The Four Things Every Home Buyer Should Know

April 19, 2010 — -- Home-buying hopefuls have until April 30 to write a contract on a house if they want to qualify for the $8,000 tax credit for first time home buyers or the $6,500 credit for current homeowners who are trading up. So it seems like a good time to share what I call "The 4 Walls of Home Ownership."

This is the four-part plan I developed for choosing a home you can truly afford, maintaining it properly and paying it off early to SAVE BIG. During the bubble years, people were buying homes they simply couldn't afford and the continuing foreclosure crisis is proof. "The Four Walls of Home Ownership" is my antidote. Here goes.

Houses need four walls to stand, right? Your financial foundation for home ownership needs to be strong too. When you have all four of these walls in place, they will be a sound financial structure for the sturdy house you hope to buy.

For the first wall, you save up a substantial down payment of 20 percent or more in a savings account that you open for this purpose and this purpose only. Stretch and strain for this sizable down payment, because it's the key to everything. During the bubble years, people were routinely putting just three to five percent -- even zero -- down. That's wrong. Why? Saving up a down payment is one way you prove to yourself that you are financially ready for home ownership. More importantly, the bigger your down payment is, the smaller your monthly payment will be and that will be a comfort in tight times. Furthermore, if you put down less than 20 percent these days, you will have to pay private mortgage insurance, which is a huge waste of money.

The next wall is making your mortgage payment equal your rent payment. That mortgage payment must include principal, interest, taxes, homeowner's insurance and condo fees, if applicable. I know it sounds crazy, but in most markets it is absolutely possible to buy a home at a price point that gives you a mortgage payment equal to your current rent payment. (If you live somewhere with stratospheric real estate costs, the solution is to save a larger down payment.) As long as you can currently afford your rent, this is one way to know for sure that you can afford your home. I don't like the vague, theoretical formulas real estate agents and mortgage brokers use to figure out what you can afford because everybody's personal financial situation is different. I created a nifty one-of-a-kind calculator that shows you what price home you can afford based on your current rent payment. It's a great conversation starter! (Note that the calculator automatically assumes a 20 percent down payment. If you can afford to put even more down, then you can afford a more expensive house than the calculator will reflect.) Try it here.