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Compared to other investments such as stocks or bonds, purchasing a home presents a personal and lasting tangible asset offering a significant appreciation of value over time.
Though first-time buyers are often overwhelmed with the process, the benefits from real estate are worthwhile for those willing to put in the effort, beyond just having your own place to call home.
Continue reading for a high-level look at making your first investment in the housing market a success.
Unless you're in the enviable position to purchase the home with cash, you'll need to begin with the financing process. This starts with a detailed accounting of your cash flow. The raw data on your assets, cash on hand, investment liquidity, debt liabilities, and monthly miscellaneous expenses.
Lenders want absolute clarity about your employment history, current and future income, outstanding debts, and your ability to repay the loan. Use a mortgage repayment calculator to help put numbers on the different scenarios. At this point, these are rough estimates to establish a baseline for how much you'll need to borrow.
Now is also an excellent time to request a credit report, evaluate the score, and correct any glaring errors which would impact your ability to qualify for favourable interest rates and mortgage terms.
A 760 score is typically the premium benchmark, which gives borrowers a low-risk rating in lenders' eyes, guaranteeing the best rates and terms. A score between 700 and 759 still positions you well for competitive loan terms, while 620 and below is where things get dicey. Here, borrowers face the highest interest rates and large down payment requirements to offset the perceived risk.
To improve your score, you'll need patience and consistent effort. Pay all your bills on time and reduce outstanding credit card balances. Manage your credit mix with diversification, and avoid opening numerous accounts in short periods. Instead, work towards keeping long-standing accounts open and updated on payments, thus ensuring a good history and responsible credit management.
Your debt-to-income (DTI) ratio measures your recurring expenses relative to your incoming cash flow. To express it as a percentage, divide your total monthly debt outlay by gross monthly income, then multiply by 100.
The higher your DTI is, the more likely you'll face a high mortgage interest rate. Most lenders consider an ideal threshold of 36 per cent for monthly expense payments, including housing-related costs. Excluding housing costs, lenders like to see that number at or around 28 per cent. Depending on the lender, the absolute DTI ceiling is between 43 per cent and 50 per cent.
Finalising the mortgage contract means you'll pay closing costs ranging between two per cent to six per cent of the purchase price. Lenders, attorneys, home inspectors, and appraisers also charge fees for the paperwork and other services related to the completion of your purchase.
Once you close the sale, you'll also have moving expenses (fuel, truck rental, labour), cleaning, repairs, and other miscellaneous costs associated with move-in activities. Start saving early in preparation for the expenses due on closing day.
Begin the process of choosing which type of mortgage works best for you. Generally, you'll decide between a fixed or adjustable rate (ARM). Fixed-rate contracts allow for a predictable yet higher interest rate and corresponding monthly payment.
ARMs begin with a lower rate for a specified period, followed by predetermined intervals where your rate may rise or fall. The direction of ARM fluctuations depends on the prevailing market rate adjustments, the RBA's inflation rates or central bank policies, and overall economic conditions.
The main advantage of an ARM is the introductory period, where you enjoy the lower initial interest rate. This may be your best option if you plan to own the home for a relatively short period. Beyond that timeframe, don't forget that you risk exposure to potential longer-term rate increases if the market turns out of your favour once the introductory period expires.
You should also compare fixed-rate loans of either 15 or 30 year duration. The shorter option offers you lower rates. So, you'll save significant money in interest if you can swing the larger monthly payment.
It all depends on what you and your family have planned regarding living arrangements, investment goals, and so on. Those with a short-term outlook are better off considering ARMs or fixed-rate mortgages less than 30 years' duration.
Buyers looking to live in the property long-term or use it as an investment to rent out would likely choose the stability of a 30-year fixed-rate loan where you can lock in a decent interest rate for the long haul.
Collaboration with your financial advisor and real estate agent is the next step toward achieving your investment goals. They will expand on the high-level concepts introduced in this article to formulate an action plan specific to your family's financial position and broader objectives.
Don't despair: everyone who's bought a home before has had to go through all these confusing and sometimes stressful processes, and all the confusion and uncertainty of wondering what the most strategic moves for them are. Everyone's situation is different, so consider your intentions with the property, and use this article to guide your decision making.