Buying a home is a big decision. There’s a lot of pressure to buy a home as it has become known as a gateway to adult life. Even many of those who have put it off and have had no problem renting (or living with parents) for years, still want to someday buy and own their own home. The pride of ownership is real. And although others’ pride can sometimes amount to pressure- only you can decide when is the right time to buy.
So for first-time buyers- what are your options? Often people decide that they are done renting and want to buy. They then see how much they can afford and find the best home they can qualify for. For most, this works. But you run into issues when either you can qualify for more than you really want and need (overqualified) or you can’t qualify for what you really need (under qualified). The best place to start is to decide if you’re buying your home for the Lifestyle benefits or the Financial benefits. You want to try to determine if you would be more happy getting the perfect home- or, to be frank, knowing you’re going to make a lot of money. If you are thinking of getting a “Starter” home- then you are buying a home for Financial Motivations, for the Financial Benefits, and should be searching accordingly.
I define a Starter Home as a home you buy with the intention of building equity and selling 5-10 years down the road so you can put that money down on a more long-term residence. This means you’re focusing as much as possible on the Financial benefits of buying a home. Your success will be based on how focused you can be on Financial benefits instead of Lifestyle benefits (putting the “Dream Home” on hold).
3 Reasons You Should Buy a Starter Home:
1. Build Equity
First, Equity build-up is the easiest form of Passive Income. Real estate is expensive. It’s really REALLY EXPENSIVE. Pick a random house out on Pinterest or Houzz and you’ll quickly realize you’re looking at homes that would cost $3k-$6k PER MONTH. Even looking at homes for sale in West Chester or Downingtown, a modest single-family home could still cost you $1,500-$3,000/mo, and that’s for a 30-year long mortgage.
Really, the only way to lower that monthly payment is to put more down on a house. When you can put at least 20% down you can get a better loan (conventional), a better interest rate, and you can avoid paying PMI.
2. Save Money
Secondly, You can leave some Margin in your budget. What you qualify for isn’t always the amount you can afford. When qualifying for a loan, the bank looks at your income and expenses, but only certain expenses like monthly debt payments, child support, and taxes (among other liabilities). They estimate all other expenses in a Debt-to-Income ratio.
The bank DOES NOT consider your standard of living, your taste in furniture, or whether you are planning on eating that month.
Or how stressed out you will be around Christmas time and your budget is looking pretty tight…
Buying BELOW YOUR MEANS might sound like a radical idea- might not give you an ego-boost at your high school reunion- but it will give you some financial margin in your life (which for many directly correlates with the quality of sleep they experience).
3. Less Maintenance
And finally, a smaller home is More Manageable for a first-time homeowner. Even if you were pretty handy around the apartment- you will be surprised at how much time you will spend on home maintenance. Getting a condo or townhome with an HOA, having little to no lawn, few flower beds and bushes, makes things easier to manage if you aren’t interested in spending your weekend doing chores.
What Should You Look For in A Starter Home?
There are some guidelines that I recommend when first-time homebuyers are looking for a home. Since you are buying for financial purposes, you want to focus on what you can afford and something that will appreciate in value quickly. To do that consider these factors:
The Neighborhood Home Values
The old adage “Buy the cheapest home in the best neighborhood” applies here. Even if a house needs work, if all the homes around it are selling for more there’s a good chance that over time the maintenance and improvements you do will pay off with interest. If a house is really nice but priced at or above surrounding homes, it is less likely to appreciate as much because most of its hidden value has already been uncovered.
Label a neighborhood a “buyer” area or “rental” area. Some condos, areas, or neighborhoods are more conducive to one over the other. Try to consider who might want to live in the house after you and if you are going to want to sell it to put the profit down on a new house, or rent it to build an investment portfolio. Typically is easier to sell a house that fits the “American Dream” profile- a single family home with at least 3 bedrooms, One full and one-half bath. A house might be a really great place to live, but for some reason initially turn off buyers- in that case, it might be a good rental opportunity.
The Buyer Pool
Consider the potential buyer pool size. The value of any home (of anything really) is directly linked to the size of the buyer pool for that home. The number of potential buyers reflects the demand for that property which affects the price. For example here in Chester County, we see a trend of people whose main motivation for moving is to be in a better school district. Therefore homes in school districts that are, and potentially will continue to be in high demand, are more likely to appreciate. Conversely, if you are planning on living in a home for a long time- appreciation doesn’t matter as much so outside of where you send your kids, the school district doesn’t matter as much.
Your Personal Criteria
Switch your criteria. When first-time homebuyers are asked what they want in a home- they describe the perfect home they’ve been dreaming about. However, if you ask them what they need to rent, it’s typically a list of practical features, most of which they would give up if it raises the rent too much. This is because their criteria change depending on if they are shopping with a Permanent mindset versus a Temporary mindset. There is a good chance yours does do. The key to buying the perfect starter home is to shop with a temporary mindset for a home that will quickly appreciate. This is how you switch to the investor mentality, even though your home will be more than just an investment. Because your starter home is more than just an investment, there are factors to consider outside of price and value… Although you need to focus on the profitability of the purchase, you still consider that you will be living in the home. You want to make sure you can still live comfortably for the time you are living there. Most importantly, you want to make sure that if circumstances change you can stay longer than initially planned. I have friends who bought at the height of the market. They bought a townhome with every intention of up-sizing as soon as they got the chance. When the market crashed in 2008, a lot of people in the neighborhood still needed to move and that drastically affected their home value. Instead of selling for a loss, they stayed in the home and raised 4 kids in something they would’ve thought impossible years ago. Over time they saved money by not moving, gradually paid down their mortgage and when the market came back have built a good amount of equity that puts them in a pretty good position if/when they do move. The lesson is if they bought too little house for their first time purchase, perhaps a 2 bedroom condo, the market would have devastated them financially, as they would have sold low and bought too soon, never really getting the home they want.