Whether you’re getting ready to buy your first home or are looking to upsize or downsize, there are many essential things to do before signing the closing papers. Buying a home can be exciting, but there’s also some financial risk involved.
Of course, one of the best things to do before you buy a home is to check your budget and make sure you know exactly how much you can safely spend on a home. Run the numbers for a down payment, property taxes, and monthly mortgage payments. When you know exactly what your price limit is, you can prevent the frustration of falling in love with a house and then discovering you can’t afford it.
After you’ve got your budget down, take the next steps to minimize your financial risk. By putting some protections in place before you contact a real estate agent or mortgage broker, you can protect yourself as a buyer and later, as a homeowner.
Fixed interest rate
If you plan on taking out a mortgage to buy your home, decide ahead of time to look for a fixed-rate loan. Interest rates are rising right now, and they may continue to do so for some time. In a high-interest market, “cheaper” options like adjustable-rate or interest-only loans may seem attractive, but these aren’t good long-term choices.
In a high-interest market, “cheaper” options like adjustable-rate or interest-only loans may seem attractive, but these aren’t good long-term choices.
The safest thing you can do is get a fixed interest rate. There’s no way of knowing what will happen to rates in the future. With a fixed-rate loan, you can know exactly what your monthly payments will be for the life of the loan. Plus, if interest rates drop in the future, you can always look at refinancing.
Emergency fund
The next essential protection is a healthy emergency fund. The standard rule of thumb is to save up between three and six months of living expenses, but there’s some wiggle room in there. The key is to have at least some money saved for a rainy day before you buy your first (or next) home.
If it’s not feasible for you to save up six months of living expenses and a 20% down payment for your house, which one should you prioritize? It might sound counterintuitive, but the emergency fund should take precedence. Yes, having a bigger down payment could lower your mortgage, but without an emergency fund, your finances can quickly spiral out of control.
When you’re a homeowner, you’re on the hook for home maintenance. You can’t just call your landlord if your furnace breaks or your roof leaks or you get a crack in the foundation. Having emergency fund money for those unexpected expenses prevents you from having to take out an expensive personal loan or put large purchases on a credit card.
Life insurance
The next protection to have in place is life insurance, which can allow your partner and children to stay in your home after you pass away. This may not be the happiest thing to think about, but it’s vital nonetheless.
You should have a substantial amount of life insurance coverage – probably more than you might think at first. Most people get enough coverage to pay off the entire mortgage and have an additional financial cushion for several months of living expenses. Alternatively, you can build a policy that would pay off all debts or a smaller amount just to cover income replacement.
If you have a partner, it’s best for both of you to have life insurance policies, especially if you have children. Even if one of you doesn’t work outside the home, they should still have coverage. A stay-at-home parent provides numerous services (child care, cleaning, cooking, etc.) that would cost a lot to replace should they pass away.
Disability insurance
What happens if you become ill or get in an accident and lose the ability to work? Life insurance won’t cover that, so what you need is disability insurance. Most disability insurance plans are designed to replace a portion of take-home pay: usually between 50% and 80%.
It may seem like disability insurance is an unnecessary expense. Realistically, what are the chances that you’ll need it? Probably higher than you think. According to the Social Security Administration, more than 1 in 4 20-year-olds will be disabled before they reach retirement age (67).
If you work for a large company that provides a well-rounded benefits package, you may already have disability insurance through your employer. Take the time to verify your coverage, especially before buying a home. The last thing you want is to think that you have disability coverage and find out you don’t when you need it. Knowing that there’s a safety net for you and your family if you can’t work for a while brings significant peace of mind.
Umbrella insurance
The final piece of protection for a potential homebuyer is liability insurance (sometimes called an umbrella policy).
This is additional insurance on top of your standard home and car insurance. An umbrella policy is designed to cover expenses that exceed your home and auto insurance coverage.
Although an umbrella policy is a fairly common insurance product, it’s an underutilized resource for many homebuyers. But having this extra level of coverage just provides more financial security if something goes catastrophically wrong.
If you don’t have liability insurance, take a little time to see what coverage would cost. Start by contacting your home and/or car insurance provider. Most insurance companies will offer a discount on multiple policies (e.g., home, auto, liability).
Protect your finances before buying a home
When you’re ready to buy a home, you might start dreaming about location, floor plans, and architectural style. Those are all good things to think about, but it’s even more important to consider the financial risks of being a homeowner.
By thinking ahead, you can protect yourself, your family, and your bank account in case things don’t go exactly as planned. Building an emergency fund, getting adequate insurance, and choosing a fixed-rate loan are great ways to lower the financial risks of homeownership.
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