By Paula Pant, WiserAdvisor contributor
A home can be a wise purchase, but don't get in over your head. Too many people jump into buying a house without giving it enough thought, simply because it seems like the next "thing to do" on their life checklist.
Unfortunately, many of these people become "house poor." Don't be like them.
Instead, ask yourself the following critical questions to make sure that you're not just buying your dream home -- you're also making a financially-savvy choice.
#1: Should You Buy, Rent or Rent-to-Own?
First of all, should you buy a home? Or are you better off renting? There's a pervasive myth that people who rent are "throwing money away," but that's a gross oversimplification.
Take a good look at your one-, five- and ten-year plans. Ask yourself how long you plan on staying in your area. After all the transactional costs that come with home buying (closing costs, realtor commissions, inspections and appraisals), it might be cheaper for you to rent, if you think you may be moving soon.
If you're not sure, you can always rent-to-own. This is officially called a "lease purchase," or a lease with the option to buy down the road. (To use a stock market or business analogy, it's like having a "call option" or a "first right of refusal" on the property.)
Here's how it works: You and your landlord sign a lease-purchase agreement prior to move-in. The agreement specifies that you have a limited time period (usually 2-3 years) in which you can exercise your "call option" to buy the house at a specific price. If you choose to buy the house, your rent payments (retroactively) will get applied towards your home purchase, as if they had been mortgage payments. But if you don't buy the house, they'll remain as rent payments.
Lease-purchase options are generally used in conjunction with owner financing. This comes at a price: Owners generally charge a higher interest rate than banks or credit unions.
If you're certain you want to buy, try a traditional route. But if you're on the fence, or if you can't qualify for traditional financing, consider a rent-to-own option.
#2: How Much of a Down Payment Can You Afford?
Making a significant down payment can eliminate your private mortgage insurance (PMI), which is tacked on to each mortgage payment you make.
PMI is a lender's way of protecting themselves in case you default on your mortgage. This mandatory insurance can cost an extra $40-$50/month for every $100,000 you borrow.
If you're able to put down 20 percent or more of the purchase price of the home, you'll avoid this extra fee.
#3: Do You Know How Much You'll REALLY Be Paying?
Your principal and interest aren't the only numbers you need to estimate when buying a home. You want to get a grasp on other ongoing costs like real estate taxes and homeowner's insurance. Different areas have different tax rates, so take that into consideration when looking at neighborhoods.
Bear in mind the county can always raise taxes, and your insurer can always raise rates, so you don't want to be too close to the brink when it comes to how much you can afford. Leave yourself a little "wiggle room" for future increases and stay away from those homes that are in the tip-top of your budget.
#4: Can You Afford the Upkeep?
Even brand-new homes need repairs and maintenance. If you get a reputable home inspection, you should hopefully avoid buying a money pit, but you'll still have to deal with occasional repairs and the everyday upkeep of lawn maintenance, snow removal, gutter cleaning, tree-pruning, HVAC tune-ups and even the higher utility costs that come from moving from an apartment to a house.
In addition to calculating how much you can afford each month for a mortgage, take into account both regular maintenance and unexpected emergencies. As any homeowner will tell you, there always seems to be something that needs to be done when you have your own house. Plan for more expenses than you expect!
How much? One very broad rule of thumb is to set aside one percent of the purchase price of the house annually for maintenance costs. If your house costs $300,000, for example, set aside $3,000 per year, or $250 per month. You won't literally spend this every month -- some months, you'll spend $0, and other months, you'll spend $12,000 replacing the roof.
#5: How Soon Will You Sell?
When you buy a home, you'll need to pay for a huge heap of closing costs. These include real estate agent commissions, title insurance, attorney fees, recording fees, surveys, excise tax, points to the lender, inspection fees, warranties -- the list feels interminable.
In theory, closing costs are negotiable. You can ask the seller to cover some of these expenses. But "negotiable" is not a guarantee of anything. The seller might reject your offer. Or they might counter with a purchase price that's higher than they otherwise would have granted. One way or another, those closing costs will get paid.
If you're planning on selling your home and moving within the near-term, you might want to avoid purchasing a house. After accounting for all of the closing costs, plus repairs, maintenance and the amortized mortgage, you might not end up in a better position than you would have been if you were renting.
In the End
Purchasing a home can be a savvy financial move, as long as you manage it well. Make sure to ask yourself the above questions before signing on the dotted line, and your dream home can bring you joy for many years to come.
Avg. listing price: $1,230,880 Median household income: $110,929 Pct. households $200,000+ income: 30.3% As of 2010, the median income of households in San Carlos was more than double the U.S. median of $51,914. Over 30% of households in San Carlos earned more than $200,000 per year, more than five times the national rate of 5.4%. San Carlos is one of the most expensive housing markets in the San Francisco metropolitan area. Over a twelve month period, ending in October, it had the nation’s highest median home price per square foot at $473 among all homes listed, according to Trulia. In San Francisco, the median age of home inventory was just 45 days as of the third quarter of 2012, according to Realtor.com, lower than in all but seven markets. Read more at 24/7 Wall St.
Avg. listing price: $1,232,167 Median household income: $74,489 Pct. households $200,000+ income: 18.7% Carmel-by-the-Sea, a small coastal city in California, is well-known for its former mayor, actor Clint Eastwood. Currently, the average four-bedroom, two-bathroom home in the city lists for more than four times the nationwide average listing price of $292,152. With nearly 19% of households earning more than $200,000 in 2010, many families and individuals in the small town can afford expensive properties. One house, despite being not much larger than 2,000 square feet, is currently listed for nearly $4.5 million. Read more at 24/7 Wall St.
