For most people, buying a home is the biggest financial transaction of their life. Hence, it is important to think about certain things before going through the process. You want to be mentally and financially prepared for any costs you might incur.
Here are three issues to plan out for before buying your first home.
1. The cost of a real estate transaction
In general, the main focus for a homebuyer using a mortgage is the seller price, but there are other costs to consider as well.
Using a broker during the process can offer great value as they can provide the buyer with more details about other expected fees. The specific costs to consider depend on each individual transaction. However, some of them include an appraisal fee, a home inspection, title fees, property taxes (prepaid), and an attorney’s fee.
The Federal Reserve Board estimates that the average amount of these costs could be between 3% and 6% of the mortgage amount. From a financial planning perspective, a buyer should prepare accordingly and have cash on hand to cover these additional fees that are due upon completion.
2. The running costs of owning a home
Home ownership is a great achievement and can be a solid foundation for wealth creation. However, a buyer should also understand the ongoing costs associated with owning a home.
- Property taxes: Tax liabilities vary from state to state, and within a state the amounts can vary from city to city. For example, my company is in New Jersey, which has the highest property tax in the United States.
- maintenance: Regardless of where a house is or how big it is, maintenance is required. Some of these costs include lawn maintenance, landscaping, garbage collection, and minor repairs.
- Improvements: Over the years it is inevitable that things will stop working properly in a house and / or will collapse completely. These items are less common than minor repairs, but are generally more expensive. Examples could be roof repairs, upgraded kitchens, replacing the stove, remodeling a bathroom, or changing floors.
- Utilities: The amounts vary depending on the heating or cooling season. However, homeowners need to consider these costs. In addition, there are fees for water consumption. In general, the monthly utility bills are higher for larger homes.
- Homeowner insurance: Award amounts vary depending on many factors, including state location, home size, and the specific coverage selected.
There are different factors involved in all of these ongoing charges, but a total (yearly) amount can potentially be anywhere from 4% to 5% of the value of a property.
Take an example of a house in New Jersey: For a $ 400,000 home, this cost could run to about $ 16,000 to $ 20,000 per year. Before buying a home, buyers should factor these expenses into their cash flow / budgeting projections to ensure their income (and potential use of cash reserves) is sufficient.
3. How buying a home affects your ability to save
As mentioned in the sections above, there are definitely home ownership costs that can decrease a person’s saving ability. Hence, it is very important that a person does not lose sight of their longer term financial goals like retiring at a certain age. Before buying a home, buyers should evaluate their projected expenses to get an idea of whether they can still make consistent contributions to investment vehicles.
Yes, homeowners will increase the equity of their home over time (via mortgage repayment and property appreciation), but continuing to save on other accounts is extremely important and a very prudent decision. If a buyer realizes that a monthly mortgage payment and ongoing homeowner expenses are preventing them from saving elsewhere, the person should consider reducing their price range on a home.
Take the following example:
Brian and Jennifer married four years ago and recently had their first child. They are currently renting an apartment but want to buy a house to have more space for the family. They have consistently saved significant amounts in their retirement accounts throughout their marriage.
Brian and Jennifer start looking at several homes, but find that the price range they are targeting will dramatically reduce their savings ability. After checking the cash flow numbers with their financial planner, they choose a home that is not that expensive, which still gives them the flexibility to add good amounts of retirement assets on a regular basis.
People love to find their “dream home” but it is wise to ensure that purchasing that “dream home” still offers the financial flexibility necessary to meet their financial goals.
Martin A. Scott, CFP, is the founder and financial planner of Lasting Wealth Principles, a paid comprehensive financial planning firm that helps married couples and professionals in their thirties and forties achieve their financial goals and dreams.
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