Are you ready to make one of the biggest purchases of your lifetime?
Carrying a $100,00+ home mortgage is something you’ll have to consider several times before your sign any papers. Even though this is a huge obligation, too many people don’t spend enough time preparing for this purchase. It’s almost like the sudden urge to buy a house, or watching friends/family purchase new homes dictates that “it’s time”.
There’s no “perfect time” to start looking for homes. It will take careful planning, and enough education. Understanding the difference between an adjustable rate and fixed rate mortgage is a great place to start educating yourself.
Hopefully, after reading this article you become more prepared to purchasing your new home, even if it’s a tiny bit 😉
Fixed Rate Mortgage
The name says it all, it’s “fixed”.
However, depending if you get a 15 or 30-year mortgage there are some differences. For example, if you opt-in getting a 15-year mortgage then your monthly payments will be higher. The upside is that your interest rates will be lower and you’ll end up paying less interest on the loan.
On the other hand, with a 30-year mortgage, you’ll have lower monthly payments. The downside is that you’ll have a higher interest rate and end paying more interest in the long-run.
ARM (Adjustable Rate Mortgage)
An ARM (adjustable rate mortgage) is only fixed for a period of time, then subject to change.
For example, on a 30-year mortgage, a “5/1” ARM means your interest rate is fixed 5 years, then adjusts annually for 25 years. Other types of ARMs include 10–15 years locked in a fixed rate. Typically, an ARM will have lower rates initially but can end up costing you double your monthly payments if chosen in the wrong scenario.
Depending on your personal and financial situation an ARM may be best suited for you. For example, if you know that you’ll be moving within 5–10 years then a “5/1” or “10/1”ARM may be appealing to you. This is because you’ll reap the benefits of the lower interest rate before it has the chance to climb up.
Deciding On Purchasing A Home
By now you should have a decent grasp on the key differences between adjustable and fixed rates.
But how do you decide when it’s the best time to purchase your first home?
You can use the following checklist:
1. Start calculating all of your expenses and follow the 28/36 rule.
This rule states that your house related expenses (mortgage, home owner’s insurance, misc. costs) shouldn’t exceed 28% of your pre-taxed income, and all your combined debt shouldn’t exceed 36% of monthly pre-taxed income.
For example, if you make $5,000 monthly (pre-tax) then your house related expenses can’t exceed $1,400, and your combined debt can’t exceed $1,800.
2. Have enough cash saved up
You’ll need anywhere from 5%–20% of your mortgage total saved up to use as a down payment, plus additional closing costs. It’s ideal to have additional money stashed up for those unexpected emergencies that happen in the most inconvenient times.
This is only the tip of the iceberg. There are many other steps involved when purchasing a new home, but they are irrelevant if you can’t meet the criteria mentioned above.
Focus on building your wealth and removing most of your debt. Your finances need to be on point before you acquire $100,000+ debt. Forget about keeping up with Jone’s and rent until you know that you can afford your new home.
Just because you can afford $1,000+ in rent doesn’t mean you’re ready to acquire a mortgage around the same price range. As a tenant, you have the pleasure of keeping your expenses low since your landlord takes the hit on major house expenses.
Buying your first home is exciting, but it can quickly turn into a nightmare if you don’t do your due diligence. Become educated on the different mortgage loan types, rates, and evaluate your financial situation.
Understanding the different type of rates you have available, and some of the criteria you need to meet before you start shopping for your first home is a great start.
Are you still ready to make the biggest purchase of your lifetime? Let me know in the comments below.
I’m sure you’ll make a smart decision when the time comes.