When you’re ready to settle down and buy a home, be prepared for the various costs and decisions that will arise in the process. Here are a few tips to know on the road to becoming a homeowner.
Know what you can afford
Despite all the enticing homes for sale in town, be practical about what you can afford. A good rule of thumb often used by lenders is to figure you can pay 28% or less of your pretax monthly income on housing, including a mortgage loan, taxes and insurance. This will help you limit what you owe on your home; the average American’s mortgage is about $155,000.
Decide on the type of mortgage
There are two main types of home loans: fixed-rate and adjustable-rate mortgages, or ARMs. The first may be a better choice if you plan to stay in the home for decades, since the rate and loan payments don’t change over time. But if you anticipate moving within a decade, the typically lower starting rate of an ARM may make it a better choice. Generally, ARMs come with a period of years at a fixed rate, then convert to a form where the rate can change periodically, depending on a market gauge.
Choose your down payment
The percentage of the home’s price that you pay in cash, called the down payment, can be the biggest upfront cost of buying. Although many lenders may give you a mortgage without a large down payment, putting up 20% or more typically means you won’t pay private mortgage insurance, or PMI, which can add hundreds of dollars to your monthly bill.
One way to reduce the interest rate you pay is by buying points. Generally, one point equals 1% of the loan and provides a fraction of a percentage point reduction in the rate. So on a $200,000 mortgage, one point would cost $2,000. Paying points can be a strategy for saving money on a long-term loan. But this upfront cost may be more than your eventual savings, if you sell or refinance the home after only a few years. Lenders like United Financial Credit Union have calculators that let you compare monthly payments for different terms and rates.
Factor in other costs
Obtaining a mortgage generally requires paying costs that can total from 3% to 6% of the property’s purchase price. Some fees pay for an appraisal, an inspection, underwriting costs, a title search and deed transfer. Often there are also legal and other transaction costs.
Knowing in advance what costs and decisions you need to make when buying a home can smooth the process. These tips should help do that and get you off to the right start.
Spencer Tierney, NerdWallet