First-time Homebuyer Guide
Updated: Oct 5, 2022
A home is the largest store of wealth for the majority of American families. It is a great way to build and store wealth for your family. However, it is well known that purchasing a home is much more difficult today than it was for previous generations. I hope that this guide will help new homebuyers today enter the housing market with confidence, knowing they will find a place that is not only a sound financial investment but also a fitting home.
Should you rent or buy?
The first question you should be asking yourself is actually if you should be buying a home in the first place. Although you would almost always save money purchasing a home in the long-term, you can actually lose money compared to renting if you sell the house within a few years. Your combined monthly payment when owning a home (mortgage principal, mortgage interest, HOA, insurance, taxes, and utilities) is usually significantly less than your monthly payment when renting a similar home. However, there are closing costs when buying and when selling a property (3% to 5%, sometimes less, sometimes more).
You would break even on owning rather than just renting at around 3 to 5 years of owning. If you are uncertain about your future or if you expect you may need or want to move for work or other reasons in the coming years, renting may be a better option for you. One exception to this would be if you would be willing to hold onto your property and rent it out when you move.
Do you see yourself ever being a landlord?
If you move and choose not to sell the place, you have the option to hire a property manager. A typical price for a property manager is around 10% of gross rent. Also, know that a hired property manager will never manage your property with as much care as you would. They manage dozens or even hundreds of properties at once. Their job is to get the vacancy filled (so they may be more lenient on applicants than you would be), repair problems (which may cost you more), and maintain a relationship with the tenant (you would have less rapport with your tenant). That last one may be seen as a benefit, especially if you need to enforce contract terms with your tenant; you would already have an arms-length, business relationship with them. It is harder to say no to late payments when you are friends with your tenant.
On the other hand, if you don’t plan on moving far, you can manage the properties yourself. If you hope to build a multi-property real estate portfolio, consider “house hopping”. House hopping is where you purchase a new property, move into it as your primary residence, and rent out your previous home. There are numerous benefits to house hopping:
Mortgage issuers charge higher interest rates on mortgages for rental properties, so you would be able to lock in the lower personal property mortgage rates.
You will gain a deep understanding of your rental property. There won’t be any mysteries about your investment. You lived there and know the finicky nature of the A/C unit and that the washing machine could break down any day now. Plus, you know if you were happy living there, your tenant will be too.
You get to upscale your home and real estate portfolio over time. By saving diligently, you can first buy a condo, then a townhouse, then a single-family house, then a mansion – eventually owning them all! As your income grows and your family needs require a bigger home, you will be able to afford it. Plus, your real estate portfolio will be well diversified; condos are usually easier to rent out, but higher-end property values tend to appreciate more.
Additional resource: I have used this website in the past for my tenant contracts and found it useful.
House buying is a multi-year process, not a 1-month process.
When I talk to clients who are beginning to think about buying their first home, they often say they would want to buy a home in “3-4 years.” And I have found that in their head that means “I’ll start dealing with that whole process in 3-4 years,” but also expect to buy a home at that time. NO. That is one of the biggest mistakes you can make. In most cases, you have to save for years to be able to afford the down payment (but don’t forget the closing costs, any improvement/repairs, and furnishing the place). If you start dealing with it in 3 years, your homebuying timeline just went from 3-4 years to 6-7 years.
Realize that saving for a home often does take YEARS. Even if you don’t plan on buying a home any time soon, saving for a home should still be part of your budget. Put a little aside each month in a separate, designated home-buying savings account. Your future self will thank you.
Calculate how long it will take to save for your ideal home with this formula:
Home price x 15% / Monthly savings = Number of months to save for down payment
Substitute the 15% with your target savings amount (between 10% and 30%). Even though you are sometimes allowed to put as little as 3%-5% as a down payment, remember to also include your closing costs (another 3%-7%), repairs, and furnishings in your target savings amount.
Beyond just saving for the initial cost of the home, the two other aspects of home buying that can take years are (1) building your credit score, and (2) finding the perfect property.
If you already have a solid credit score (700+) and don’t carry high-balance or high-interest debt, like credit cards, keep up the good work! You won’t have to worry too much about being able to be approved for a mortgage. However, if you don’t have any credit history, and therefore don’t have a credit score, you will not be able to be approved for a mortgage when the time comes.
Responsibly using credit cards is a great way to begin to build or strengthen credit. Check out my previous blog post on credit cards.
Finding the right home.
Finding the right house is difficult. Although you can change your mind in the future and sell the place, buying a property should be seen as a lifelong commitment. The traditional way to find a house is to talk to your real estate agent and have them show you what houses are currently available on the market. However, I believe this is the wrong way to find your perfect home. First of all, the best deals are not the ones currently sitting available on the market. The best ones get posted and have offers within the week by real estate investors and prepared families. I want you to be one of the prepared, vigilant homebuyers.
