Buying Your First Home: Are You CRAZY? (Part I – Beginning the Process)
Although this may be a bit outside the scope of what I usually write about, I thought it would be interesting to document my experience as first-time home buyer in Chicago. It’s been a crazy experience so far.
My fiance and I recently purchased a condo in Wicker Park (a neighborhood in Chicago), and although we haven’t closed yet (that’ll be next month), I have plenty to write about. Buying a home is usually the biggest purchase most people make in their lives, and doing it for the first time can be exciting, scary, and frustrating all at the same time.
This isn’t meant to be a tutorial in buying your first home, but I think there are definitely some valuable lessons to take away from the experience I’ve had so far.
Because I could probably write volumes on this topic, I’m going to break it up into at least 2 or 3 parts. This is part 1: beginning the process.
First Things First: Figure Out What You Want
Buying a home shouldn’t be taken lightly, because, let’s face it – you’re probably going to be shelling out most of your life savings, especially if it’s your first time buying a home.
It goes without saying that you should probably figure out what you want first. And it gets more complicated when you’re buying with someone else (in my case, my soon-to-be wife), because you need to balance what you both want. Fortunately for me, we both essentially want the same thing.
Most of it ends up being cosmetic and “luxury” vs. actual necessity, but I’m of the mindset that if you’re going to spend a LOT of money, and it’s for your home where you’ll be spending most of your time, why not get the things you want (vs. simply focusing on the things you actually need)? I’m definitely not a minimalist, and while I also wouldn’t consider myself overly materialistic, I still want things to look nice.
Here’s a sample of some of the things we were looking for:
- 3 Bedrooms (or 2 bedrooms + a space that can be used as an office)
- 2+ Bathrooms
- Duplex unit (two floors) or a penthouse unit (i.e. top floor unit)
- Hardwood flooring
- “Updated” kitchen and bathrooms (i.e. granite counter tops, stainless steel appliances, etc.)
- Outdoor space (deck/patio)
Location was also a big deal for us too. I won’t bore you with those details, as I’m sure many of you aren’t familiar with the streets of Chicago.
Decide on Your Budget, and Get Pre-Approved
Your budget isn’t necessarily going to be the maximum you can afford, nor should it be. Everyone’s financial situation is different, but in my opinion, owning a home shouldn’t be the reason your finances are stressed.
How do you keep from being financially stressed? Make sure your budget is reasonable.
I think a reasonable budget for a home is one that allows you to make a 20% down payment. That’s not to say you must put down 20% (the bank will have the final say on that one), but it’ll reduce your monthly payments due to the fact that you are borrowing less and you won’t have to pay PMI (i.e. mortgage insurance that is typically required when your loan is greater than 80% of the property’s value).
In our situation, we set our budget at $450,000-500,000.
Wait – Where’s The Money Coming From?
While you determine your budget, there’s another important consideration: the source of the money you plan to use. In particular, the source of funds you will use for the down payment and closing costs.
For the sake of argument, I’m going to assume that your monthly mortgage payment will come from your current earnings. It’s a pretty safe assumption, because most lenders aren’t going to approve your mortgage if you can’t prove that your salary/business income is sufficient for the mortgage.
Back to the down payment and closing costs. If you are putting down 20%, this is a substantial chunk of change.
For us, 20% is $95,000, and the lender estimates that closing costs will be approximately $11,000 (around 2.5% of the purchase price – this will vary). That’s $106,000 we have to come up with before the home is even in our possession.
Time to panic. OK, breathe in…and exhale. We planned for this. It’s going to be okay…
Okay, so you need to figure out where that money’s going to come from. Some people have generous parents who will help or are lucky enough to have a trust fund they can draw from, but for the vast majority of us (myself included), this money is coming from savings.
Simple enough, right? Wrong.
Simply having enough money in savings isn’t enough to move forward with your budget – at least, not if you’re planning appropriately.
What other major expenses are on the horizon for you? In the case of my fiance and I, we have a wedding to pay for in November. So, if buying a house completely wipes out our savings, we aren’t going to be able to afford a wedding.
Even if you don’t have any major expenses planned, you still need to plan for the unexpected (i.e. you still need to keep an emergency fund). Some people say a good emergency fund is six months of living expenses, but it’s going to depend on what you feel comfortable with.
What about using retirement funds?
