The Biggest Purchase of My Life – Part I
During the pandemic, my fiancé (now wife) and I arrived at the conclusion that a one bedroom, 750 square-foot apartment is not ideal for two people and a dog to share 24-7 for an extended period of time. As a researcher, I took this as an opportunity to conduct a deep dive on the home buying process (which also led to a new stock on the buylist, D. R. Horton). Fortunately for us, we were in a good position when the pandemic hit because we had already taken the first step in the home buying process, which is saving for a down payment.
Naturally this led us to the next question… how much money do we need to save? To address that question, we needed to understand our monthly cash flow and how much we could comfortably afford to pay on a monthly basis. Spreadsheets work great for this analysis, although my wife started to cringe at the mention of it. Thankfully, our financial planning department had plenty of resources to help forecast income and expenses and look at various buying scenarios.
Next, we utilized Zillow and Redfin to get a general idea of how much properties were selling for in various areas. Using the websites’ built-in calculator we gained a better understanding of how the recurring payment varied when adjusting the down payment percentage and interest rate. Combining our cash flow plan with these estimates allowed us to confirm… that we still needed to save more money (the DMV is so expensive!).
- The biggest external factor to consider when deciding on a down payment — Understanding private mortgage insurance (PMI). PMI is an extra fee that you (the borrower) pays to reduce the risk for your lender, in case you default on the mortgage. To avoid paying this fee, the borrower needs a down payment of at least 20%. If you put down 10%, the borrower can submit a request for PMI payment removal once the principal balance is no more than 80% of the home value.
Step 2, for millennials like myself, is to move in with their parents to save. For everyone else, step 2 is finding a realtor that can find your dream house in your dream budget range. Fortunately, this was easy for us as close family friends in the real estate business were there to help. In this step, everyone's process diverges based on preferences. As we visited more homes and areas, our vision for the future changed frequently. The list below contains some key elements my wife and I focused on:
- List out the top 3-5 things you value in a home (ex: location, land, space, layout, amenities)
- Will the house need any additional work?
- How long are you planning on staying?
- Good for resale value: 1) Square footage / location of lot (corner); 2) School District; 3) Windows
While the search was in progress, step 3 was in motion as we applied for mortgage pre-approval. West Financial Services’ parent company, Sandy Spring Bank, was the first lender we approached. Essentially, my wife and I uploaded our combined income and assets into a web portal and we were approved for a mortgage loan. This is the size of the mortgage you can receive, but NOT what you can afford. A lot of people are tempted to go to the upper limit of the range. But you need to stick to your original budget to avoid cash flow issues.
It is definitely worth shopping around lenders to see which can provide the most competitive rate. But what rate to choose? Fixed rate, floating rate, 15-year, or 30-year mortgage? As a rule of thumb, floating rates are lower than fixed rates at the time of purchase, because they adjust up or down over time, while fixed mortgage rates do not change over the life of the loan (note that payments can change in either scenario due to taxes and insurance). Additionally, a shorter time frame on the mortgage will lead to higher monthly payments of principal and interest, but less interest over time, due to paying down the principal faster. Rewinding a bit, the pre-approval step could also be done as the first step in the process so a home buyer knows what they are approved for before they start searching.
As my grandfather always used to say, luck is when preparation meets opportunity. Now that we worked out our financial situation, found a realtor, and received our mortgage pre-approval from a lender, it was decision time! In the final part of this story, I will walk you through the biggest purchase of my life that was made in only a few hours.
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