financial planning for young adults: mortgage basics and tips for buying your first home
/
By Halsey Schreier | Published November 17, 2020
Are you tired of renting? Are you considering purchasing your first home? Do you dream of owning a house that can provide both you and your family a sense of stability and community?
For many Americans, home ownership is an important part of the American dream. Being a homeowner means having a space to call your own and a place where you belong. It also means being a part of a community. Owning a home may provide other financial benefits, such as the ability to build wealth through home equity, and potentially lower housing costs and savings over the cost of renting.
Is buying a home right for you?
For first-time potential homebuyers, this could be an especially attractive time to fulfill the dream of home ownership. Historically low mortgage rates are helping prospective buyers get more bang for their buck by boosting their purchasing power and offsetting the cost of rising home prices. But buying a home is a deeply personal choice. Young buyers often assume that purchasing a home is the next step simply because their family, friends and co-workers tell them it is. However, homeownership may not be right for everyone. Buying a house can easily be a dream or a nightmare, depending on your perspective. Many people—especially those who are just getting started in their careers—are ambivalent about becoming homeowners because they worry about getting tied down and taking on a large amount of debt.
Make sure you’re financially prepared
Buying a home may be one of the most important and largest financial decisions you’ll make during your lifetime. However, the process is often a complicated maze of paperwork and procedures that can be overwhelming and stressful, especially for first-time homebuyers. The last thing you want is to fall in love with your dream home only to discover you’re not financially qualified—which is why it is important to make sure your finances are in order before you start the buying process.
Check your credit score
Getting a good mortgage rate requires a good credit score. If you’re considering buying a home, you’ll want to check your credit report for errors and if needed, get your credit score in shape. To improve your credit score, you’ll want to use credit wisely, pay down debts, make payments on time, and avoid applying for new credit. You’ll want to start the process early, well before you apply for a mortgage.
Saving for your down payment
A down payment is the upfront partial cash payment you make on a home. Most mortgage lenders require you make a down payment to represent your initial ownership stake in a home. Minimum down payments typically depend on the type of loan, for example the minimum down payment is 3.5% for government-sponsored FHA loans. If you do not have enough to pay for a down payment, you may need to set up a savings plan and evaluate your current spending habits.
Renting vs. owning—what can you afford monthly?
When it comes to your monthly mortgage payment, it is easy to think you can afford the same amount as you can when you rent. However, although your monthly mortgage payment might be lower than your rent payment, that doesn’t necessarily mean homeownership is cheaper. However, home ownership may also include property taxes, home owners insurance and Private Mortgage Insurance. When you rent, your landlord pays for the costs of maintaining and improving the property. But when you are the homeowner, you’re on the hook for anything that breaks – these costs can be substantial over time.
Understanding your mortgage options
Before you start shopping for a mortgage, it is helpful to understand some of the basic terminology, the options and the process.
Fixed-Rate vs. Adjustable Rate. With a fixed-rate mortgage, you pay the same interest rate for the life of the loan and you know what your payments will be each month. However, if interest rates drop substantially from your current fixed rate, you’ll have the potential to refinance to take advantage of the drop in rates. With an adjustable rate (ARM), the interest rate varies, which can be helpful in a falling or low-interest-rate environment. But it also means that when interest rates rise, your mortgage payment will too.
15- vs. 30-year. All mortgages have a term—the length of time that it will take you to pay off your mortgage if you make the minimum payments each month. While mortgage terms can vary widely, the most common options are 15 years and 30 years. Typically, 15-year mortgages offer better interest rates, because the term is shorter and there is less risk to the lender. However, a 30-year mortgage will generally have a lower monthly payment.
Government-insured vs. conventional. Government-insured loans are easier to get if your income is low, you have poor or short credit history, or you don’t have enough to make a more substantial down payment. However, they often come with restrictions. Conventional loans tend to be more cost effective in the long term, have fewer additional fees, and better interest rates, but generally require a good-sized down payment and a good credit score.
Pre-approval. Mortgage pre-approval helps presents you as a serious, qualified buyer when searching for a home. It is a free and non-binding process that proves you have access to financing, which can put you in a better position in a sellers’ market.
Private mortgage insurance (PMI). If you put less than 20% down, your lender will likely charge you PMI, a monthly premium that protects the bank in the event you default on your loan and the value of your home declines significantly.
Buying your first home is exciting, but there’s a lot to think about before you start looking. CIBC Private Wealth Management’s “Wealth Your Way” podcast series is an educational offering for clients and their children, which is part of our commitment to developing the rising generation. Listen to the podcast on mortgages and buying your first home here. There, you will also find other informative podcasts that are designed to help rising professionals steer through their personal financial journey.