To be one of those buyers, you first need to know if a listing is a good deal or not. Is $100/sqft good? Or $150/sqft? Maybe $200/sqft? It all depends on the area, and the building type, and the amenities, and the market. The only way to know what is a good deal is with experience. But as a first-time homebuyer, you don’t have that experience yet.
To gain that experience takes time. In the coming years that you are saving for your home, you need to acclimate yourself to the market. You need time to decide what you like. Looking around at houses with your real estate agent for a month isn’t going to do that. Instead, I recommend setting up Zillow alerts.
Setting up Zillow alerts.
There are a number of sites like Zillow and Redfin that will provide you with similar functionality, however, I used Zillow’s phone app on my real estate journey and found it invaluable.
Through the Zillow app, you will be able to set up “Saved Searches” that will notify you when new homes enter the market that meet your set criteria. You can set it up to send you each morning a daily batch (usually 8 to 10) of new listings that meet your criteria that Zillow thinks you will like. Starting today, every morning I want you to take three minutes as you’re waking up to go through each listing, look at the pictures, and read each property’s pricing and details. Over time you’ll see patterns and understand how much a fireplace or vaulted ceilings add to the price of the property. Maybe you’ll see multiple 1,000 sqft, 2 bed, 2 bath condos going for $150,000, and now know that $200,000 for a similar property is expensive and $125,000 is a deal.
Now don’t be discouraged if on the first day you find the perfect place but can’t afford it yet. I promise you: more amazing homes will become available, and one day you will find an amazing deal on a perfect house and you will be able to afford it.
Step-by-step how to set up Zillow alerts:
Type in the county you are interested in in the main search bar (if you are interested in searching in multiple counties, you can repeat these steps to create additional saved searches.)
Hit “Filters”, choose “For Sale”, and add your filters, your price range being the most important. (I wouldn’t put a minimum price; the best deals may be under what you would expect you could get!)
Hit “Save Search” and then hit “Save”.
Hit “See Results” to return to the main screen.
You can now see all the current results that fit your filters on the “Updates” tab. Any new listings that come on the market that fit your parameters will also show up here with a notification bubble.
Hit the “ ⋮ More” tab and then hit your profile picture in the top right. Select “Notifications” and make sure you are opted in to receive notifications on your “Saved Searches” and “Recommended Homes”.
Review each new listing when it comes on the market. Learn what you like, what is a good deal, and what is a bad deal. After you have seen many listings, eventually you will see a deal that seems “too good to be true”. Go see that place in person the same day you see the listing (speed is key). You already know you like it; you already know it’s a good deal. What you are looking for are red flags that would explain why it is “too good to be true.” If you find any significant ones, walk away. Keep looking; you will find a better place. Eventually, you will find a perfect place with a price tag that is just too low... Buy that one!
Find the right professionals.
You should establish a relationship with a real estate agent and a mortgage lender (a bank or a mortgage broker) before you are ready to buy property. When you find that perfect home from your Zillow alerts, you want to be able to act fast. You don't want to have to first find a reputable agent and mortgage lender before you can visit the property. If you have a prior relationship with an agent, you'll be ready to see that listing day of or the next day. If you find a mortgage lender early, they can help you determine how large of a mortgage you could qualify for based on your income, which will help you determine your price range. (Remember, even though you can afford a more expensive place, doesn't mean you should be spending more. Start small!)
I personally used a great mortgage broker and agent in the past that made the process easy. Please reach out if you would like recommendations for good agents, mortgage lenders, or other professionals. I would be happy to help!
The common advice you will hear for what type of mortgage to get is simply "get a 30-year fixed mortgage." I agree; don't get an adjustable-rate mortgage (ARM), stick with a fixed-rate mortgage. You can always refinance a fixed-rate mortgage if rates fall significantly in the future. However, I believe the majority of people would be better served with a 15-year mortgage instead of a 30-year.
You see, mortgages follow what is called an amortization schedule. Simply put, at the beginning of the loan, your monthly payment goes mostly to the loan's interest, and the majority of the principal is paid off near the end of the loan. Interest is front-loaded and actually paying down the loan is back-loaded. One common mistake I have seen clients make is refinancing a 30-year mortgage every few years to try to get a lower monthly payment. Each refinance has closing costs (1%-2% of the loan) and resets the clock. They think that they are saving money, but what they are really doing is perpetually paying mostly interest on their mortgage, never really paying it down, and not earning equity in their home.
Especially with rising mortgage interest rates, you will be better served with a 15-year mortgage; they have lower interest rates than 30-year mortgages. Go with a 15-year, even if that means a higher monthly payment. (My blunt advice is if you can only afford the lower 30-year's monthly payment and not the higher 15-year's monthly payment, you can't afford the house in the first place.)
The exception to this rule is if you are a growth-at-all-cost real estate investor in a low mortgage rate environment with the intention to reinvest the excess cash flow from a lower monthly payment into another rental property and write off the interest expense on your taxes. Still, they are often better served by a 15-year mortgage; I recommend that they do the math before deciding.
