Are we financially prepared to buy a home?
Part of the whole “We Bought a House Young” things is that you have to kind of dive head-first into things, not being wholly prepared, but knowing that and keeping your eyes wide open.
I think buying a home is somewhat similar to having a baby….you are never really prepared. Generally when preparing to buy a home, you need several things:
A 20% down payment (there are exceptions to this).
Money for closing and moving costs.
A credit score that will allow you to take out a mortgage.
First, the 20% down payment. Kind of daunting, right? When purchasing a $150,000 home, the down payment would work out to $30,000. Wow, that’s a lot of dough! Typically lenders require a 20% down payment, but there are exceptions to this such as FHA Mortgages and other specialized zero or low down payment mortgage programs. A traditional mortgage requires the 20% down payment, but your credit score must be up to snuff (see the credit score explanation below), and the lenders are more picky about the condition of the house.
With an FHA mortgage, the route that we chose to go, the lender only requires a 3.5% down payment. If purchasing a $150,000 house, the down payment would only be $5,250, a difference of $24,750 from a traditional mortgage!! There are, however, downsides to an FHA loan. The main one that I was concerned with was Private Mortgage Insurance, or PMI. Lenders require this on any loan with a down payment of less than 20%, and since you pay it each month, the costs can really add up over the life of a mortgage
Just for kicks, I used Good Mortgage.com’s PMI calculator to show how the cost of PMI adds up over the life of a loan! I plugged in variables for a $150,000 home, with down payment amount of 3.5%. The PMI worked out to:
$138.75 per month
$1,665.00 per year!
$49,950.00 over a 30 year loan!!!!!
Good Mortgage PMI Calculator
In spite of the PMI, we decided to go with an FHA mortgage because we wanted the extra cash for repairing the house, the purchase price was so stinking low, because an FHA lender is less strict about the condition of the house, and because we will have this house paid off in 7 years, cutting $38,295.00 off of the PMI cost! Score One for the Retired by 40 family!
Closing & Moving Costs
A lot of people overlook closing costs when figuring the cost of buying a home, but the reality is that they can be quite significant. Most of the time, closing costs run 3-5% of the purchase price of the home. For example, in our $150,000 home purchase scenario:
3% – $4,500
4% – $6,000
5% – $7,500
To me, that is a lot of money on top of the down payment and the costs still to come!
Moving costs are also significant, but depending upon the move, can be cut down drastically. A cross-country move can cost a couple thousand dollars up to ten thousand, but choosing how you move can put you on the lower or higher end of the spectrum.
If you are only moving down the block or within a couple hours of your current home, moving costs can be even less! In our case, we were moving an hour away, so The Big Guy rallied all of his friends with trucks and trailers, we paid for gas and fed them lunch, and they were happy. The entire move cost us about $400! Plus, his friends like to hustle, so we were completely moved into the new house in 4 hours! Can you believe that?
Then, because there were these big, ugly bushes in front of the house, his friends stuck around and pulled them out with their manly trucks! Do we have the best friends, or what :-)
Well, I could write on credit scores for days, and maybe I will sometime, but for now since this post is getting a little long, I’ll be quick:
To take out a traditional mortgage (20% down, no PMI), your credit score has to be 650 or greater. They will not even consider you for a traditional mortgage if its less. Realistically, though, scores of 680 or less applying for a traditional mortgage will get significantly higher interest rates if they are even approved.
An FHA Mortgage (3.5% down, has PMI) has less stringent standards. The minimum score is 500, although credit scores of 500-570 have to put 10% down on the home. Credit scores below 620 have higher interest and PMI rates, and anything above 620 qualifies for the good interest rates and easier application process.
The reality is that credit scores are a complicated thing that I’m not even going to try to explain today. Paying your bills on time, paying credit cards off every month, and no being overextended on payments will generally lead to a higher score. Most people should try for a traditional mortgage because of the money they will save, but in some cases, like ours, an FHA mortgage was totally the way to go!
What do you think? Did we make the right decision going with an FHA Mortgage? How about thoughts on the cost of buying a home?
Other Posts in This Series:
We Bought a House (at 22)! – Part 2