04-07-2014 09:00 AM
Content provided courtesy of USAA.
Buying your first home may seem like a smart move right now. With home prices on the rise, you might be thinking it's time to take the plunge while interest rates remain low. It's even more tempting when you compare a friend's or family member's mortgage payment to your monthly rent.
The price of homeownership, however, is made up of other recurring expenses that aren't always so obvious.
"Getting into a house is only the first step," says J.J. Montanaro, a CERTIFIED FINANCIAL PLANNER™ practitioner with USAA. "Because you want to be able to stay in the house, you've got to make sure you'll be able to meet all the costs."
To do so, Montanaro suggests creating a monthly budget for any house you're considering buying. Figure these eight home expenses into your budget when you're planning to make the move.
1. Mortgage payments
If you finance your home, your monthly mortgage payment will go toward the principal (the amount you originally borrowed) and the interest on that principal. The amount of your payment will depend on how much you borrow, the interest rate on your home loan and the amount of time you have to pay off the loan.
"Play it safe," warns Scott Halliwell, a CERTIFIED FINANCIAL PLANNER™ practitioner with USAA. "Just because the calculator says you can afford a home doesn't mean you really can. You've got to compare your cash flow to all the extra costs of homeownership."
Added to your monthly mortgage cost could be a payment to build an escrow, or reserve, account. Escrow accounts allow you to save incrementally for homeowners insurance and property taxes. Lenders keep this money on deposit, and pay local governments and insurance companies when those bills are due.
"If these expenses aren't included in the monthly payment to your mortgage company, you'll need to budget for them and make sure you pay on time. Not having the money or not paying on time can be financially disastrous. Sometimes, it's just better to have a lender handle these expenses for you," says Halliwell.
2. Private mortgage insurance
If your down payment is less than 20% of the home's price, you usually are required by the lender to take out a private mortgage insurance policy. This policy protects the lender in case you default on the loan. According to the trade group Mortgage Insurance Companies of America, for a home costing about $200,000, the monthly premium runs between $50 and $100. The closer your down payment is to 20%, the lower your monthly cost for PMI.
You may be able to have the PMI removed when you reach 20% equity. Often, you'll have to request this from your mortgage provider.
3. Homeowners insurance
"Homeowners insurance is critical in ensuring you're able to cover rebuilding, repair or replacement costs in the event of a major catastrophe or theft," says Halliwell.
If you borrow money from a mortgage lender, you're required to purchase homeowners insurance. According to the latest information available from the Insurance Information Institute, the average home insurance premium costs around $900 per year. "Before you buy a house, ask your insurance agent for a quote so you can budget accordingly," Montanaro says.
4. Property taxes
Local governments charge real estate taxes to pay for public expenses, such as schools, parks and sidewalks. The seller or seller's real estate agent can tell you the current annual tax on a property. "Also ask when the next tax assessment is scheduled and whether it will be increased by the sale of the home," suggests Halliwell.
Once you find the right house, ask the seller for a record of a year's worth of utility bills. "This way, you can budget for heating, cooling, electricity, natural gas and water expenses," recommends Montanaro. "Be sure to account for any differences in family size. A single person will likely use far less water, for instance, than a family of four."
When you own a home, there's no landlord to call if it needs repairs. A qualified home inspector can walk you through the condition of a residence before you sign on the dotted line. "Based on the home inspection, you'll get a pretty good snapshot of what to plan for — the life expectancy of major components, like the roof, heating, plumbing and electrical," says Greg Herb, former regional vice president for the National Association of Realtors®, and broker and president of Herb Real Estate Inc. of Pennsylvania.
Even so, you still should have a line item in your budget for other, ongoing maintenance. Whether it's replacing furnace filters, staining or refinishing decks, painting exterior trim or refreshing the plants and mulch in your landscaping, there's a high likelihood that you'll be spending regularly on your home's upkeep.
"Owning a home magnifies the importance of maintaining an emergency fund equivalent to at least three to six months of routine living expenses," says Montanaro.
7. Making the house your home
"One of the biggest categories I've seen catch people off-guard is what I call 'making it mine'," says Halliwell. You might fall in love with a house, but when you move in, your furniture doesn't fit, you don't like the kitchen counter or you'd prefer wood floors to carpet.
"You could easily spend thousands of dollars if you're not careful," Halliwell warns. He suggests making a list of what you might need to buy — furniture, rugs, window treatments and lawn-care equipment, for example — and then creating a budget. Too often, says Halliwell, buyers struggle to make a down payment and then put their making-it-mine expenses on a credit card. "The next thing they know, they're buried in credit card debt, and what started out as a happy event quickly turns negative," he says.
8. Other costs to consider
"As rewarding as homeownership can be, it does seem to come with an endless stream of expenses that fall into the 'other' category on your budget," says Halliwell. Whether it's a home security and monitoring system or weekly trips to the local home improvement store, make sure you have the money to cover it by building some wiggle room into the budget for your new home.
You'll also need to factor in HOA fees if you purchase a condo or town house or move to a community covered by a homeowners association.
Finally, don't forget about the cost of purchasing extra life insurance. For many families, having enough coverage to help pay off the mortgage should something happen to a significant chunk of its income is a necessity. SGLI or employer group coverage, which is dependent on your employment or military status, may not be enough. If you get laid off or leave the military and lose those policies, and then pass away unexpectedly, your family could be left without even that basic coverage to help pay the mortgage.
A 2013 consumer study conducted by Life Insurance and Market Research Association indicated 50% of U.S. households said they needed more life insurance, and 41% of recent shoppers of life insurance said a life event motivated them to shop for it. "A new home is definitely a life event," says Montanaro, "and that requires a fresh look at your life insurance coverage."