How To Buy Your “Need-House,” Not Your Dream House

When I began my search for my second house, I started looking in the city where I had been renting. It had all the amenities I wanted and it was familiar to what I experienced as a first time home buyer.

My apartment had two bedrooms and one bathroom and cost a whopping $1,800 per month. I thought as long as my mortgage payment was less than that amount for at least the same amount of space, I would be golden.

I didn’t need a lot of space so I started looking at townhomes priced around $250,000. In my area, that amounted to a two-bedroom, two-bathroom townhome, not much bigger than my apartment.

I didn’t really have a good reason to pick $250,000 other than it was a common price for townhomes in that area. I fell into the trap of thinking a certain income meant I needed to buy a house starting at a minimum value.

Here’s a fun fact: your home does not have to portray your wealth. Warren Buffett has lived in the same house since 1958.

Using a mortgage calculator, my payments would be about $1,700. That was doable, right?

Oh, wait, that didn’t take into account the insane property taxes, that I may not qualify for the 4.25 percent interest rate the calculator was using or take into account closing costs. Also, the properties, while gorgeous, had an additional $300 to $500 in monthly homeowner association fees.

This was my reminder that there is so much more to homeownership than making the mortgage payment on time every month. My rent included parking, water, trash and maintenance. When my dryer stopped working, I put in a maintenance order for no additional charge. I wouldn’t have that luxury as a homeowner.

I’d have to add that to my estimated monthly expenses, plus electricity, internet, taxes, association fees, homeowner’s insurance, home warranty, at a minimum. I had two choices: increase my budget for my “dream house” or find a cheaper house. What would you do?

Reality Check For a First Time Home Buyer- How Much Can I Really Afford?

As much as I wanted to buy my dream house, I had to knock some sense into myself. First, I was not planning to live in the house for more than 5 years, if that. This would be a home, not a long-term investment. For the amount of money I would need for the down payment, closing costs, and other costs, it wouldn’t make sense to overspend on a house. All of those costs are based on the value of the home.

Second, I didn’t need to increase my monthly housing costs. The point of buying the home was to reduce my expenses and increase my income by getting a roommate.

It would only be economical if my mortgage payment and home expenses were low, to begin with. But that begs the question, could I afford to buy a house either way?

When I became a first time home buyer in 2009, I had no clue what I was doing. My only goal was to pay less than I was paying in rent. My rent at the time was $1,042 for a studio apartment and a parking space will all utilities included.

One of my neighbors in my apartment building owned a house that he rented out that covered the cost of his rent and the mortgage payment. I was intrigued and thought I could find a low payment with rental income. He made it seem so easy.

I wanted the least expensive house that met all my needs and wishlist items. I found an inexpensive foreclosure that was a fixer upper and required some compromises. It ended up being a great move since I rented out my basement and used the now-defunct first-time homebuyer tax credit for renovations. The difference between my two home-buying experiences was the amount of money I was making. I let my bills creep up with my income to my detriment.

Can You Afford To Buy The House You Want?

The short answer: it depends.

You might be able to say the house is affordable if the estimated payment is close to what you’re paying in rent.

This is a myth.

If you are currently spending $1,800 on monthly rent, then you would be wrong to assume you can afford an $1,800 mortgage. Your rent typically includes living quarters, amenities and maintenance.

Sometimes, if you’re lucky, your rent will also include utilities and/or cable. More than likely, you pay a flat fee each month with little to no variance. Having a house and a mortgage is not that simple, as there are several fees to take into account compared to renting.

Mortgage Payment

Your $1,800 mortgage payment might include the mortgage principal, interest and perhaps escrow for property taxes and homeowners insurance, unless you choose to pay your taxes and insurance separately. The principal is your repayment of the loan itself.

The interest is the interest earned on the loan, which will normally be higher than the principal repayment for the first 15 years. Your mortgage payment may change over time if your taxes change or if you have an adjustable rate mortgage. Your monthly payment may not be as set in stone as you would like it to be.

