Ready for Home Ownership?
I received letter from a young lad recently that asked a very good question. He wanted to know how he should prepare for home ownership. While I’ve written about what you have to do when it comes time to buy a home, there are also things you should do well in advance of hitting the pavement to go shopping.
1. Save a downpayment. When I tell people they should have a minimum of 20% of the purchase price for a downpayment on a home, they balk. TWENTY PERCENT! How are we ever going to come up with that kind of money? Well, sweat is one way. Cutting back on what you’re spending is another. Here’s the thing about NOT having 20%: You immediately make the home more expensive because you have to incorporate mortgage insurance fees into the equation. On a $210,000 house with only $10,000 down, the mortgage insurance would be 3.1% of the value of your home or $6,200. Added into your mortgage, that mortgage insurance premium would end up costing you $13,605 if you amortized for 25 years, or $19,330 if you amortized for 40 years.
2. Calculate your carrying costs. I can’t believe the number of people who leap into home ownership without a clue about the financial responsibility they’re undertaking. Home ownership is NOTHING like renting, so if you figure you can afford a home because the mortgage payment is almost like rent, you’re a dope. You’ll have utility costs. You’ll have taxes. You’ll have insurance. And then there’s maintenance… the cost everyone likes to ignore. Resist the urge to guestimate what these costs will be. Find out. Ask friends and family in the area what they pay for heating, electricity, water, oil, whatever your house consumes. Look at real estate listings to see what the taxes on comparable homes in the area are running at. Use the rule of thumb of between 3% and 5% of the value of the home for maintenance every year. If you can’t afford to carry the sucker, then you’ll know you’re not ready to buy.
3. Calculate your closing costs. Some experts say to estimate 1.5% of the value of your home for closing costs. Others say more. You need to know what to expect so you can make a budget that’s realistic. There are legal fees and expenses, a home inspection fee (don’t skimp), adjustment costs for things like pre-paid property taxes, an appraisal fee, land transfer tax, title insurance, an interest adjustment, a property survey (maybe), water quality inspection if you’re living in a rural area, and hook-up fees for setting up your new services like a phone line. And don’t forget GST.
4. What will you need or want to buy for your new home? From window coverings to appliances, from a new bed to new broadloom, there are always ways to spend money on a home. If you have grass, you’ll need a lawn-mower. If you buy a house with a pool, you’ll have calculate the on-going costs to open, maintain and close the pool each year. If you have a driveway, you’ll need a shovel or a snow blower, or you’ll have to hire strong backs to do the shoveling for you.
Once you’ve worked out what you’ll need to have ready in cash, you can get busy accumulating the money. Let’s say you decide you’re buying a $250,000 house.
- Your downpayment will be $50,000
- Your closing costs will be $3,750.
- Your new stuff budget will be $6,000.
In total you’ll need to save $59,750.
Alrighty then. Now to the cost to your cash flow:
- If you’re buying a $250,000 with 20% down, at 4% amortized over 25 years, your monthly mortgage payment will be $1052.05.
- Let’s say the property taxes run at $2400 a year, so that’s $200 a month.
- And you’ll have to pay house insurance, which we’ll estimate at $100 a month.
- Then there are the utilities, which we’ll estimate at $300 a month.
- And maintenance. Following the rule of thumb you’ll need to budget about $625 a month.
For a grand total of $2,277.05 a month… which is what it’ll cost you to actually live in your new home.
So now we come to the Gail’s Great Advice part. This is where you figure out if you’re ready for the responsibility of home ownership. If you can come up with $2,277.05 a month for your savings (less whatever you may be paying to keep a roof over your head right now), then you’re ready.
Hey, I’m not talking about if you can THEORETICALLY come up with the money. I’m talking about taking that money and socking it away every single month. So if you’re currently paying $1,000 a month to keep a roof over your head, you’d be committing to socking away $1,277.05 every month to your Home Buying Account.
Here why you’re going to do it this way:
First, you’ll learn to live on less disposable income. You better start practicing before you buy your home so you’re ready for the adjustment in your lifestyle when you do take the big steps. Loads of people buy a home and then keep on spending like they did before they became home-owners… racking up gobs of debt.
Second, the $1,277.05 a month is going to get you to your 20% downpayment in under four years. Yup. In just four years, not only will you have enough to put 20% down on your home, you’ll have your closing costs and your new stuff budget covered too. In the mean time, you could have friends and family gifting all the stuff you’ll need for your New Home Adventure for all the birthdays and Christmases in between.
So, whaddaya t’ink? Are YOU ready to take the dream of home ownership from the I-wish-we-could stage to the I’m-gonna stage?