Written by: Amanda L. Herrick Smith, CFP®
As we go into spring and the flowers begin to bloom and we have a bit more warmth and sunshine, the housing market begins to take hold in upstate New York. Being a homeowner was something that was very important to me at a young age. I grew up in apartments and my parents bought their first home when I was 14 years old. Having my own room and making our house a home made a strong impression on me. At the young age of 26 I was ready to begin the home buying process; however, it was very scary and daunting. Was I getting over my head? What wasn’t I thinking about? Could I really do this as a young women all on my own? The answer, absolutely! However, it took good planning, research, and understanding to be sure it was the right fit for me.
Don’t Buy too Much House
Many people dream of having a home where it is move in ready, checks every box on the list, and doesn’t need any major repairs. I knew that this wasn’t going to be an option for me because the houses in my price range were not going to check every box. A house that was move in ready was too expensive so I knew the home I bought was going to take some “elbow grease.” Spending too much on a house would limit my cash flow for anything else I wanted to do such as vacations, entertainment, buying a vehicle, or future house improvements. I didn’t want to be house poor, so crunching numbers and understanding my cash flow was an important first step to buying my first home.
Crunching the Cash Flow Numbers
The first thing I did was to put together a cash flow. I listed my net income and all of my expenses including any expenses for entertainment. Once I found a house that I thought I could afford, I replaced the rent in my budget with the estimated mortgage, escrow and PMI. I also included any additional new house expenses and made adjustments to my utilities. Oh, and don’t forget to include the trash! How did my cash flow feel? Was it tight? Did I have enough left over to do repairs or other home improvements? I concluded that my cash flow felt reasonably comfortable given the new financial responsibility of home ownership. I had some money left over every month for upcoming cash needs such as home upgrades and of course some entertainment.
About a year before I had done this same exercise and identified that the time was not quite right, so I was not comfortable moving forward with buying a home. I was thankful that I went through the cash flow process as it helped me to make an informed decision. It also helped to encourage me to save more money to provide me with the added flexibility when I was truly ready.
What is Escrow?
A new term I had to become familiar with during the home buying process was escrow. First time home buyers often make the mistake that they can afford more house than they really can because they inadvertently exclude the cost of homeowners insurance and real estate taxes. Incorporating these two expenses into the calculation is extremely important because it can vastly impact how much house you can afford.
When the bank pays for the homeowners insurance and real estate taxes on behalf of the mortgage holder they create an escrow account. This escrow account is similar to a separate bank account where the financial institution will deposit a portion of your monthly house payment into the account and then use the funds to pay for your homeowners insurance and real estate taxes. So your monthly home payment will comprise of two parts, (1) your mortgage and (2) escrow.
The Down Payment and PMI
Preparing to purchase my first home took a lot of work. I had to make sure the timing was right and I was in a strong financial position. I had a laser focus and discipline to pay off my student loans, which help to improve my monthly cash flow. I knew that my income was the only income to rely on so it was important that I was in the best financial position I could possibly be in to weather any new homeowner storms. The best way I could do this was to eliminate debt and save as much as I could toward my down payment, furnishings, and home improvements.
Because I wasn’t able to put a 20% down payment on the home I had to further understand PMI. PMI is Private Mortgage Insurance, which is different than homeowners insurance. It is a type of insurance that is required if less than a 20% down payment is made on the home purchase. PMI helps to provide protections to the bank in the event you cannot pay your mortgage and the house becomes underwater, which is when the mortgage is more than the value of the property. PMI comes at an added monthly cost. When I was looking into different mortgage options, I considered the cost of PMI as it can differ depending on the type of mortgage.
I had heard about mortgages available to first time buyers, where less of a down payment is needed, sometimes as low as 3% to 5%. Doing some quick searches online I put together the differences between each type of mortgage available to understand what the best fit was for me. There are also conventional mortgages which are a great fit for someone who can do the 20% or more down payment.
After my preliminary mortgage research, I scheduled to meet with a mortgage originator at my local bank to understand what types of loans their branch offered. I put together a comparison of the pros and cons of each including the down payment required, monthly PMI, estimated closing costs including the origination fee that the financial institution collects. Because I was looking at homes that needed some upgrades, I knew keeping as much cash on hand as possible was going to help me do repairs so I decided to go with a government mortgage. This type of mortgage allowed me to put a minimal 3% down and also allowed for a seller concession, which helped with covering some of my closing costs.
A seller concession is included in the proposed purchase offer and requests that the seller pays for some of the closings costs. The seller concession is a percentage of the purchase price generally up to 6%. If the purchase price of the home is $100,000 and the seller concession is 3%, the seller will pay $3,000 toward closing costs ($100,000 x 3%). A seller concession helps to reduce the amount of closing costs the buyer pays out of pocket. Since I wanted to keep as much cash as I could toward home improvements, a seller concession was a perfect tool for me to use!
