Talking Money: Homeownership 101

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Posted: Sep 30, 2009 2:27 PM

If you have homeownership on your list of financial goals, perk up your ears, the odds are in your favor right now! In most parts of the country, home prices are still low. (Although we are starting to see a slow turnaround.) Interest rates on mortgages are low, averaging 5.20 percent right now for a 30-year fixed rate. And, if you're a first-time homebuyer, you'll see a nice tax credit come your way if you seal the deal before Dec. 1, thanks to the American Recovery and Reinvestment Act of 2009. It credits you with 10 percent of the purchase price, up to $8,000 ($4,000 if you're married, filing separate tax returns).

Even with all these positives, purchasing a home is not to be taken lightly. I've always thought that although many people can afford to buy a home -- they have the down payment in the bank, the credit score to get a mortgage -- those same people often don't stop to consider whether they can afford to own it. Here's how to evaluate the whole picture:

-- Run the numbers. The amount in mortgage debt you're pre-approved for is not how much you can afford to spend. Even in these more conservative times, lenders may be willing to lend you more than you can afford. "The banks have their own calculation, a certain percentage of your disposable income that they want you to allot toward a house, and I tend to think it might not be conservative enough for some people," says Ilona Bray, co-author of "Nolo's Essential Guide to Buying Your First Home." So do your own math -- take a look at your monthly budget, subtract any expenses that can be deleted (rent, for starters) and see what's left over each month. That's the amount you can afford to spend on your home each month, not only for the mortgage payments, but also maintenance, taxes, insurance and utilities. If you want to be really safe, practice living without that amount for a month or two, just to see how things go.

One note: Don't forget that mortgage interest is tax-deductible in most cases, says Dr. Gary Smith, co-author of "Houseonomics: Why Owning a Home is Still a Great Investment." "If you're borrowing at a 6-percent rate, it might only be 4 percent after taxes, depending on your tax bracket." Your accountant or online tax-prep software can help you run the numbers. ?

-- Factor in closing costs. They can be expensive, often running upwards of $3,000, depending on the purchase price and area. To get a rough idea of what yours might be, ask your real estate agent, or take a look at your state's average on Bankrate.com, which released its 2009 Closing Costs Study at the beginning of September. Once you have an estimate, you'll know how much you have left for a down payment. If it's not 20 percent of the loan amount, you'll have to pay PMI (private mortgage insurance) on a monthly basis, which can add $100 or more to your monthly mortgage payment.

-- Consider maintenance, taxes and insurance. Property taxes can really get you, depending on your state. Your real estate agent should be able to give you an estimate. Asking the seller what they paid can be misleading, says Smith. "In California, for example, property taxes are tied to how much you paid for the home, plus an increase of 2 percent every year. If you buy a home from a seller who purchased it 30 years ago, their taxes will be based on what they paid then." You can, however, ask the seller how much they pay in homeowners insurance, and it's a number that can usually be fiddled with a bit, by raising your deductible or shopping around for a lower rate.

As far as maintenance, take a good, hard look at the home inspection. It will alert you to any other major problems coming down the pipeline. You always have to expect the unexpected, and that means socking away money for emergencies. The rule of thumb is to count on spending 1 percent of the purchase price of your home every year for maintenance. But be smart: If you live in an older home or fixer-upper, you should expect to save even more. ?

-- Remember additional fees and expenses. If you're moving to a new city or town, you need to account for a change in your cost of living. That could mean a longer commute, higher grocery costs or uniforms if you live in a school district that requires them. If you're buying a condo or will live in a planned development, you need to ask about monthly fees as well. "They can be as high as an apartment rent -- $500 to $1,000 a month -- and they can change," says Bray. Ask for a history of those charges -- it's standard for the association to hand it over along with the covenants, conditions and restrictions that dictate how they operate and what rules you need to follow. That way, you'll see if they've been increasing each year, and by how much.