Avg. listing price: $1,238,208 Median household income: $91,082 Pct. households $200,000+ income: 14.7% Kailua is one of just two cities on this list not located in California. The O’ahu Island city is 12 miles northeast of Honolulu, which had a vacancy rate of 2.7% — better than most areas but considerably worse than the other areas on the list. As of October, the median price per square foot for a home in the Honolulu area was $398, more than in any other metro except for San Francisco. According to Trulia, a 0.75 acres plot of land, which includes 128 feet of beachfront, is currently for sale for $16 million in Kailua. Read more at 24/7 Wall St.
Avg. listing price: $1,312,250 Median household income: $146,069 Pct. households $200,000+ income: 53.0% The average listing price for a four-bedroom home in Rye is more than $1,300,000, or more-than $1 million above the U.S. average. Employees in the often high-paying finance and insurance industries accounted for a 27.8% of employed population in Rye in 2010, well above the 7% average rate nationwide. As of 2010, 53% of households earned more than $200,000 annually, more than any other expensive city, and nearly 10 times the national rate of 5.4%. Additionally, just 1.3% of households lived below the poverty line versus 13.8% nationwide. Among the properties available for sale are a five-bedroom, 7,446 square feet waterfront home for $12.9 million and a 34.2 acre plot of land for $19 million. Read more at 24/7 Wall St.
Avg. listing price: $1,444,214 Median household income: $120,971 Pct. households $200,000+ income: 37.5% Los Gatos is one of several cities near San Jose on this list. Like these cities, Los Gatos likely benefits from the overall boom in the San Jose real estate market, which currently has the lowest vacancy rate of all metro areas surveyed by Trulia at just 1%. Currently, a number of unique properties are available in the city, including an 11,000 square feet property with an eight stall horse barn and a garage that fits 12 cars listed at slightly under $13 million. Also for sale is the former home of Apple Inc.’s co-founder Steve Wozniack. It is currently listed for $4.5 million. Read more at 24/7 Wall St.
Avg. listing price: $1,495,364 Median household income: $120,670 Pct. households $200,000+ income: 39.3% In Palo Alto, 48.7% of adults have a graduate or professional degree — well more than four times the national rate of 10.3%. The city’s proximity to Stanford University, one of the top universities in the nation, may be partly the reason behind the city’s highly educated population. Among the companies headquartered in the city are Hewlett-Packard and Tesla Motors. The city is a large employer of highly skilled employees, as 25.3% of its workers are employed in professional, scientific and management occupations, well above the 10.4% of workers nationwide. Perhaps the most famous resident of Palo Alto is Facebook founder Mark Zuckerberg, who Read more at 24/7 Wall St.
Avg. listing price: $1,506,909 Median household income: $107,860 Pct. households $200,000+ income: 34.9% Menlo Park is one of just four cities where the average listing price for a four-bedroom home exceeds $1.5 million. As of 2010, the median income in the city was slightly below $108,000. However, the recent Facebook IPO has been a windfall to the area. In June, real estate listing service Zillow reported that the “proportion of million-dollar listings” in Menlo Park — where Facebook is headquartered — rose by 87% between the company’s IPO filing and its first day as a public company. Among the houses available in Menlo Park are a five-bedroom home with a gym, theater area and wine cellar, which is listed for $4.6 million, and a six-bedroom 5,200 square feet home that’s listed for slightly under $5 million. Read more at 24/7 Wall St.
Avg. listing price: $1,582,434 Median household income: $145,023 Pct. households $200,000+ income: 43.1% Though home prices in the nearby San Jose metro area fell by 25.1% peak-to-trough, Saratoga is yet another example of how the Silicon Valley housing market has recovered. Currently, the median price per square foot for homes in San Jose is $337, according to Trulia, more than all housing markets except San Francisco and Honolulu. Prices for many homes in the area have skyrocketed, according to listings on Zillow. A home currently listed for nearly $10 million last sold for just over $2.1 million in 2000, while a home listed for $14.9 million last sold in 1994 for just over $1 million. As of 2010, 43.1% of Saratoga households earned more than $200,000 per year, while 40.9% of adult residents had a graduate degree, versus 10.3% nationwide. Read more at 24/7 Wall St.
Avg. listing price: $1,658,000 Median household income: $107,007 Pct. households $200,000+ income: 37.6% Outside of Northern California, Newport Beach is the most expensive city to buy a home. Home prices are so high in the city that in 2009 legendary bond investor Bill Gross bought a nine-bedroom, 11,000 square feet home for $23 million — and then tore it down. In 2011, Gross listed the empty plot of land for $26.5 million. Orange County as a whole has a vacancy rate of just 1.5%, among the ten lowest in the nation. Despite a 32.7% drop in home prices from peak to trough during the recession, Orange County’s median price per square foot is $265. This trails only the Honolulu, New York, San Francisco and San Jose metro areas. Read more at 24/7 Wall St.
Avg. listing price: $1,706,688 Median household income: $149,964 Pct. households $200,000+ income: 43.6% In Los Altos, the average four-bedroom, two-bathroom home lists for nearly $50,000 more than any other city in the nation. According to Coldwell Banker, for that price a buyer could purchase 28 similar homes in Redford, Mich., the nation’s cheapest housing market. In Redford, the average home lists for just $60,490. Currently, asking prices in the San Jose metro area have risen 12.7% year-over-year, according to Trulia. This is more than nearly every other metro area in the country. Read more at 24/7 Wall St.
Follow WiserAdvisor.com on Twitter: www.twitter.com/WiserAdvisor