Step 1: Determine your maximum price
When we started looking for a house we didn’t have much of a down payment. We were still socking away money because we had moved the Debt Snowball payment into the Emergency Fund payment, so switching to the Down Payment Fund was easy. Didn’t feel a thing. Remember the formula for getting a mortgage is at least 20% down and a payment no more than 25% of your take home pay. You have to meet both criteria. At this point in our process, the down payment was our limiting factor. The good news is that every payday we upped the maximum price of houses that we were looking at since we were increasing the Down Payment Fund. Add $1,000 to the fund, and you can look at houses that cost $5,000 more than last time.
We started off looking at some really, really cheap houses. We were looking at houses in the $80,000 range in a market where the median home price is $200,000 just to give you an idea. (One quick note: At the time, no lender would give a mortgage less than $50,000. Your minimum price would then be about $65,000 to account for your down payment.) As our down payment grew, our maximum home price grew as well. Eventually, we would have gotten to the point where our down payment would be more than 20% in order for us to keep the mortgage payment at an acceptable level.
We made an important decision here, by the way. We have several friends who had bought houses based on both spouses working, because they knew that mom would always want to work. Then, they got pregnant. Mom changes her mind and wants to stay home but can’t because they can’t afford the house without her income. Given the choice between continuing to work or moving to another, cheaper house, every couple chose to have mom continue working. After seeing that happen, we decided to base our maximum mortgage payment on my income only. If Mrs wizardpc decides to not go back to work after lilwizard comes home, it’s totally okay. If she does go back, that’s okay, too! Right now the plan is for her to work part time, but the important thing here is that it’s her choice, and she has that choice because we opted for a smaller mortgage. The best thing about getting out of debt is that you have more choices. Anyway, just something to think about.
So let’s say your take home pay is $4200 per month. From yesterday’s numbers we know that means your maximum mortgage should be about $150,000. To hit your maximum, you’d need to buy a house for $187,500 and put $37,500 down.
“But what if I want a $200,000 house?”
Well, since you’re maxed out on your monthly payment, your down payment has to be larger than 20%. In this example, you’d need to put down $50,000.
So you wind up with two formulas. The first one is:
House Price = Down Payment x 5
Use that formula until you get to the maximum loan amount you’re comfortable with. Once you hit that point, your new formula is:
House Price = Maximum Loan Amount + Down Payment
I feel like I should remind you that your down payment is not everything you have saved up to this point. Your down payment does not include your Emergency Fund! Your down payment does not include any closing costs, loan fees, or moving expenses! You have to save for those, too! Your realtor will be able to give you a good idea what to expect for those costs, but an extra 5% of purchase price is probably a safe number.
The temptation to use some of your Emergency Fund money to pay for closing costs or as part of your down payment will be strong. DON’T DO IT! You may move in to the house and have the heat go out, or the pipes may freeze, or you might accidentally flood the bathroom! Your transmission might die! If you spent your Emergency Fund, you’ll have an even bigger problem!
Now that you know what your maximum price is, you can actually start looking at homes.
Step 2: Determine your minimum requirements
Talk this one through with your spouse, because otherwise you might be looking for two different things. Your requirements may change as your maximum price goes up. For example, when we were looking at $80,000 houses our square footage requirements were much smaller than when we were looking at $145,000 houses. Number of bedrooms, bathrooms, garage spaces, etc. When we started I think my only requirements were three bedrooms in a neighborhood that didn’t scare the crap out of me.
Step 3: Getting professional help
At this point, you should have a buyer’s agent. A buyer’s agent is your realtor. They may or may not also sell houses. Getting an agent will allow you to get inside homes and they will also help navigate the paperwork when it’s time to buy. They’ll also do the negotiations. Get a buyer’s agent. This is non-negotiable.
You’ll also want to get pre-approved for a mortgage at this point. You’ll lock in your rate when you pick your house. Get with a local mortgage broker so you don’t have to do everything by fax.
You’ll probably want to interview several agents and brokers.
Step 4: Finding houses to look at
This is where having really good requirements helps. Your agent will be able to sign you up for daily emails of every house that either comes on the market or has a price change that meets your requirements. You may also check out your local MLS. Here in the middle Tennessee area, that’s RealTracs. It’s a very powerful service with lots of granularity. Sites like Zillow may or may not include the entire MLS listings for your area. Ask your agent.
The internet is your best friend here. We literally investigated every house in an eight county area. On the first pass, we verified that the requirements were okay. On the second pass we verified that the location was okay (ie not in a scary neighborhood, or not so far from work that the commute would be excruciating).
Your agent and broker may also know where to get lists of bank-owned properties. There are so many foreclosures out there that you’d be stupid not to at least look at them.
Step 5: Looking at houses
Once we had a list of houses, we mapped them out. We usually did this on Friday night, and on Saturday morning we would leave with our map and printouts of all the houses we wanted to look at. I think we typically drove by 20 houses in one day. Doing this also allowed us to expand our knowledge of which neighborhoods were safe and which ones were scary, helping to limit our searches later.
If any of the houses excite you and your spouse, call your agent to schedule a showing.
Your agent will also probably try to get a list together for you and show you a bunch of houses at once. The agent will actually be able to take you inside, whereas when you go looking by yourself you’ll just see the outside.
I think we looked at houses for 4 months before we actually bought one.
Step 6: Getting the house
Once you’ve found a house, it’s basically up to the professionals you’ve hired to take you through the process. If you found good ones, this will be a smooth process. If not, well…you have my sympathies.
In any case: Congratulations!
Tomorrow I’ll cover some of the math showing why keeping a mortgage–even a 15 year one–makes your home a bad investment.
The Mrs. and I are also following Ramsey’s plan. We are currently on Step 3, having paid off our cars and cards, our only debt is our mortgage.
The one comment I would like to add is in regards to determining your maximum home price. That 25% cap is for all housing expenses, not just the mortgage. Since you’re putting down 20% you don’t have PMI, but you will have state and local taxes and insurance. The easiest way to look at it is if you’re using escrow, the ENTIRE check you write each month should be no more than 25%.
Thus, if you live in a high-tax area, you’re going to be able to afford less house. Conversely, if you live in a lower-tax area, then the house portion of your payment can be less.