The American dream is still homeownership. Despite living through the 2008 recession, real estate bubble, predatory lending, and stock market crash, millennials still have googly eyes for a mortgage. It does take them longer to hit the housing market than it did generations before them. Waiting longer to get married or have kids, along with freakish amounts of student loan debt are two major reasons for the delay in trading in the rent for a mortgage.
Carrying large student loan debt makes it significantly harder to secure a loan for a house.
As a Gen Xer, my young, hopeful millennial friends ask me questions about owning a house. They are pumped and innocently think that saving for a down payment will be the biggest hurdle. They don’t worry about not having 20% for their down payment, because they will be first time home buyers who qualify for Federal Housing Administration (FHA) loans that accept low credit scores and reduced down payments.
It is hard to crush the dreams of young folk that this is all an illusion. Hence, this soul-crushing informative piece will come in handy, complete with how I’ve been screwed so that you don’t have to be! It’s only meant to keep you from becoming part of the 63% of millennial homeowners who regret buying because they underestimated the costs and the work. If you have the money and time to invest in a house at this point in your life, you will know after reading this article.
I am living in my third house now at 41 years old and my first home was purchased almost 20 years ago, in my mid-20s. I’ve been through a foreclosure, from when I couldn’t sell my house during the 2008 debacle, I’ve been through surprises at the closing table, when it’s too late to back out because the buyer and the seller both have their U-hauls packed up and ready to go, and I’ve lived through the headaches of day to day homeownership. I have an opinion on buying, informed by the realities of owning.
The Down Payment Delusion
Contrary to the myth that the down payment is the most daunting aspect of home ownership, there are several other expenses many eager first-time house hunters probably haven’t considered. I should know. I was once one of them. But my home-buying innocence has been shattered and the hopeful dream of homeownership is not something I recommend to just anyone.
It’s expensive, it’s hard work, and if you don’t plan to stay in one place for at least five years, it’s probably not worth it.
One thing lenders don’t like to tell you about FHA loans is that you will pay each month for the privilege of putting down less than 20% on your house. This is called private mortgage insurance (PMI) and it protects the lender, not you. But, you will be footing the bill, which drives up your monthly payments.
The good news is that once you do pay 20% of your principal, your PMI drops off. The more you put down, the less PMI you will be paying. During the closing on my first house, I was surprised when this PMI was added into my monthly payment. The lenders kept it a dirty little secret until the very day I was handed the keys. Not cool.
If you are thinking that a mortgage payment will be equal to or less than what you are currently paying in rent, keep in mind that a lower down payment means a higher monthly mortgage payment. You can’t have your cake and eat it too in real estate. If you’re thinking that you’re throwing money away on renting and can own a home for the same amount you’re wasting on rent, then you will need to consider a higher down payment to get there.
Student Loan Debt Matters — Even if it’s deferred
I was once a sucker for that FHA loan promise and having just been married and with a baby, buying a house seemed like a logical step. Luckily, I was still in graduate school with my student loans in deferment, so there were no payments to factor into my monthly expenses. But, lenders still calculate your debt-to-income ratio using the estimated future monthly payment of your school loan.
If your debt-to-income ratio is 40% or higher, it is unlikely that a lender will approve your loan. High student loan balances are not offset by deferment or lower income-based repayment plans. Don’t be surprised when the mortgage estimate comes back with an unexpected number included as your estimated student loan payment.
Action Item: Use this simple debt-to-income ratio calculator to get an idea of where you stand in a lender’s eyes.
Home Insurance and Property Taxes Are Gonna Get You!
First-time homebuyer programs can still be great options, as long as you understand exactly what you are getting into, in terms of finances and commitment. Escrow payments toward your home insurance and property taxes are two unavoidable expenses that add to your monthly mortgage payment. An escrow is just an account that holds money for use later.
It is not mandatory to establish an escrow account, but it helps, if you don’t want to fork over thousands of dollars once a year to both your insurance company and the tax commissioner. Instead, the home insurance premium and an estimate of your annual property taxes are divided by 12 months and that amount is put into escrow each month for you, until it comes time for payment. Then the mortgage company pays these on your behalf from the escrow.
Your home insurance rate will mostly depend on your location, the condition of your house, and any previous claims made on the property. The national average home insurance rate is around $1200 per year for a $200,000 property, but this number varies drastically by state.
Action Item: Research home insurance rates wherever you want to purchase! You can find averages in your state here.
Same with property tax rates. You’ll be paying into your escrow each month to cover your annual property tax bill. If your property taxes aren’t estimated accurately during the loan process, meaning not enough is going into your escrow, you’ll get a nice big bill for the difference when tax time comes. This will also suddenly increase your monthly payments, because your mortgage company will reassess your escrow payments based on the actual property taxes you owe.
