3 Steps Renters Should Take to Prepare for Buying a Home
The debate between renting and buying is not a black and white debate. Different circumstances and vastly different housing markets can directly affect whether home purchases are a logical choice for your needs. And while homeownership may seem like a distant possibility for some tenants, according to the National Association of Realtors, the average first-time homeowner buys his home before 32.
If you're currently renting, but plan to buy a home at some point in the future – be it near or far – make sure you're preparing for your future purchase.
1. Know the complete cost of homeownership.
As a renter, your monthly cost for housing includes a single rental fee. But as a landlord, the monthly bill for housing covers four primary factors: principal, interest, taxes and insurance (P.I.T.I.). Understanding these expenses will help you decide how much you can afford to buy a home.
Together, the monthly mortgage payment includes principal and interest, with the principal paying down your loan balance every month, and the interest paying your cash borrowing fee. To calculate how much of your payment goes toward principal versus interest per month, use a mortgage calculator.
Taxes apply to taxes on land that are levied by the county in which you reside. Per year, they average 1.2 percent of the value of your house.
Insurance, paid to the insurance provider of your choosing by a homeowner, is required if you have a mortgage. Lenders require that if it is destroyed by fire or other catastrophe, the insurance will cover the cost of restoring the house. Your insurer calculates this "replacement cost," and your lender must consent to it. For a single family home, insurance would usually cost $700 to $1,200 per year.
There's a fifth monthly expense group for condo owners: homeowners association (HOA) dues. These payments include community area amenities, landscaping, ongoing repairs, and reserves such as roof repair or exterior painting for potential maintenance. These monthly dues vary from $100 for less luxurious condos to $1,000 for luxury condos or more.
Buyers of single family homes may take a useful cue from HOA budgets, which typically demand that reserves be charged for at least 10 percent of dues. It's a smart idea to set up a similar savings plan for potential repairs, such as repairing a roof or major appliances, even though you're not buying a condo.
2. Research mortgages and how they work.
One of the most complicated and confounding aspects of homeownership is applying for and getting financing. You will work on being a better borrower if you understand how mortgages work now. This means keeping your debt burdens to a minimum, such as student loans and credit cards, so that when the time is right, banks can be more comfortable lending you greater sums.
You can still get a mortgage with as little as 3 percent down if you do not have 20 percent to put down. If your down payment, though, is less than 20 percent, you would have to pay for mortgage insurance, which is around .85 percent of your loan value, which is not tax deductible.
On a $300,000 home with 3 percent down and a 30-year fixed mortgage at 4 percent, the average P.I.T.I. (which includes mortgage insurance) is around $1,995. This gross housing expense decreases to roughly $1,614 after tax deductions. And for the down payment, you'd just need $9,000.
For a shorter-term loan like a 5-year ARM, you can still lower the rate and P.I.T.I., but rates on these loans will change in 5 years, so if you intend to live in the home longer than that, you risk making a much higher payment.
3. Begin preparing your credit score now.
You can, as a renter, make a habit of paying your rent as soon as you can. You can also focus on your credit score when you're planning and saving for a down payment. Lenders, for the best cost, want to see it above 650. Take out your report and find any places, such as previously unpaid bills, that can be changed.
For having the best mortgages with the lowest rates, credit scores are important. As well as credit depth, lenders want accurate on-time payment history.
More credit accounts are better, so renters can consider getting more credit with just one credit card. Just remember that when you first open a new account, your credit score will drop 5 to 15 points, then come back up when you have built a strong payment history.