Home is where you hang your hat. It’s where the heart is. Hopefully, it’s sweet. It’s also likely the biggest purchase you’ll ever make, and the entire process hardly ever goes smoothly.
Browsing listings for your dream home is the fun part, but there are some key financial bases to cover in the meantime.
Here are four things to get out of the way before you go open-house-hopping:
1. Figure Out What You Need and Want
Maybe you've had a dream house picked out your whole life. Now it's time to get real. What are absolute must-haves when it comes to your home? How many bedrooms? How many floors? Do you need a garage?
Notice I said "need." Be sure you know the difference between what you'd prefer to have in a house and what you absolutely cannot live without.
And remember that buying a home is a long-term investment. To make the purchase worth the closing costs and other incidentals, most real estate experts recommend planning to hold onto the property for at least five years.
So think about what you'll need in a home years from now. For example, you may be child-free now and completely comfortable in a two-bedroom house. But if kids are in your future, your housing needs are bound to change. On the other hand, you don't want to buy too much house and wind up with more rooms than you'll ever want to maintain.
All of these factors, as well as exactly where you want to buy, will weigh heavily on how much you can expect your home to cost.
2. Check Your Credit History
Your credit score, which measures borrower creditworthiness based on details in your credit report, helps lenders determine the rate you’ll pay on your mortgage. The most widely used score is the FICO score, and it’s issued by the Fair Isaac Corporation. FICO scores can fall anywhere between 300 and 850, with 300 being the lowest possible score and 850 being the highest. A FICO score of 740 or above qualifies you for the best mortgage rates.
For example, in some New York City suburbs, if you have an excellent credit score and a 20% down payment, you may qualify for a $400,000 30-year fixed-rate mortgage at a rate as low as about 3.4%, according to Bankrate.com. With a score between 680 and 700, your rate on the same loan goes up to between 3.6%–3.8%. Apply that range to the aforementioned mortgage, and you’ll end up paying $18,300 to $34,500 more to the bank over the next 30 years than you would at a 3.4% rate. That’s a lot of money you could be investing for other goals instead of using it to pay off your mortgage. (And if you’re not sure about investing as a general concept, watch this short and sweet video for some mind-blowing numbers.)
You can purchase your FICO score at myFICO.com. Some banks and credit card companies give you access to your credit score for free, but it’s not always the most accurate or up-to-date. If you do check and see that your score is low, get a copy of your credit report and identify what’s hurting you.
Fixing your credit score can be a gradual process, so the earlier you start, the better. Late and missed payments hurt your credit score the most, but they matter less as time goes on — kind of like every one-hit wonder — so long as you stick to paying bills by their due date. Your credit utilization ratio (how much credit you’re using relative to your credit card limit) also heavily impacts your credit. The good news is that your ratio and credit score are quickly updated after you pay down your credit cards. Yet another reason why you should take care of that credit card debt ASAP!
3. Calculate What You'll Need for a Down Payment
At Ellevest, we help you figure out how much money you’re likely to need for a down payment. Let’s say you’re making $100,000 a year. To qualify for a mortgage, banks typically require you to maintain a front-end debt-to-income ratio — which only applies to your housing expenses — of 28% or lower. So the bank would offer you a mortgage with a maximum monthly payment of $2,300.
How much house does that buy? Well, it depends. According to our calculations based off of your salary, we’d recommend looking at houses that cost $400,000. But the bank isn’t going to give you a mortgage to cover the entire asking price. Generally, buyers are expected to make a down payment at least equal to 20% of the home’s value (and, believe me, you don’t want to try for a lower down payment than this), so you’d be on the hook for $80,000 if you were to buy Casa Elle today.
Now, imagine you go to the bank and qualify for a 30-year fixed-rate mortgage with a 3.75% interest rate after the 20% down payment. Your monthly payment for that $320,000 mortgage payment will be $1,950, which is lower than the $2,300 max. Considering that your total debt-to-income ratio (housing and other expenses) shouldn’t exceed 36%, or $3000 a month, staying below $2,300 leaves you with more money to take care of student loans, invest — oh, and buy furniture.
But odds are that you aren’t actually buying that house today, so we think $92,000 is a safe bet for your down payment. Wait, you may be wondering, why does Ellevest say I should shoot for $92,000 if I’m aiming for that 20% sweet spot? Two reasons: timeline and inflation. We default to a six-year timeline while calculating your down payment goal — though you’re free to adjust it to fit your needs — and we factor in inflation because as your grandmother always said, a dollar doesn’t go as far as it used to. Therefore, in order for you to get the 2022 equivalent of a house that costs $400,000 today, we recommend aiming for a down payment of $92,000 in six years.
Ok, let’s address the elephant in the room. Yes, our estimates at Ellevest are conservative, but we believe a cushion is a damn good thing to have, so we’re happy with that. Remember: you're better off borrowing less than what you actually qualify for. Just because you can buy it doesn’t mean you should, especially if it will stretch you to the max.
And if you can pay more than 20% of the home value up front, that's great, too. It will help you keep your monthly mortgage payments low and manageable—leaving you more money to invest elsewhere.
4. Start Investing
You can invest to reach your goal of buying a home. Yes, we have a goal for that.
For our “A Place to Call Home” goal, Ellevest assumes you’ll want to buy your house in six years, but your timeline is customizable. You can change it to three, ten — whatever your personal goal date happens to be. We’ll also recommend amounts for one-time and monthly deposits toward this goal, and build you an investment portfolio with an eye to giving you a 70% chance of reaching it — or better — over that timeframe.
We do this by investing your money into a highly diversified portfolio of low-cost ETFs; we customize the portfolio to your timeline, including shifting it into more conservative the closer you get to your goal timeline. That way the money for your down payment is less sensitive to market ups and downs when you need it.
Why not just “save” the money in a high-yield savings account or even a short-term CD? Because by investing, you have the opportunity to grow your money, which — if you’re several years away from buying — may mean more home.
Once you take these first four steps, you'll be well on your way to reaching your goal of being a homeowner. And the smarter you are with these early moves, the lower you can make your housing costs. That means you'll give yourself more room in your budget to invest in your other goals, and to decorate your new digs.
The projections of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Information was obtained from third party sources, which we believe to be reliable but not guaranteed for accuracy or completeness.
The information provided should not be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice.
The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person.
Diversification does not ensure a profit or protect against a loss in a declining market. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
Investing entails risk including the possible loss of principal and there is no assurance that the investment will provide positive performance over any period of time.