fact, it usually is because there are so many variables, from qualifying for a mortgage to saving for a down payment, to covering closing costs, and more.

It can be intimidating.

Still, millions buy their first homes every year, so it is certainly doable.  Here, then, is a summary of steps that can allow you to get from your apartment or parents’ basement to a residence you can legitimately call your own:

1) Commit to the process. You can’t buy a home “half-way,” or realistically just give it a try.  You have to want it, and even more importantly, understand what has to be done and sacrificed to get it.

While there are numerous first-time buyer programs that really do open barriers which otherwise might be nearly impossible to overcome (try being in your 20’s and having to save up 10% or even 20% for a down payment on a $150,000 home), it’s never going to be free to get into a home purchase.  The most common avenue, via the Federal Housing Administration (FHA) first-time buyer program, generally requires a 3% down payment and escrow closing costs.  On the aforementioned $150K house, you’re still looking at about $8,000 out of pocket before you pack a single box.

Hey, Mom and Dad… got a question for ya.  Oh, and have I said ‘I love you’ yet today?  I sure do!

Realistically, even if your parents are willing to help, you’re going to have come up with some scratch.  Let’s say you need $5K on your own.  At $300-400 a month saved, a lot for most people in this category, it will be well more than a year from when you first decide to go for it that you will be able to come up with enough.  Are you TRULY willing to be disciplined and save on that level in order to make this happen?  If not, keep on writin’ those rent checks.

2) Learn and understand what’s involved in owning versus renting, benefits and pitfalls. Sure, when you own you’re buying something that is yours, that typically appreciates in value, and that you can eventually sell.  You can also write off the mortgage interest on your income taxes (unless proposed tax code changes eliminate that – a step that is unlikely except perhaps for the largest jumbo mortgages). Rent money is, by most accounts, squandered money.

On the other hand… and there’s always an other hand… renting doesn’t require you to buy homeowners insurance or pay property taxes, the two of which often cost an additional 15-20% on top of the principal and interest on your mortgage.  And while it’s true that you can do almost anything to a home you’re buying in terms of improvements, if something breaks it’s up to you pay for the repairs.  When you rent, you can generally just call the landlord and the problem will (should) get resolved without any cost to you.

3) Avoid setting your sights too high on your first home.  Oh, but how it would be cool to have an extra bedroom for my man-cave, a pool and hot tub in back, and wrought iron fencing all around with gated entry.  Our palace!

Truth is, you’re probably looking initially at a cookie-cutter, tract 3-bedroom with few luxuries.  You have to crawl before you walk, and walk before you run, etc. I’m fascinated by the advice I read in nationally-recognized publications and websites that suggests finding a suitable home first, then locating the financing to make it happen.  That’s exactly backwards.

As a first-time buyer, you need to determine the maximum monthly payment that you can afford on your current budget, including principal and interest, taxes and insurance (PITI in real estate lingo), AND THEN SUBTRACT AT LEAST 10% FROM THAT FIGURE.  Give yourself some wiggle room.  If you feel like your budget allows for a $1,600 payment (on a traditional 30-year mortgage), limit yourself to a max of $1,440.  There are numerous unforeseen issues that can quickly drain your housing budget.

And make sure you’re realistic as you establish that initial budget.  If your current rent is $1,000 a month, for instance, and you’re unable to save more than $100 or so monthly, where the heck are you going to get that extra $340 every month when you buy?

(By the way, be sure you don’t attempt to qualify for a 15-year mortgage on this first home purchase, even if you can afford the big payment.  Yes, the interest rate for such a loan would be slightly lower, but you’d be backing yourself into the corner of a much larger minimum payment.  Get the 30-year loan, and if you wish and can swing it, pad your payments (check with the lender for the proper way to assure your extra money goes toward the principal balance and that there no pre-payment penalties) or make a half-payment every other week as a strategy to accelerate payoff.  This latter method results in the equivalent of 13 monthly payments in a year, not 12, and cut a 30-year term to less than 23 years.)

After… and only AFTER you determine what you can truly afford to pay monthly, do you set out to find a home.  Determine with your real estate agent (always use one to help you buy – the seller generally will cover his or her commission at the close of the sale) how much you can finance to wind up at the payment you seek.  Work backwards, remembering to factor in your initial up-front costs.  Ultimately, if done correctly, you’ll conclude that the most you can offer is, for example, $165,000.  STICK TO THIS MAX. DO NOT EXCEED.

4) Interview real estate agents and select one to represent you. Don’t just go with the first person you talk to.  Some buying agents really hustle and seek out the best home for your particular situation, while others will focus only on their own listings or those from another agent in the same office, trying to maximize their commission.

In fact, instruct your agent that you do not want to consider any homes which are listings from that agent or that office. If they agree without hesitation, you may very well have a keeper.  Otherwise, move on.  You can always relax that requirement a week or two later if you’re convinced the agent is truly working to represent your best interests.

If you can, try to avoid a buyer representatative agreement.  If you sign one, the agent will be eligible to receive a full share of the commission even if you end up finding the desired home on your own.  Understand, though, that if you find the home but utilize the agent to help you navigate the buying process, have the agent put in your offer, etc., that the agent is entitled to be paid if you, indeed, buy the home and close escrow.

When working with the agent, be specific (and realistic) about what you’re looking for, and stick to your guns.  Be open-minded, but direct.  If you inform your agent that the home must have three bedrooms, and he or she tries to steer you to a 2-bedroom because “it’s a steal,” inform the agent that you have set your parameters and you expect them to be met.

5) If you feel confident about the situation, go for it.  Otherwise, don’t.  Buying a home is, obviously, a major commitment.  If you have reservations about the home you’ve picked, or your agent, or any other variable in the process, take a step back and re-evaluate.  There’s no pressure here.  You’re in charge.

Once you’ve satisfied every facet, and you find yourself excited about the prospect of buying and moving into the home you’ve chosen, have your agent make the offer – ideally, 5-10% below the asking price or your pre-determined maximum price, whichever is lower – and, to repeat, stick to your game-plan.  NEVER let emotions affect your strategy, or be visible to sellers.

Follow these fundamental steps, and the result will be a truly satisfying process.  And if you have to soak in a blow-up kiddie pool in your new backyard until you can reasonably afford to move up in house enough to have a legit party pad with spa tub, accept that… and set your new goals for the upgraded digs, when the timing makes sense.

Once again, I thank you for reading.

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DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.