Getting Ready to Buy a House

In the comments to my colleague's excellent post, one thing did surprise me: the era of the tiny downpayment is still very much with us.

Obviously, I knew this at some level--it's the reason that the FHA has become such a large fraction of mortgage originations.  They're about the only people in the market these days who will let you buy a home with 3.5% down.

And yet, it's shocking to me to see so many people who positively assume that it's natural to buy a house with 3.5% down.  We had about 13% down, which I felt rather guilty about, even though the lender agreed to pick up the PMI.

A couple of years ago, I ran through our thinking about how much house we could afford.  I think it's worth reiterating some guidelines for people who think they might want to buy:

1.  You want a decent downpayment.  FHA loans are more of a hassle and more expensive than conventional loans; conventional loans with less than a 20% downpayment usually require hundreds of dollars worth of mortgage insurance, the dreaded PMI.  

Moreover, saving a reasonable downpayment--ideally 20%, and minimally, at least 10%--will save most people from the temptation to buy more house than they can afford.  Yes, you may have to wait longer.  But the houses will still be there next year.

2.  Figure out whether it's worth it to rent or buy.  The New York Times has a great calculator for this, which includes things like maintenance and property taxes, and lets you see whether it works out over different time horizons.  If you think you won't want to move for 15 years, it's often a good deal; if you're thinking three years, rarely.

As I've emphasized, this isn't only a financial decision--it's okay to buy a house because you want to tailor it to your needs, even if the calculator says you'll lose a little bit of money that way.  But you should be aware of the relative costs.

3.  Think about the downsides.  We're pretty conservative, so we wanted a house that could be supported mostly on one of our incomes.  Instead of buying as much house as the bank was willing to go for, we bought as little house as we felt we could be happy in.

In most cases, your house should cost no more than 2.5-3x your annual income, and your payment should be no more than 25-30% of your take home.

4.  Don't forget maintenance, insurance, and taxes.  This is probably the biggest mistake that homebuyers make: they look just at the mortgage payment.  Figure out what your insurance and taxes will be, and budget about 1.25% of your home's value for annual repairs and maintenance.

5.  Don't pour all your savings into the downpayment.  You will also need cash for closing costs, moving costs, and a cushion for emergencies.  And no, unused credit card limits do not count.

6.  Be honest with yourself about how much work you're willing to do.  Me, I prefer a fixer-upper.  That way, I can control the quality, and get exactly what I want.

But my husband was not willing to live in a wreck.  We had to compromise on something that we could live comfortably in now (central A/C, no holes in the walls) but that wasn't an overpriced renovation with builder-grade materials.

There's nothing wrong with saying that you don't want a fixer-upper.  But don't think that new construction means "no problems".  No builder is perfect . . . and over time things will break or need updating.

Conversely, don't assume that you're going to gleefully dive in and do everything over (unless you're the sort of person who generally enjoys that sort of thing.)  Any longtime realtor will can tell you about all the times they've sold a house to a couple who talked about all the things they were going to fix--and then came back to list it seven years later with all that work undone.  And people who take on fixer-uppers, but don't have the cash flow to do the fixing, can end up in desperate straits.

So if you can't live with it basically the way it is (and you don't have the cash to fix it up instantly) don't buy it.

7.  Don't count on raises or inflation to bail you out of a too-expensive house. They may arrive, in which case you can spend them on something terrific.  They also may not, in which case you're ultimately at high risk of losing the house.

8.  Don't forget utilities.  A bigger, fancier house usually means bigger, fancier bills for electricity, maintenance, even lawn care.  Most people forget that.

9.  Keep your "must haves" to a minimum.  If you don't compromise, you'll be tempted to overspend.

10.  The hardest thing to fix is a bad neighborhood, or too little space.  Rooms can be painted, fixtures upgraded, windows expanded, walls torn down.  But additions are expensive and often hard to get through the zoning board or the HOA, and the neighbors and views and noise that you dislike now are still going to be there five years from now.  We love our neighborhood, and it makes a huge difference in our happiness with the house.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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