Property Taxes

You will usually pay taxes on your home and any assessed land or buildings on your property to your county. Local laws will dictate things like assessments and rates.

For example, states such as New York and California have extremely high property taxes. Florida is also known for having higher property taxes, but this is mainly due to a lack of income tax. If your property taxes are paid in escrow, and they increase, your mortgage payment will be adjusted accordingly.

This happened to me more than once. I was able to decrease my taxes on my first home by filling out a one-page form and sending it to the county tax office. This was not the case on my other properties.

Homeowners Association (HOA)

Some neighborhoods or communities have an HOA. This is a board that makes decisions about the maintenance and amenities in a building or community. Those that are a part of the HOA make regular payments (your HOA fee) and vote on decisions and board members.

The fee is in addition to your mortgage payment and is paid directly to the HOA. There are rules and regulations for every HOA, and they vary by Association. Even the most affordable homes could be out of your budget when you factor in the HOA fee.

My first two homes had monthly HOA fees under $200, while my last house was $200 for the entire year. I have heard of HOA fees being over $3,000 per month in South Florida. Always check if there is a fee and how often a payment is due.

Private Mortgage Insurance (PMI)

If you have a down payment of less than 20% of the home value, using a conventional loan, you will likely also have to pay for Private Mortgage Insurance, usually known as PMI or lenders’ mortgage insurance.

Until your loan value is equal to 80 percent of your home’s value, or less, you will overpay your mortgage, just in case you default on the loan one day. PMI is essentially money thrown out of the window because it is not applied to your mortgage balance and it does not protect you. Avoid paying it!

Planning Ahead for Closing

Closing on your home should be a momentous occasion and it is. Not only do you sign about a hundred sheets of paper, but you and the seller will also hand over large sums of money.

Closing Costs

You must also remember the taxes, fees, and other upfront costs. Average closing costs, not including down payment and realtor fees, total $7,227.

They range from two to five percent, with lower closing costs on bigger transactions. For the $250,000 home, let’s say the closing costs are 3.75%. That is an additional $9,375 out of pocket I would be required to pay before the moving truck has been scheduled. Excluding the down payment, I need to budget for $24,375 in costs and fees.

Sometimes these fees are included in the loan. This can ease your upfront, out of pocket burden; however, this can increase your monthly payment and the amount of interest paid over the life of the loan. You can use amortization calculators to estimate your long-term costs.

Down Payment

Down payments vary by loan type, property type and personal preference. The general rule of thumb is 20% down for a primary residence, as this will eliminate PMI. However, some loans, like the Federal Housing Administration (FHA) loan, require a minimum 3.5% down based on creditworthiness.

The VA loan, provided by the Department of Veterans Affairs, allows some veterans to qualify for 0% down payment financing. For investment properties, at least 15% is required. If you put 20% down on a $250,000 home, you will need $50,000. In some states, you can buy a whole house for $50,000.

Realtor Fees

Realtor fees are between five and six percent of the home value. For this example, let’s use six percent. For the $250,000 home, that’s $15,000 to your realtor. What if you want that $400,000 house with the lake view on the golf course even though you don’t play?

That’s $24,000 in realtor costs. Normally, the realtor fees are paid by the seller and won’t impact your purchase. However, even though it may not come out of your pocket now, it will when you sell the house in the future.

My estimated total closing costs and down payment for a home priced at $250,000 would be around $59,375. In some cases, like with my first house, the additional closing costs beyond the down payment can be included in the loan.

This made my payments a little higher every month and I ended up paying interest on the amount, which only benefited the bank. However, I didn’t have to bring a ton of money to closing. I had an FHA loan, so my down payment was 3.5% of the loan value.

For my second and third houses, I paid the costs upfront because I had more funds available after the sale of my first house. I also wanted to keep my payments lower and reduce the interest paid.

If you plan on refinancing your loan at some point, there are fees and closing costs then, too. When I refinanced my first home, I paid over $3,000 in closing costs in order to lower my monthly payment and remove PMI.