Additional resource: I have used this website in the past to analyze the amortization schedules of my mortgages and calculate the effect additional payments have on the loan.
Get a condo.
I got a condo as my first real estate property and would highly recommend it. Condos are a great first-time homebuyer option. It acts as an easy first stepping stone into the real estate market. Here are a few of the benefits:
They are much less expensive than most single-family houses. In Maryland (an expensive state for real estate), you can consistently find nice condos for less than $200,000. Less expensive on your first home means you can become a homeowner sooner and stop losing money to rent.
You don't need to worry about the foundation or the roof (big expenses). The only times I have seen buying a home become a real nightmare is when the buyer discovers that their new house has many expensive hidden repair problems. Foundation and roofs can be extremely expensive to repair. When you buy a condo unit, you only own what is inside the studs. Your condominium association owns the rest. Now, you still pay for it all through your HOA or condo fee (which is higher than an HOA fee on a single-family house), but a lot is included in that monthly fee. Your condo association will have a master insurance policy on the building to cover repairs for the roof, foundation, and common areas; so your insurance is less expensive (you only need to insure from the studs in). Your condo fee also often includes trash removal, snow removal, landscaping, and some utilities like water or electricity.
They are very easy to rent out. Small condos are much more affordable for many renters than larger single-family houses. If you hope to build a large real estate portfolio or just keep one rental when you upgrade to a single-family house in the future, condos are a great first investment.
Rent out a spare room.
If you get a 2-bedroom condo as your first home, consider renting out your spare room. This is a mini way to start "house hacking". House hacking is when you generate income from your home. Traditionally, it involves purchasing a multi-unit property (like a duplex) and living in one of the units while renting out the others. This strategy can eliminate your housing costs and have some tax benefits. Renting out a spare room (or even putting it on Airbnb) is more intrusive than owning a duplex (someone is in your space instead of in a private unit), but can be just as profitable. Duplexes are hard to find and much more expensive; you can still massively reduce your housing expense with just a spare room.
Game Plan: How much do you need to save? Where should you save?
I recommend getting a condo for less than $200,000 as your first home purchase for a young single person or couple. Say you are targeting a $150,000 list price condo:
Using approximate market rates from September 2022, your all-in monthly payment would be around $1,400 per month. You would need a ~$56,000 salary to ensure your housing payments do not exceed 30% of your income (a good rule of thumb).
You need (hypothetically) 10% down, plus 5% in closing costs, plus 5% in repairs and furnishings. That would mean that you need to save 20% or $30,000:
Saving $500 per month would take 60 months (5.0 years)
Saving $750 per month would take 40 months (3.3 years)
Saving $1,000 per month would take 30 months (2.5 years)
Saving $1,250 per month would take 24 months (2.0 years)
Saving $1,500 per month would take 20 months (1.6 years)
Remember your finance order of operations! (Read more about what you should be prioritizing in this blog post.) Before saving for a home purchase, you should:
Have a 6-month emergency fund
Be investing up to your 401(k) employer match
Pay off your high-interest debt (interest rates above 5%)
Maximize your Roth IRA at $500 per month
I recommend saving for a home in a separate savings account. (You should have a Roth IRA for retirement, a savings account for your emergency fund, and a second savings account to save for your home purchase).
In most situations, maximizing your Roth IRA (at $6,000 per year) is more beneficial than saving for a house. Roth IRAs offer the most tax-advantaged vehicle for saving for retirement. Additionally, Roth IRAs offer the ability to withdraw all of your direct contributions at any time (because you already paid taxes on that money), plus up to $10,000 of Roth IRA earnings, free from both taxes and penalty, for a home purchase if you meet certain requirements.
You can use your Roth IRA as a backup pool of savings to help pay for your down payment. For example, if you find a great deal on the perfect condo but are short a few thousand for the down payment, you can withdraw what you need from your Roth IRA. However, a Roth IRA should not be seen as the primary source for your down payment. Don't "rob your retirement". 20, 30, or even 40 years of tax-free compound growth is extremely valuable. Maximize it each year; your future self will thank you.
So say you have $1,500 per month of free cash flow to save / invest. I would first put $500 per month into your Roth IRA and the remaining $1,000 per month into your down payment savings account. In two and a half years you will be able to afford your $150,000 condo.
And again, if you find the perfect condo in two years before you've finished saving, you can take a little of your Roth IRA savings to make up the difference. (But ideally, you have enough saved separately to purchase your first home while leaving your Roth IRA untouched.)
Remember: it’s a waiting game. Be picky. Find the perfect home and save up while you look for it. There will be “perfect” homes that you will miss out on before you have enough saved up to afford them. Another great home will come around, and by waiting, you’ll have more money saved! You won't have to pull any money from your Roth IRA and will be able to furnish your new home with nicer things. Stay positive; your patience will be rewarded.
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