Editor's note: This article is adapted from Kiplinger's 2008 Success With Your Money guide. Order your copy today.
Today's housing market may be bad news for borrowers saddled with mortgages they can't afford and developers stuck with houses or condos they can't sell. But it can be a golden opportunity for first-time home buyers.
Home prices in the 20 largest metropolitan areas have fallen 17% over the past two years. Meanwhile, the average interest rate on a 30-year fixed-rate mortgage was recently 6.5%, which is low by historical standards.
And, says Elizabeth Blakeslee, regional vice-president for the National Association of Realtors, "there is excellent inventory all over the country." During the peak of the housing boom, first-time buyers were fretting that they'd never be able to afford a home. Now, it seems, they can take their pick. But just because it's a buyer's market doesn't mean you should dive in. Before you rush to put in a bid on the house down the street, answer the following five questions.
Can You Stay Put?
Aside from the price itself, purchasing a home is an expensive process. As the buyer, you'll have to pay closing costs for expenses such as a title search, title insurance, attorney's fees and much more. In fact, those expenses typically total 3% to 5% of the purchase price.
In the past, the rule of thumb was that you should plan to own the house at least three years in order to recoup your closing costs through price appreciation. But given the uncertainty of today's market, you're better off with a five- to seven-year time horizon. Consider any imminent life changes -- such as switching careers, going back to school or getting married -- that could throw a wrench into your plan.
Are Your Financial Ducks in a Row?
When applying for a mortgage, three factors are critical: your income, your down payment and your credit score. In the heady days of subprime loans and relaxed lending standards, "you could get away with having two out of those three," says Jan Valecka, a financial planner in Lewisville, Tex. "But now you need all three."
Needless to say, stable employment is a must if you're thinking about buying a home. Lenders will also look at your other debts, such as student loans, when determining how large a mortgage you can take on.
As for the down payment, Blakeslee says 10% is the minimum and 20% is even better. That will save you the $50 to $100 per month you would otherwise pay for private mortgage insurance on a loan for more than 80% of your home's purchase price. You may be able to tap your IRA or Roth IRA to beef up your down payment.
Applying for a loan insured by the Federal Housing Administration (FHA) is one option that allows you to make a down payment of as little as 3%. There are limits on the size of a mortgage the FHA will insure, and you'll pay a slightly higher interest rate in return for the insurance. For help finding an FHA-approved lender, go to www.hud.gov.
Order your credit report at least six months before applying for loan preapproval, and fix any errors you find. It costs $48 at www.myFICO.com to get your report and credit score from each of the three credit bureaus. FICO can simulate how certain actions, such as paying all of your bills on time for a year, would affect your score. To qualify for the best interest rates on a mortgage loan, you'll need a credit score of at least 760; a score below 620 places you in subprime territory. The FICO Web site also lists current average mortgage rates for different credit-score ranges.
How Much Can You Afford?
If you're serious about buying, spend some time tinkering with Kiplinger's housing calculators that cover everything from home prices in your area to closing costs, homeowners insurance and more. But rather than stretch your finances to the max, think about what you can comfortably fit into your budget.
Rich Bergen, a financial planner in Garden City, N.Y., recommends that you compare your current monthly rent with the monthly net cost of ownership. Don't forget to factor in maintenance costs, utilities, homeowners insurance and property taxes, plus savings from your mortgage-interest tax deduction. And you'll still need to sock away money for an emergency fund, retirement and college for the kids.
Zach and Sarah Kirk, a recently married couple in Austin, Tex., who are in the market for their first home, decided that even though they qualify for a $350,000 loan, they're going to buy a home in the $200,000 range. Zach may attend graduate school, and Sarah will likely take time out of the workforce when the couple have children. "We could buy a house at the top of our budget range," says Zach, "but if there were any sudden changes and we lost one income, we'd have to reevaluate the whole situation."
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Are You Ready For the Responsibility?
Your home will likely be the biggest investment you ever make, so you need to be mentally and financially prepared to take it on. If the hot-water heater leaks, you can't ask the landlord to fix it. And someone's going to have to mow the lawn and clean the gutters, whether you do it yourself or hire help. "There are some people who just don't want to have to think about 'What if the toilet breaks down in the middle of the night?'" says Avani Ramnani, a financial planner in Jersey City, N.J.
Still, "there's nothing like walking into your own home for the first time after settlement," says Blakeslee. "You can paint the walls plaid if you want to, and you don't have to worry about the landlord coming down on you."
Do You Know What You're Looking For?
Gorgeous, spacious and sunny? Sure, but think practical, too. If you drive to work, look for the most convenient route. If staying downtown is a priority, you may have to scale down your vision to a condo. "If you start out looking for the perfect home, you're not going to find it," says Elizabeth Blakeslee, of the National Association of Realtors. "You need to think about what's important to you."
Terri Carguillo was pregnant when she and husband Tom started looking at homes in North Babylon, N.Y., so a good school district and a safe environment were top priorities. "We did a lot of research," says Terri.
Educate yourself about the local market. Even within the same city, markets may differ depending on the neighborhood or the type of housing, says Elaine Scoggins, a financial planner in Seattle.
Go to www.zillow.com to research prices in areas that interest you so you can drive a hard bargain. "Prices are crazy right now, so you need to do some serious digging," says Scoggins.
Elizabeth Leary (née Ody) first joined Kiplinger in 2006 as a reporter, and has held various positions on staff and as a contributor in the years since. Her writing has also appeared in Barron's, BloombergBusinessweek, The Washington Post and other outlets.
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