Buying a home may be one of the most important financial decisions you make in your lifetime. There are so many ways that buying a home will affect your personal life and your finances. You’re selecting the place where you’re going to spend a long part of your life, and where you’re going to make some of your most precious memories. Perhaps this is the place where you’re going to start a family, the place that your kids will refer to as their “childhood home.”
Sentiments aside, purchasing a home is as much as a financial investment as it is a personal investment. In fact, homeownership is a primary source of net worth for many Americans, but the transaction could have a substantial impact on your credit, your retirement, and your financial well-being.
In 2018, first-time home buyers made up 33% of all home buyers, and this demographic has a higher likelihood of making a costly mistake than the remaining two thirds during the process. Between eager excitement and lack of experience in the real estate market, first-timers may get ahead of themselves and make the wrong financial decision—one that they could spend decades repaying.
Don’t let that be you! So long as you do your homework, you can learn from the ones who came before you and avoid making the same home-buying mistake. Below, we take a look at common mistakes that first-time home-buyers make. If you want to make the most of your investment, do your best to avoid these 12 errors. They can be divided into three categories:
A. Home Financing Errors
1. Viewing Before Applying for a Mortgage
This is often the first mistake that home-buyers make, so let’s address it up-front: don’t start viewing homes until you’ve been pre-qualified or approved for a mortgage!
Home buying is no doubt an emotional process, but it’s also a major financial endeavor that requires pragmatic decision-making. You might be overtaken by restless giddiness when you decide you’re ready to buy a home and feel compelled to begin house-hunting immediately. Unfortunately, you don’t know what homes are really in your price range until you get pre-qualified or approved for a mortgage loan.
It might be a waste of time to view homes before you’re pre-qualified approved for a mortgage. But here’s what’s worse than wasted time: dashed dreams. You don’t want to fall in love with a certain home, only to realize that it’s way out of your price range. It’ll make the home buying process less fun and more heartbreaking. Moving forward, you might have unrealistic expectations, make false comparisons, and wish that the homes within your budget had the same qualities of the homes that aren’t. This might cause you to be too picky and inefficient when looking around.
Rule number one: keep your home buying experience rooted in logic from the very beginning.
2. Poor Credit Management
Do your best to maximize your credit score before you apply for a mortgage loan because your credit score will influence your mortgage terms in a number of ways.
If your score is too low, you might be denied a mortgage outright. First-time home buyers tend to have lower credit scores than repeat home buyers because they don’t have any prior mortgage payments to positively impact their credit history. Still, it’s recommended that, at minimum, first-time home buyers have a credit score between 620 and 650 when applying for a mortgage; if your score is below 620, it’s less likely you’ll be approved for the loan, so take the time to improve your credit past this number before applying.
Secondly, a favorable credit score is more likely to earn you a better interest rate on your mortgage. The higher your score, the better indication that you’re more likely to pay off your loan in a timely manner. Statistics show that applicants with low scores are much more likely to default on home loans than applicants with high scores, which is why lenders may charge riskier borrowers higher interest as a form of protection. You want to appear to be a safe bet.
Don’t underestimate the importance of earning a low-interest rate. It might not seem like there’s a big difference between a 3.6% rate and a 4.0% rate, but those rates add up tremendously over the 10+ years you’ll be paying off the loan. A home is a long-term investment, so you should be keen on saving as much money in the long-term as possible.
How do you know what your credit score is? And how can you boost it?
If you’re serious about getting the best rate on your loan, utilize a credit monitoring agency. A credit monitoring agency will review your credit score and suggest ways in which you could boost it. Turbo, for instance, can review your finances and provide you with a TransUnion VantageScore. This provides an in-depth analysis of why your score came out the way it did so you can try and boost it before you apply for a mortgage.
One of the key ways you could boost your credit score is to pay off any existing debt in a timely manner. Always make your payments on time, whether you’re paying off student loans or a credit card.
Remember, though, that your credit score is a very complicated calculation that depends on a variety of financial factors and there are many different ways to improve your credit score. Do some research on the subject if you’re in the dark.
3. Overlooking Guaranteed Loans (FHA, VA, USDA)
Guaranteed loans are advantageous to first-time home buyers. These are loans that are insured by the Federal Government insures who promise to assume the debt if you’re unable to pay it back. It’s similar to having a co-signer on a lease.
To a lender, a low credit score or a low down payment suggests greater risk. A guaranteed loan reduces that risk because the lender is guaranteed to get its money back if you default.
- There are several types of guaranteed loan programs backed by the federal government: The Federal Housing Administration loan (FHA loan) is most popular with first-time home buyers. An FHA loan enables you to get a mortgage with a credit score as low as 580 and with a down payment as little as 3.5%.
- The Veteran Affairs loan (VA loan) guarantees loans for military veterans.