Action Item: Figure out the property tax rates based on location. This tool is helpful.
My mortgage surprisingly went up by over $400 per month after my first year in the house I purchased in 2018! The lender will split any property tax not covered by your escrow into 12 monthly payments for the next year to pay back the taxes they covered for you, along with the additional amount needed to cover the property taxes for the upcoming year. This is not a welcome surprise for anyone.
If you are able to pay the lump sum of unpaid taxes, then your escrow payments will only increase by the amount of the newly assessed tax rate. Still, this is a jump in your monthly expense. I paid the lump sum of unpaid taxes, bringing the $400 per month increase in escrow down to $100 per month. Better, but not great.
How does this happen? Sometimes lenders estimate your property taxes lower than they actually are in order to get a loan approved and down to a monthly payment that the buyer will accept. Other times, the lender uses the previous owner’s property tax history to estimate the property taxes on your new loan. This backfires when the previous owners had a bunch of exemptions for being elderly.
Understand that your home insurance premium and property taxes will fluctuate, so you have to be prepared for increases in your escrow payments, which will increase your monthly rate.
Hint: Applying for a Homestead Exemption will lower your property tax rate.
All the Other Delightful Hidden Fees
Home Inspection: Once you put an offer on a house, you will want to have a professional home inspection to make sure it’s in good condition. House inspections are not required, but it can save you from unexpected costly repairs later. You don’t want to invest in a property that will need a ton of expensive work once you move in. If the home inspector finds serious issues, you can either decide to walk away, renegotiate the price to compensate, or ask the seller to fix the problems.
House inspections cost up to $500, depending on the size of the house. That covers just the basics, and if you want the house checked for pests, radon, mold, or lead, you will pay extra. Septic tanks are also not included in a normal house inspection, and these are huge drain on the wallet when something goes wrong. Otherwise, it’s nice to have the low water bills.
Closing Costs: The fees associated with your home purchase, including loan origination fees, title transfer fees, taxes, real estate commission for both the buyer and seller agents, attorney fees and a slew of other prepaid costs necessary to complete the real estate transaction. It’s a long list of fees. What’s important is knowing that closing costs can be 2% to 5% of the purchase price. The average for closing costs in 2018 on a single-family house was roughly $5,000.
If you find yourself basking in a buyers market or doing business with a motivated seller, you are likely to successfully negotiate with the seller to cover all or part of these costs. You can also opt for a no-closing cost mortgage, but you will end up paying more in the long run, because the lender will increase the interest rate or add the closing costs to the mortgage, which means you pay interest on it.
HOA Fees: The dreaded HomeOwners Associations (HOAs) are everywhere these days. They used to be mostly associated with condominiums or suburban subdivisions with pools, tennis courts, and trails. But, now any little cul-de-sac can establish an HOA and set rules for you to follow, lest you be fined. Your monthly or annual HOA fee depends on the amount of maintenance for neighborhood amenities. Make sure you ask if a home has HOA fees! It can increase your monthly costs.
Home Warranty Costs: Homeownership is hard. Something always breaks and it’s often expensive. If you aren’t a handyman or don’t plan on living with one, you probably want to purchase home warranty coverage. This cost is sometimes paid by the seller, but only once. Once the annual renewal comes, you’ve got to pay up, if you still want handymen available for less than $100 a visit. These plans are around $500 a year, or you can break it up into monthly payments, and cover most home systems and appliances.
As If That Wasn’t Enough…
Utility Costs: You’ll want to consider higher utility bills. The bigger the house, the more expensive it is to heat and cool. Find out whether the house is all electric or also includes gas for heating. Make sure you look at the age and condition of the heating and cooling systems, as well as the water heater. If these are inefficient, your utility bills will be higher.
Loan Preapproval: Get a preapproval letter from a mortgage lender BEFORE you start house hunting. Some agents won’t bother showing you houses if you aren’t prequalified for a mortgage. This lets the agents and sellers know you are serious and capable of affording a house. Be aware, the mortgage rate they quote on the preapproval letter might not be the one you get at closing. If the rate goes up (or down) by the time you purchase, the rate on the letter no longer applies.
Take Your Sweet Time: Give yourself plenty of time, at least 6–12 months. Buying a house is a stressful process as it is, and rushing on top of that is not wise. You are far more likely to make a mistake along the complex winding road that leads to homeownership if you move too fast. Trust me, I did it. I want better for you!
Now that you’re armed with a realistic expectation of what it takes to buy your first home, go get it!
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