For the majority of our clients who have graduated from law school, their first year salary is the most money they have ever made. Many are even making more than their parents ever did. As their salaries and bonuses increase each year, many clients find themselves wondering how they can begin to responsibly build their financial independence. The decision to buy a home is often a top choice that can help secure financial security.
Although it can be overwhelming, the home buying process doesn’t always have to be. Follow the steps below and you’ll be on your way to building wealth via homeownership.
Determine How Much You Can Afford
Despite COVID-19, real estate markets across the country are soaring. Given the high demand, it is incredibly easy to get entangled in the frenzy and bid for houses out of your price range. The first step a potential buyer should take is to determine their realistic purchase capacity. Keep in mind, most buyers put down between three and 10 percent. Think about any non-housing related cash needs you will have in the next couple of years and then decide how much you’re willing to put down. The higher the down payment, the lower your monthly mortgage will be. You also want to ensure that you retain at least three to six months of living expenses after accounting for the down payment, closing costs and any other maintenance the home will require.
Lenders use a variety of factors to evaluate your borrowing capacity. One of the primary metrics is the debt-to-income ratio. Prior to reaching out to lenders, calculate your ratios so that you know where you stand.
Once you know your debt-to-income ratio, you should reach out to a lender to obtain a pre-approval letter. This document will give you a preliminary estimate regarding how much you will be able to borrow to buy a home. Before making a determination, the lender will require a slew of information, including your tax returns, W2s, pay stubs and bank records. The pre-approval letter shows your agent as well as potential sellers that you are serious. In a competitive market, this matters. Prospective buyers who come armed with a pre-approval show all parties that they’re ready — and able — to buy.
Find an Agent
There are a variety of opinions about whether or not you need an agent during the home buying process. If you’re a first-time buyer, I always recommend using an agent. High-quality agents are able to walk you through the process, give you deeper insights into neighborhoods, answer your questions, and connect you to other professionals you may need, such as handymen or contractors.
So, how do you find a good agent? Reach out to your personal network to find a highly recommended professional. You want someone who has extensive experience in your desired location and you also want to make sure there is chemistry. You want to feel comfortable because you may be in this relationship for months as you view homes. You may also want to use your agent again for future purchases or sales.
You will be tempted to buy the nicest house on the block that is at the top of your price range. Do not do it. Instead, make a list of your desired home features and then break the list into three categories: needs, wants and deal breakers. Your needs are items that any home you see must have. Without these things, you wouldn’t even consider the home. Wants are the items that are nice to have but you may be able to do without. Deal breakers are those features that you are not willing to compromise on. This sounds like the needs category, but it is very different. For example, for our first home, my wife and I were adamant that we did not want a split-level property. That was a deal breaker for us. Share your list with your agent so that you are on the same page. There is no need to waste time on properties that don’t hit your specific criteria.
Decide Where You Want to Live
Location, location, location. Do you want to live in the city or the suburbs? Is being in a good school district important to you right now? Are you thinking about eventually renting your property? If so, you may want to make sure you are close to public transportation or a commercial shopping district. These are all questions you need to consider as you start the home buying process. Your agent should be able to give you insight into these factors as well. Once you’ve identified an area, it’s time to view homes.
Viewing and Finding Homes
Armed with your pre-approval letter, list of must-haves and location preferences, start to view homes. This process can take a few weeks to several months. Buying a home is a huge financial decision and you should not rush the process. Your agent is incentivized to find you a home, but you are the one who has to live in it. Be patient. If it takes a while to find the perfect place, so be it. It is a competitive market. You will likely be outbid. Know that going into the process and do not get discouraged.
At this stage in the home buying process, clients often call me asking if they can increase their budget for a home. The conversation typically goes like this:
Client: I found the perfect home but it’s $100k more than we discussed.
Me: What is it about this house that you like?
Client: It’s in a great area with solid schools. I think that if we were to relocate in five years it would make a great rental property.
Me: Ok, so if you were to pay an extra $100k for this home, then these are the tradeoffs we would have to make in order to stay on track.
From there, I outline where we would have to make adjustments to ensure we are still working toward the financial goals we had previously established. At this point, it’s up to the client to re-evaluate if he or she is willing to proceed.
Make an Offer
Once you make your offer, it will either be accepted or declined. If it is declined, you may have another opportunity to make a higher offer. If your offer is accepted, you will need to pay 1-5% of the purchase price, called “earnest money,” as a good faith gesture. In certain cases, you will be refunded your earnest money if the deal falls through. Be sure to speak with your agent about the rules in your state. If everything goes according to plan, your earnest money is typically credited to your closing costs.
Secure Your Financing
Once you notify your preferred lender that your offer has been accepted, the bank will initiate the final approval. The pre-approval will be reviewed and any outstanding items will need to be resolved. Once you are approved, you will be offered an interest rate for your loan based on your creditworthiness. If you are not satisfied with your loan terms, you can shop around for a better rate. The lender will also send out an appraiser to verify the value of the home and you will need an inspection to identify any major structural issues with the home. Typically, your agent can make a referral unless you have someone in mind. An inspector will then assess the condition of the home.
Once you get the inspection report, you will have the opportunity to negotiate any fixes with the seller. If the seller refuses to fix items, you have the option to walk away from the deal.
You made it! This is the last step in the home buying process. A closing can last three to four hours, so make sure you give yourself enough time. You will review and sign all loan documents. Your agent will assist you through all of the steps. You will need to bring a certified or cashier’s check to cover your down payment, closing costs, prepaid interest, taxes and insurance. In some states, you will need to wire this cash prior to the day of closing. The earnest money you paid when the contract was accepted will be credited to your closing costs. When you have completed signing the paperwork, you will be given the keys. Congratulations! The house is now yours!
With your home purchase behind you, now is the time to be mindful of your spending. You may want to think about tightening up a budget or adding to your emergency fund. Your financial planner can help guide those decisions to ensure you make informed choices.
Brian McKinney is a Senior Wealth Advisor at GRID 202 Partners, a financial planning firm with locations in Washington D. C. and North Carolina. As a Certified Financial Planner™, he has extensive experience working with high net worth families to grow, protect and build wealth. Brian also holds an MBA in Finance and Real Estate from the Goizueta Business School at Emory University.