- The United States Department of Agriculture loan (USDA loan) guarantees loans for those buying homes in rural areas.
Explore these options before taking out a traditional mortgage and determining your potential down payment. If you are offered a low down payment, bear in mind that it might mean you pay a higher interest rate. If you do obtain a guaranteed loan, as with any other mortgage, know that the lender could still seize the house if you default. The guarantor will pay back the loan for you, but you’ll lose the house and your credit score will probably be eviscerated.
4. Not Shopping for Loans
Many first-time home-buyers make the mistake of taking the first mortgage they’re approved for. They go to a single lender, apply for a mortgage, and take it when it’s approved. That could be a mistake.
Applying for a mortgage is not quite as fun as viewing homes, so first-time buyers may become impatient and take the very first mortgage they get approved for. Here’s what you should do instead: go to several different lenders and apply for mortgages at each. If multiple mortgages are approved, you’ll be able to pick the one with the best terms and rates.
A mortgage inquiry may lower your credit score. However, the credit bureaus encourage rate shopping. So long as you make all loan inquiries within 30 days, any change in your credit score will only reflect a single inquiry.
Make inquiries with as many lenders as you can and try and get the best possible mortgage loan. Like we said earlier, there’s a big difference between a 3.6% rate and a 4.0% rate.
5. Making a Down Payment That’s Too Small or Too Large
Avoid making a down payment that’s too small or too large.
Some lenders may allow you to make a very small down payment. Small down payments are enticing because you don’t have to save up as much money to make the purchase. The problem with small down payments is that the interest rates tend to be higher. Higher interest rates will not only make the monthly payments more expensive, but they also make the house more costly in the long run because high-interest rates can ultimately cause you to pay thousands of dollars more than the asking price for the home.
Similarly, you shouldn’t make a down payment that’s larger than what’s within your means. Keep in mind that a house is going to cost you far more than a monthly mortgage payment. You might have closing costs on the home transaction, a realtor to pay, moving expenses to cover, and so on. You should also prepare yourself for common homeownership expenses (we’ll discuss this further along in the post). Instead of placing an overly-large down payment, save some of that money to pay for the expenses of your new home.
The recommended down payment for a conventional mortgage is 20% of the home price. It’s a tough housing market, though, and so it’s difficult for many home-buyers to save up 20%. According to the National Association of Realtors, the median down payment in 2018 was 7% for first-time buyers. Just be aware of the added monthly and long-term costs if you’re going to make a down payment significantly less than 20%.
B. Financial Planning Errors
6. Not Planning for Future Equity and Retirement
When you buy a house, you’re making a long-term investment in your wealth. Many first-time home-buyers fail to account for this. The buyers believe that someday, they’ll sell the house and use the profits to buy a new, possibly more luxurious one.
It’s not a bad idea, but you have to account for depreciation and equity.
In some cases, a house may be a depreciating asset. Contrary to popular belief, homes don’t always gain value over time. Most of the time, it’s only the land that gains value. Houses typically lose value. This is due to the natural aging of the structure: the roof gets worn down; the wood rots; the HVAC systems become outdated; the architecture goes out of style. If the house has depreciated far more than the land has appreciated, you might not be able to sell the home for as much as you bought it for.
You could have a bigger problem if you sell the home without having fully paid it off because you must use the proceeds of the sale to pay off the remainder of the loan, then you get to pocket the rest. If a large portion of the loan is outstanding, you may profit very little from the sale of the home. That would leave you with little money for a down payment on a new home. You’ll have to take out another big mortgage that could take, like your first home, 10 to 30 years to pay off.
Not only could this drastically reduce your wealth, but you could potentially make your retirement very difficult. You might consider paying off your home before you retire so you won’t be burdened by hefty mortgage payments. If you’re forty or fifty years old, and you take out a mortgage that’s going to take 20 to 30 years to pay off, you might still be paying off the mortgage well into old age. Mortgage payments could siphon money from your retirement, and they could also prevent you from contributing the annual maximum to your retirement plan.
Smart home buyers know that they shouldn’t sell a home before it’s profitable. But life is unpredictable. You could change careers. Your company could relocate. The neighborhood could change, and you might not enjoy the new character. In the 10 to 30 years it’ll take to pay off a mortgage, you could have very practical reasons for selling your home.
That’s why it’s important to know the difference between a starter home and forever home. A starter home is a home in which you don’t plan on living forever. It’s a comfortable place to pass the time until you’ve saved enough money to purchase your dream home. A forever home is that dream home—it’s the house you want to live in for the rest of your life.
Bearing equity in mind, your starter home should be relatively inexpensive and have a low mortgage rate. You want your starter home to become profitable as soon as possible, so it should be cheap enough to where you can pay off all or most of the mortgage in 10 to 20 years. With the mortgage paid off, you’ll gain much more money from the sale. You could use that money to buy a new home in full or buy a home in which you could pay off the mortgage in under 15 years.