I had done a lot of homework leading up to this point and I hadn’t even visited one house! Before I met with a realtor I knew there was one more thing I had to do, obtain a mortgage pre-approval. This document shows how much mortgage the bank is willing to lend. Keep in mind that this number can be very different than what you “really” can afford. It is important to have the mortgage pre-approval document in hand before you meet with a realtor so that they have verification that you can afford to purchase a home.
Before I began the house hunting process I was lucky to have identified the realtor I wanted to work with. I located the realtor through my personal contacts. She was patient, informative, and could help guide me through the new to me, home buying process. In our area the seller pays the commissions of their real estate agent and also the buyer’s agent. Great! I didn’t have to pay anything additional for my real estate agent’s services.
When I had the initial meeting with my real estate agent, we went over my price range and what type of home I was looking for. She took down this information and set me up to receive e-mails from the MLS system, which is known as the Multiple Listing Service. I received frequent e-mails when houses fit my criteria and I could view the listings. I also did some searching on my own through Zillow, Realtor, or other similar types of websites. My realtor also made some suggestions based on homes she had visited that she thought I might like.
Finally we found one! The home was a couple of blocks from my current apartment so I knew the area well. We scheduled an appointment to see the home and once inside we looked at the condition, to see if there were major improvements needed. The home was nice but did have some things that were of concern. At the same time, my realtor strongly suggested I look at another house that originally I was less interested in. Why not! Having a comparison is helpful to identify the pros and cons of each home.
When inside the second home, I knew it was the right one. It checked most of my boxes and had a solid structure, good roof, and furnace. The price was within my range and it needed a lot of cosmetic work, which was the work I was most interested in doing. Plus it was within a 15 minute walk, and 5 minute drive to work. Perfect! We moved forward quickly to put in an offer.
My realtor helped to draft the purchase offer taking into consideration my asking price and contingencies. A contingency is a restriction that the purchaser or seller places as part of the purchase offer. These restrictions must be met in order for the purchase/sale to go through. In my offer I placed a contingency for a structural inspection. This gave me the ability to walk away from the purchase in the event a major issue was identified. I also had a mortgage contingency, which made the offer subject to me being able to obtain a mortgage. In addition I included that the contract was contingent on my attorney’s approval. I decided to hire my own attorney to review the contract on my behalf. Often the sellers will place a contingency on closing on their next home so that they have someplace to move. Since the home I was putting an offer on was from an estate, there were no seller contingencies.
Soon after my offer was submitted the sellers accepted it! So now the home was under contract. As part of the contract, I made my deposit which the seller has rights to if I fail to comply with the contractual obligations. Because of the contingency for the structural inspection, I had to quickly find an inspector to visit the home as I had 10 days of presenting any major concerns to the seller.
The Home Inspection
I decided to come to the inspection and I was thrilled that I did! The inspector walked up on the roof, looked for pests, tested the heating system, ran water, started the washer and dryer, checked every single outlet, and looked for any potential issues he could find. I learned a lot about the property including where all of the shut off valves were for water and gas. The inspection took a couple of hours, which was longer than I had expected. Within a few days of the inspection he presented me with a 40+ page report detailing everything and included pictures. The inspector did locate one major issue, the main electrical breaker box.
Because the inspector located an issue with the electrical system, I hired an electrician to assess the issue and provide me with a quote of how much it would cost to repair it. I shared the quote with my agent who then drafted an addendum to our contract requesting that the full amount of the funds be provided at closing so that I could choose my own electrician to do the work. This started the negotiation process.
Within a day or two the seller responded indicating that they would cover half of the cost of the electrical panel repair because they felt as though the current home price was already at a great value. We agreed and proceeded with the arrangement.
As a result of obtaining a government backed mortgage it took some time before I received the mortgage approval. In fact, this was the last piece of the puzzle that we were waiting on to proceed with closing. Once I received the mortgage certification a closing date was scheduled. I was almost on my way to receiving my first set of house keys! However there was one final step, the paperwork.
And let me tell you, there is some serious paperwork to sign when buying a home in upstate New York! With a certified check in hand for the remaining closing costs, I visited the attorney’s office on the scheduled closing day. The meeting included my attorney and the seller’s attorney. The seller had already signed all of their documents in advance of the meeting. After my arm practically fell off from signing all of the paperwork, the attorney handed me the set of keys. Wow, the day was finally here and I did it! I was officially a homeowner! Then the real fun began, moving in!
The process of buying a home was a whirl wind of emotions and was overall quite exhausting. There is a lot of preparation, research, time, and patience. Yes, there is a lot of patience. Once my offer was accepted it took over three months before I was able to close. Things take time and a great deal of effort and follow up.
Whether you are buying your first home, second, or even a rental property it is ideal to work with people who will guide you along the way and point out things for you to look out for. As a Certified Financial PlannerTM professional I do just that when I work with my client families. If you have any questions regarding the house buying process I welcome you to reach out!