This is a little bit of a gray area. Most financial planners will almost always tell you that you shouldn’t touch your retirement fund(s). If it’s necessary to pull money out of your retirement fund to buy a house, it means the house is out of your budget.
I tend to agree with this advice, but I don’t think it’s always that black and white. Where I do think it’s black and white is when you’re considering pulling money out of a 401(k) or traditional IRA account and would be faced with paying both tax AND a 10% early withdrawal penalty. Don’t do this to yourself. You are literally throwing money away in this situation.
Now, if we’re talking about a Roth IRA, the decision gets a little trickier. Currently, the IRS allows you to withdraw up to $10,000 from a Roth IRA account to use to purchase your first home, and it’s tax and penalty free. The only real downside is that this money won’t be available when you retire (and you’re also giving up the tax-free growth that money would see between now and when you retire).
There are some restrictions to using your Roth IRA for this purpose, so be sure to educate yourself on them before making any moves. Bottom line is, you need to determine if it’s worth reducing your funds left over for retirement. If I were to do this, I might increase my regular 401(k) contribution at work (or however you contribute to a retirement fund) to try and eventually offset what I’m withdrawing.
Before Getting Pre-Approved – Know What You’re Up Against
When a potential lender goes to pre-approve you, they are going to dig up a lot of dirt on you (if there’s any there). It’s to your benefit to know what’s out there first. One thing you can (and should) do is run your credit report. This will allow you to essentially see what the lender will see when they determine if you are credit worthy.
If there’s anything on the report that you can clear up, it’s best to do so before applying for a mortgage; but even if you can’t clean it up, it’s a good idea to come equipped with a good explanation (if you have one).
Here’s one place you can get your credit report for free (though it won’t contain your actual credit score):
Pre-Approval is More Important Than I Originally Thought
When it came to being pre-approved, my experience was that the bank was willing to approve an amount that was much higher than I would ever be comfortable spending. So, my banker basically asked me, “What amount do you want your pre-approval letter to show?” I said $550,000, just to give us a little bit of wiggle room in the event that we decided to stretch our budget.
Make sure you get pre-approved. I initially thought it was merely a “good idea” but didn’t realize how important it was until we actually got ready to make offers on homes. It’s a good weapon to have in your arsenal, especially in a competitive market – it tells the seller you are a serious buyer.
Also, it gives you a head start when you actually have an offer accepted and begin going through the mortgage application process. Approval is the last thing you want to worry about when you’re dealing with everything else (although pre-approval is not a guarantee).
Woohoo, Time to Start the Actual Search!
This is the fun part. You’ve figured out what you want, and now you get to actually see what’s out there.
There are a few ways to go about doing this – almost everyone today begins their search on the internet (which is what we did too). From there, you can reach out to a real estate agent to see the properties you like.
Or, if you prefer, you can use your real estate agent to actually help you find properties to see. Basically, you tell him or her exactly what you’re looking for, and they will notify you (and show you) properties that match your criteria.
I’ll admit: I’m a bit of a control freak.
So when it came to searching for a home to buy, we wanted to drive the process. There are a lot of websites out there that allow you to look at homes for sale (Trulia, Zillow, and many more), but we settled on Redfin.
There’s a lot I like about Redfin (the interface is nice, they provide all the necessary detail for each property, etc.), but the thing I really liked is that Redfin is an actual real estate agency. Not only can you browse for properties on their website, but it seamlessly integrates with their real estate agents who can show you the homes you want to see.
While you will have one primary agent as a contact (this is usually someone more experienced) who will handle any actual transactions, they have a bunch of other agents who all work together as a team, so that you can almost always see a home at a time that fits your schedule.
It was super convenient for us.
Another really cool thing: they share their commission with you. For example, with the condo we purchased (more on this in the next blog post), we’re going to be getting back about $3,650. Most buyer agents won’t do this for you.
Coming Up Next…
This seems like a pretty good place to stop the first installment of the series. In the next post, I’ll go into our actual home search experience and discuss the place we finally decided to make an offer on. That’s when things really get interesting.
Spoiler alert: We didn’t get the first (or second) home we put an offer on.
What was your experience like starting out the home buying process, especially as a first time home buyer? I’d be really interested in hearing about it in the comments!
(And if you found this at all interesting, please do share it on Twitter/Facebook/etc. and let me know what you thought!)