Since I was also renting out my basement, I recovered the closing costs in about four months. If your property isn’t providing cash flow, it might take much longer to see a return on your investment. Consider the long- and short-term opportunity costs when looking to refinance.

Dream Home or Nightmare Waiting to Happen?

It’s very easy to have house envy when watching HGTV or seeing photos of your favorite celebrities beachside villas on their private islands. My not-so-guilty pleasure is looking at houses online in various cities around the country and all the photos when celebrities put their homes on the market. The first thing I think of is how much work it is to clean and maintain those massive homes.

If you’re a multi-millionaire with staff and caretakers, then this might be the last thing you think about. For many of us, the time and effort that goes into maintaining a home are just as important as the cost. If you can’t maintain the home on your own, can you afford to hire someone to assist you?

Here are just some of the maintenance costs to consider when buying a home:

• Appliance maintenance and repair
• Home warranty
• Security system
• Furniture
• Utilities
• Home maintenance and upkeep
• Weatherproofing

More house means more of everything else. A friend of mine had a large, beautiful house built. It has at least three bedrooms, an upstairs lounge area and plenty of space to spread out.

He lives alone and has no furniture (yet). His prior one-bedroom apartment came furnished. He will spend thousands of dollars to fill the vast square footage on top of spending $3,000 on his mortgage every month. Not to mention, he put over $50,000 down.

The icing on the cake … he now has to figure out the budget for heating and cooling this massive property, lawn maintenance, appliance maintenance, security systems and more.

Since he’s tripled or quadrupled his square footage, his utility costs will spike. Also, he’s no longer renting, so if anything in that beautiful home isn’t under warranty and breaks, he has to make sure he’s budgeted for the repairs.

What if you weren’t set up to handle all of these new expenses? What if you hadn’t even considered issues like weatherproofing, association fees, increased utilities or steadily increasing property taxes? What if you decided half the size and cost was sufficient?

Whether your American dream consists of a white picket fence around a large house in the suburbs or an industrial condo downtown, you will need to estimate how much your dream will really cost you before signing on the dotted line. Most mortgage calculators will tell you how much you can afford, given current interest rates and estimated monthly expenses.

If you’re thinking about buying a house, here’s your “home” work:

• Create a monthly budget.
• Decide how much you want your housing payment to be and if you can afford it in your budget.
• Use a mortgage calculator to determine your loan, down payment, property taxes, HOA and interest rate.
• Estimate your closing costs.
• Estimate your utilities.
• Estimate your annual maintenance and repair costs.
• Estimate your landscaping, furnishing and decor budget.
• Don’t forget the indirect costs of inclement weather, commute time, fuel and safety measures.
• Get realistic about how much you should spend on your house and start looking.

You know your situation much better than an online algorithm ever could. Put pen to paper or create a spreadsheet to estimate your total home buying expenses.

I eventually went back to my old thought process, like when I bought my first home and found a less expensive home with rental potential. I ended up buying a townhome for $160,000 in another city, outside my preferred area, and I found a roommate a year later. It suits my needs and saved me thousands overall.

My mortgage payment is less than $1,400 per month, including taxes, insurance and PMI. I only paid $8,757.61 in closing costs. The seller paid $12,696.33. I got a home warranty to cover repairs. I’m saving $400 of what I was paying for rent, not to mention my rental income.

My utility expenses have gone up because my place is bigger and there are two people. However, because I have a renter, my expenses to maintain my home are offset by the additional income and they reduce my income taxes. I’ve put about $6,000 worth of renovations into the house.

For every cost with my home, there is an offset or income to cover it. Since I purchased, my house has increased in value by about $20,000. Not only is my place affordable, it allows me to build wealth with and beyond the property.

Are you thinking about buying a new home or becoming a first time home buyer and have questions? Gone through the process yourself and have something to share? Leave a comment below for our community.

Flanice Lewis holds a bachelor’s in management from Howard and an MBA from Colorado Tech. She is a breast cancer survivor, speaker, personal finance blogger, world traveler, and ramen lover. In her spare time, she helps small businesses grow.