A Guide to Home Buying for Young Professionals
Buying a home has historically been a rite of passage for many young professionals. You’d graduate from college, get that first job, get engaged, then married, buy a house together, and kids were likely to soon follow. In today’s world, however, young professionals are increasingly delaying the timing of many of life’s proverbial grown-up moments and in many instances are switching up the order of them too.
However, even in the midst of redefining what life’s defining moments are, many young professionals still find themselves interested in purchasing a home at some point in their lives. That decision necessitates proper planning for what is oftentimes the biggest purchase young professionals will make.
Estimating What You Can Afford
There is likely no more important aspect to buying a home for young professionals than calculating out an appropriate price you’re willing, comfortable, and most importantly capable of paying. Estimating how much house you can afford is fundamental to your overall financial health, as far too often people find themselves house rich and cash poor which jeopardizes their ability to achieve other goals in life and to remain financially flexible.
When estimating how much house you can afford, it’s often easier to start by working backwards and estimating what you can afford on a monthly basis. As a general rule of thumb, young professionals shouldn’t spend more than 28% of their gross monthly income on total housing expenses—mortgage payment, homeowners insurance, taxes, etc.—which gives a general starting point for what an appropriate monthly payment might be.
Once you’ve estimated an affordable monthly payment using the 28% rule of thumb, you should be able to get a sense of whether or not that payment would fit into your monthly budget. From there you can use a number of helpful online calculators to estimate an appropriate price tag for your future home that will take into consideration your current household income, your down payment, homeowners insurance, taxes, potential interest rates and other debt payments.
Calculating an Effective Savings Plan
Once you’ve estimated what an appropriate price tag for your future home it’s important to craft an effective savings plan that will allow you to make that purchase a reality. This can generally be done by first estimating what your down payment will be and then backing into how you will accumulate that amount of money by the time you hope to make that purchase.
Generally speaking, it’s a best practice as a young professional to put down 20% of the home’s purchase price. This simply means you have to pay 20% of the price of the home upfront, while financing the other 80% of the home with a mortgage—home loan—that you will pay off over time. If for example, you wanted to purchase a home that costs $300,000, you can realistically expect to put down about $60,000 upfront, which is no small chunk of change.
Once you’ve settled on what will likely be required as a down payment on your home it’s important to estimate roughly how long until you want to make the purchase. If using the example above you wanted to purchase that home in five years, you’d need to accumulate $60,000 over the course of five years. This would likely require saving about $10,000 per year earning about 6%.
By arriving at approximately how much money you’ll need to save on an ongoing basis you can then automate the required savings so that your busy life doesn’t get in the way of the consistent savings required to achieve your goals. Be sure to keep in mind that no financial goal can be looked at exclusively in a vacuum, as there are likely to be other important goals—saving for retirement, paying down student loans—that will require resources to be diverted to them too. This is where financial planning becomes much more art, than science as it requires an honest assessment of tradeoffs.
It’s important to note that many lenders and states offer loan programs that don’t require 20% down for various borrowers, including many first-time home buyers. In some instances, you can put as little as 2-3% down on a home, but keep in mind that if you put less than 20% down on a home, you’ll be required to pay Private Mortgage Insurance (PMI), which is an expensive extra monthly cost. Also, a higher down payment generally decreases your monthly payment, providing you with additional flexibility ongoing.
Which Vehicle to Use When Saving for a Home
You’ve finalized the buy vs. rent decision, picked the elements of a house that are essential, settled on an affordable monthly payment, and how much you need to save for a down payment. Now it’s important to set up the appropriate savings vehicle that will allow you to effectively save for your down payment, while providing investment flexibility, liquidity when it’s time to access the money, and as much tax savings as possible.
The most common approach to saving for a down payment is simply to use a savings account or an individual investment account. Both accounts will provide complete flexibility for you to access you money when you need it, unlike a 401(k) which generally requires you to be over the age of 59 1/2 to access your money. If you plan to make a down payment on a house in the next year it’s best to invest the money very conservatively to ensure your savings don’t decline right when you need the money most. This can be accomplished with a high yield savings account or a very conservatively invested portfolio.
The other option is to use an IRA, using a little-known tax benefit that the IRS provides to first-time homebuyers. For those savings for their first home, the IRS allows penalty-free distribution from an IRA or Roth IRA of $10,000 per person. If using money from a Roth IRA, there are additional requirements to be careful of so it is important to consult a tax professional before doing so.
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