Recommendations for first time home buyers

        One survey I read recently considers buying a house more stressful than having a child and switching jobs and nearly on par with getting married or divorced. Why is everybody so stressed? It's primarily because there are really a lot of factors to think about and missing one important detail can set you back financially at a considerable level. Even very sophisticated buyers are susceptible to making mistakes. Nonetheless, there are a few recommendations you should consider before buying that might save your bacon.

Do a “rent versus buy”analysis – The first step in determining whether buying a house is in your best interest is to compare the alternative of renting. This means getting out a spreadsheet that calculates and compares your future house payment including principal, interest, insurance, and property taxes against your rental payments. You’ll also want to determine the amount of the mortgage loan interest deduction that you’ll be able to take on your federal and state income taxes. If your overall tax liability each year is low based on your income level and other deductions, the mortgage interest deduction may do absolutely nothing to save you money.

        Once you know your after tax house payment, compare it against your current rental payment. You should be able to connect the dots from there.

Tip: If the compared rental payment and house payment are about the same, you’ll need to consider other factors like flexibility. If you decide to move within a couple years of moving in, you may have to eat five figures in transaction costs to sell your house. If you plan to stay for a couple decades and have a stable job, then the comparable rental rates are less relevant.

Does the house profile as a good rental property? If you’ve completed the analysis of whether buying the house is cheaper than renting, you may want to determine whether the house can be converted into a solid rental property. This can be particularly useful if you leave abruptly for a new job, get married or just need a change of scenery. Since nobody can predict where the real estate market will be in a year, you will want to have the fallback option of renting your house out in case the market is down when you want to sell. If your house would bring in a positive cash flow if you rented it out, the worst case scenario of buying is mitigated somewhat.

See if you qualify for a loan – It doesn’t make sense to go house shopping if you can’t qualify for a loan to buy one. You’ll need to have enough money for a down payment and have a verified income. I’d visit with a mortgage broker to learn your options rather than just applying through a bank. If you’ve never bought a house before, it may make sense to learn the qualifications to buy a couple years before your purchase so you can save the money to be qualified. Not all homes are move-in ready, which means you may want to do some painting, carpet work, and other minor repairs before moving in. Furnishings and improvements should also be considered.

Tip: Be careful about dealing with mortgage brokers. The barriers are really low to become qualified to become a mortgage broker and they are in a very cyclical industry, so some brokers don’t know what they’re doing while others are just plain dishonest particularly when business is slow. They only get paid if you commit to a loan, so they may tell you what you want to hear rather than the truth. Beware of inept and/or dishonest brokers.

Buy a house within your means as you define it and not what you can qualify – The biggest takeaway from 2005-06 real estate bubble was that some lenders are off their rocker. Some lenders gambled that borrowers would hit the lottery, because they lent money foolishly to borrowers who with almost no ability to repay the loan.  Just because a bank will give you the money to buy a house doesn’t mean you should take it.  It’s your life and you should be prudent about not becoming house poor (the payment on your house is so big that you can’t afford anything else) or signing your name on a promissory note that you have no hope of repaying based on your current income. There are endless amounts of nightmare stories of people who can attest to not letting the lenders dictate the house they buy. You also shouldn’t bank on future raises and two incomes to qualify for your house. The Dodd-Frank Act phasing in next year might negate some of the worry about lenders offering loans to mediocre buyers.

Be prepared to ride out market fluctuations – Even though home price appreciation can be aggressive in certain area, nobody should be buying a house primarily due to that reason. This was the biggest mistake people made in the market bubble in 2005-06. They saw the market skyrocketing, so they jumped on bandwagon near the top. While some people jumped off and made out like bandits, the majority of homeowners ended up really far underwater i.e. their house was worth a lot less than what they could sell it for. Buy a house at a level that you can afford and be prepared to not care much about market fluctuations over the life of your loan.

Buy when the market is down – There are a lot of people in my network who bought their first house in the last ten years. Depending on who you talk to, it was either a really great decision or a really poor decision. The ones who bought in 2004-09 in rollercoaster markets usually regretted it, but the ones who bought before then or after then usually did well. On your first house, you should be taking a conservative approach to buying real estate. This may take some patience, but it will be worth it. Just remember that it’s a bad business risk to try and buy when the market is clearly up and hope that you can sell before the music stops. Don’t do that.

Avoid HOAs in most cases – There is one uncertainty about buying a house in an HOA community: you don’t know whether the HOA fees will skyrocket. If your idea is to buy the house to live in during retirement, you want to reduce holding costs to a minimum. In communities that are more established and the HOA fees have been stable, it’s less of a risk. However, your house will always be more attractive to more buyers without an HOA fee.

Should singles buy? Absolutely. If singles can afford to buy, it will always be a positive to own a house as long as it isn't underwater. If the house is underwater, you’d have to either sell at a loss, take a negative cash flow by converting the house into a rental property or take a bowling ball to your credit score through a short sale or foreclosure. On the other hand, having a good rental property is a great vehicle for retirement if the single decides to marry.

 
Other factors to consider:
• Spend extra on the inspection to ensure that you aren’t buying a money pit. You don't want any surprises after you pay for the house and are the new owner.

 

• Consider your target market when you want to sell.  Low end houses are the easiest to sell, but going too small can limit your market. Very few buyers are interested in a 1 bedroom and 1 bathroom model. Likewise, very large high end homes only draw a limited market.

• Be prepared to walk away from any house you offer on. Some people get fixated on a single house and are willing to overpay to get it. Although it’s good to have a strong interest in buying your first house, it’s still a business transaction. Be prepared to walk away if the monetary terms aren’t justified by the surrounding market.

• Taking your time to read through all the paperwork of the transaction will help you have a better peace of mind about the terms of your transaction rather than relying on others highly interested in the commission (mortgage broker/ real estate agent) to tell you terms that don’t exist in your contract. The contracts you sign dictate the deal, not the conversations before it.

• Do your homework on your real estate agent and mortgage broker. Their reputations and track record can either be an asset or a liability.

• Schools matter to most people even if they don’t to you. Being a bad school district can limit the market to sell your house.

Conclusion – Buying a house for the first time is a major life event. The house will be your place of abode and where you’ll live your life for the foreseeable future. You should care deeply about the outcome. Your effort and level of due diligence should correspond to your interest in the outcome. If you do your homework and give consideration to the recommendations in this post, the transaction may turn out even better than expected.