Buying a home is not like buying a car

Do not just show up at a bank or credit union and ask for money to buy a home. You must prepare, prepare and prepare some more before requesting a loan for a home (a mortgage). This means getting rid of your debt, saving consistently each month, and educating yourself about the mortgage process. You would be wise to spend the vast majority of your time in the preparation stage long before you hit the execution stage (actually buying the home).

Focus on the 4 C’s when buying a home

• Credit (get your credit score high and you will save thousands of dollars over the lifetime of the loan)
• Cash (have enough to put 20% down on your home as you avoid Private Mortgage Insurance)
• Capacity (make sure you can qualify based on the last 2 years of work)
• Collateral (make sure that home you are buying is safe and sound as you have it carefully inspected by a professional prior to signing the paperwork).

Get these 4 C’s right and you will be well on your way toward a successful home buying experience.

Here are the do’s

Get your credit score to 760 and you will get the best interest rate on the loan. Get rid of all of your debt before buying a home (it’s worth it, believe me). Become a consistent saver (if you don’t save prior to buying a home, you won’t save after in many cases). Have a solid relationship with your significant other (this process is stressful, it will magnify problems in a relationship). Put 20% down and avoid gimmicks that help you get in the home with little or nothing down. Keep the payment (principal, interest, property taxes, and insurance) under 30% of your gross monthly income. Get a 15 or 30 year fixed rate loan (this avoids interest rate risk that comes with adjustable loans that appear cheaper in the beginning, but can blow up down the road). Stay put. Only buy when you are ready to settle down for a long time ( at least 5 years and 10 years or more would be recommended).

Here are the don’ts

Don’t let the bank or credit union tell you how much you can afford. You figure that out and that means taking out only the amount of debt that you are comfortable borrowing (for example, you may only be comfortable with a house payment equaling 20% of your gross income or taking out a loan of $150,000 even though the bank says you are qualified to borrow $250,000). You make the decision, not them! Don’t look at your house as an investment. It is a poor investment at best and a nightmare at worse (keep reading to better understand this point).

A personal home is a mediocre investment before costs, but a poor investment after costs

Your home will probably make you around 3% to 4% per year based on location (inflation generally explains this increase in return). That is before costs. When we factor in costs (property taxes, insurance, interest on the loan, maintenance, and the many 1 time costs when you buy and sell (origination fees at the beginning and commissions to the agent who sells your home on the end for example). It could reach 10% or more per year. You will lose money on a home after costs in the vast majority of cases.

“A home is not a good financial investment and never was. But a home can certainly be a fine investment in your families happiness….” – Charles Ellis, Winning the Loser’s Game

Renting can be the right choice for many people at different stages of their lives

Renting is not throwing money down a gutter and don’t listen to people who say such a thing. Renting provides you the flexibility to move, to quit a job, and certainly to stay out of debt as you avoid the mortgage. Not convinced yet? Let’s see what Salmon Khan (if you are not familiar with Khan Academy, I recommend you do so) can teach us about this very important topic:

Do not squeeze into a home by putting all of your cash into the down payment, leaving you with nothing when you move in

Home ownership is expensive, but you will generally only understand this after you move in. There will be immediate costs that come with moving in (outside of basic maintenance and emergencies) and if you move in with no cash, you will end up using that credit card to deal with these matters. That is a big mistake and should be avoided at all cost.

Consider using a Roth IRA to buy a home and have money set aside when you move in

If you have a retirement plan at work (401k) you could use your Roth IRA (a couple will make this much easier than a single person) to save for the down payment. After a few years let’s say you have both contributed $10,000 ($20,000 total). You end up with earnings on both accounts at $5,000 ($10,000 total). That equals $30,000. You could take that money out and make a 20% down payment on a $150,000 home and pay no penalties or taxes on your contributions and your earnings (up to $10,000 per person with the earnings meeting the 5 year qualified rule). Then, when you move in, you will still have your emergency account to access for the inevitable expenses that follow.

Do not let anyone rush you into buying a home until you are ready

Is this starting to get repetitive? Good. You will receive message after message from all kinds of people (sometimes those people are well-meaning relatives) telling you to buy a home and not waste your money on rent. Don’t allow them to push you into something that you are not prepared for. Work your own plan and take your time prior to buying a home. Renting may be the right solution for many people based on their own unique individual situation.

To buy or not to buy, that is the question

Buying a home can be a wonderful experience or it could be a nightmare. The key lies with you and how you plan, prepare and execute the home buying experience. Spend plenty of time preparing as you save for that down payment. Do not let anyone rush you. Buy when you are ready and wait when you are not. This will be one of the biggest decisions of your life. Be patient and do it with as much financial education as you can.