7. Not Considering Homeownership Costs
Many first-time home-buyers forget that a home costs more than just the monthly mortgage payments. Some of the additional costs you’ll incur include:
- Closing costs on the transaction
- Property taxes (paid twice per year)
- Monthly utilities (gas, water, electricity, garbage)
- Home maintenance
When you first purchase your home, you might also have to pay for moving expenses and for new furniture to fill out the house.
All of these costs can take a lot out of a homebuyer’s budget, or, if you don’t budget carefully, they could make you “house poor.” House poor is a sad term to describe those who can’t afford to spend money on vacations, on going out, or on nice things because they spend too much of their income paying their mortgage. Being house poor is no fun—no fun at all. So when you’re budgeting for a new home, don’t only take the mortgage into account. Consider all of the costs of ownership, including the initial expenses and the ongoing expenses.
8. Using All of Your Savings
This ties in closely with the last mistake we discussed. Don’t use all of your savings on making a down payment for the home. Your savings account is tremendously important and you can’t afford to sacrifice all of it. Remember, you might need to use some of those funds to pay for initial homeownership costs. You should also be using your savings account to pay for:
A home can be a great financial investment. But draining your entire savings account is not worth it.
9. Ignoring Existing Debt
Before you buy a home, it’s recommended you pay off student loans and auto loans. Paying off these loans may improve your credit score, which may help earn you a better rate on your mortgage. You also don’t want to be burdened by large mortgage payments in addition to payments on other debt.
If you won’t be able to pay off your other loans before you take out a mortgage, be sure to budget accordingly so you’ll have enough money to make monthly payments on all your debt without being house poor.
C. Home Selection Errors
10. Buying Too Large
Here’s an instance where home buyers make an emotional decision rather than a logical one. First-time home buyers often fall in love with a home that’s too large for them and large homes almost always come with a larger price tag. Sometimes the price tag is worth it. Perhaps the home buyers want to have a large family, so they need a house with more space and more rooms. However, you should reconsider buying an excessively large home if:
- You don’t have the funds for it
- You don’t plan on having a large family
Most people probably wouldn’t think that having a large, empty home is worth being house poor.
If you’re buying a home as a single person, you might not need all the space that a larger home affords. Sure, most people want more space, but think carefully about whether or not you truly need it. It might be better to pay less on your mortgage and have more money to commit to savings and retirement.
If you’re single, or if you have a partner with whom you don’t plan on having any kids, you might get more value from buying a condo than a house. Modern condos are quite luxurious, and they’re typically smaller and more affordable than a house. By “smaller” we don’t necessarily mean “small.” Some condos are very sizable, and some have pools, shopping outlets, and communal areas. A condo is worth considering if you’re looking to own a more compact space that’s less expensive.
11. Not Considering Location
One of the Golden Rules of real estate? Location, location, location. Occasionally, first-time owners don’t consider this and they buy a home in a neighborhood they don’t enjoy living in. Sometimes the neighborhood is unsafe. Sometimes the house is too far from the buyer’s workplace. Sometimes the buyer purchases a home in an urban area when they would have preferred living in a rural area, or vice versa.
You can make renovations and improvements to the house, but you can’t make renovations to the neighborhood. Before you begin your home search, ask yourself these questions:
- Do I need a large house?
- Do I want a spacious yard?
- Do I want to live in a rural area, urban area, or suburban area?
Once you’ve viewed many homes, answer these questions about each home you liked:
- Is the neighborhood safe?
- Would I enjoy living in this neighborhood?
- Am I okay with the length of the commute to work?
Make sure to do research on the area. It doesn’t hurt to spend some time exploring the neighborhood to get a better feel for it.
12. Rushing Through the Process
You’re probably excited to make a down payment, snag your keys, and move into your new home. But it’s important that you don’t ever rush through the home-buying process. Take your time:
- Don’t be in a rush to start viewing homes
- Make sure you’ve maximized your credit score
- Shop loans to find the best rate, and consider alternative loans
- Do the math and determine the right-sized down payment for your budget
- Make plans for your future equity and retirement
- Budget for all expenses, not only mortgage payments
- Keep an ample amount of money in your savings account
- Pay off your other loans
- Find the right-sized house in a location you love
If you tread cautiously and consider every facet of the buying process, you could avoid making a big mistake that could leave you in a financial mess, or worse: leave you feeling dissatisfied with your home. The home buying process may seem very intricate, especially to a first-time buyer. But all the financial complexities should make you think carefully about your purchase.
Suffice to say, loan defaults and house poverty take a lot of the fun out of being a homeowner. So although you want to find a house that sends you over the moon, you also need to make sure it also fits into your budget and long-term goals.
For more information on home buying, read this guide by the U.S. Department of Housing and Urban Development (HUD).