How To Buy A House
Owning real estate is an important foundation for building generational wealth. Whether you're buying your first house or your 100th rental investment property, this guide is designed to simplify the home buying process and provide a framework to build wealth through real estate.
By the end of this guide, you will be well on your way to financial literacy, know how to buy a house and avoid costly home buying mistakes.
Step 1: Live Within Your Means
Financial independence is something we all strive for. The only way to be financially independent is to spend less money than you earn. The importance of this concept cannot be overstated. If you are unable to live within your means, you are not ready to buy a house, and you are not going to build lasting wealth.
When you live within your means, you accumulate savings. Your savings gives you the ability to afford a down payment on a house. Without savings, it is very difficult - though not impossible - to buy a house.
We live in a society conditioned to consume. Every day we see hundreds, if not thousands of advertisements designed to convince us to spend money. Research has shown that ones ability to delay gratification is directly correlated to high achievement. Instead of impulsively buying the hot new widget, those who avoid that natural temptation to spend will accumulate a lot more money than those who cannot resist the urge to spend money frivolous things.
Step 2: Buy Assets
In his #1 bestselling personal finance book Rich Dad Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not!, Robert Kiyosaki discusses the difference between buying assets and buying liabilities.
Buying Liabilities vs. Buying Assets
When you buy a liability, you are buying something that takes money out of your pocket. For example:
- $100,000 car that loses value the second you drive it off the lot and requires $200 of maintenance monthly.
- Renting a luxury apartment for $2,000 per month -- at the end of the day that money is gone, you do not own the property, and you are contractually obligated to pay the remaining months on your lease.
- Buying a house that requires expensive maintenance at a price that would be hard to sell to another buyer (i.e. Michael Jackson's Neverland ranch)
When you buy an asset, you are buying something that grows in value and pays you money. For example:
- Buying a $100,000 rental investment property that pays you $300 per month in free cash flow after expenses and returns 12% annually on your initial investment.
- Investing $100 per month in a Vanguard ETF that pays a 2% dividend and over time will appreciate in value 5 - 10% annually.
- Buying a $250,000 house with $12,500 (5%) down payment that costs $1,400 per month in mortgage, taxes and insurance -- after 1 year you have bought down nearly $5,000 in principal from the loan. Check out our free mortgage calculator to see a more detailed breakdown in the costs to buy a house.
The key to building wealth is to buy assets and avoid buying liabilities.
Step 3: Find A House That Makes For A Good Long Term Investment
If you spend too much money buying a house, that is a bad investment. It's not just about buying the right type of house, it's about avoiding paying too high a price. To put this into perspective, in certain real estate markets, there are people who bought houses in 2005 - 2007 during the peak of the housing bubble whose houses are still worth less in 2020-21 than when they were purchased.
One way to avoid overpaying is understand when demand outweighs supply. In this situation, such as that during the COVID-19 coronavirus pandemic, we saw record low interest rates fueling strong demand for suburban detached single family houses however there was record low housing inventory (supply) available on the open market. This resulted in intense buyer competition, bidding wars and double-digit percentage increases in home prices.
When the market heats up, a prudent home buyer will:
- walk away from bidding wars (know your max price and stick to it)
- wait on the sidelines
- look off-market where competition is lower (see OfferMarket listings, 40% Of Real Estate Investors Bought Their Last Property Off-Market)
- look at markets that are in lower demand (i.e. urban townhomes during COVID-19 housing market)
- look at distressed properties that need major renovation
To this final point, most homebuyers want to buy a turnkey property that they can move into right away. This makes sense because most homebuyers don't want to have to plunk down even more money on top of a down payment and closing costs to renovate a house. Most buyers are eager to move in right away and unwilling to delay the gratification of their home purchase. This creates an opportunity for home buyers to think like fix and flip investors and buy a less desirable fixer upper that needs anywhere from minor to major renovation. To use this strategy effectively, you need to understand how to screen and manage contractors and cost-effectively rehab a house.
Know The Market
Real estate markets are hyper local. One town could be significantly more attractive than the town over. Understand trends in economic development, local government, public school district, population.
Buy A House That You Can Keep As A Rental
If you buy a house for a primary residence (to live in), that you know you can easily rent out for a monthly rate that covers your monthly expenses and provides a profit, it makes the investment significantly lower risk. To put this in to perspective, we have House A and House B.
- Purchase price: $250,000
- Monthly principal, interest, taxes and insurance ("PITI", "carrying cost"): $1,400
- Monthly maintenance: $100
- Market rent: $1,750
- Rental Free Cash Flow: $1,750 - $1,400 - $100 = $250
- Purchase price: $250,000
- Monthly principal, interest, taxes and insurance ("PITI"): $1,400
- Monthly maintenance: $100
- Market rent: $1,250
- Rental Free Cash Flow: $1,250 - $1,400 - $100 = -$250
All else equal, House A is a much safer investment than House B. House A is an asset than could be held as a cash flowing rental property if and when you decide to buy another house as a primary residence. House B, however, doesn't make much sense to own because you would need to pay money out of pocket on a monthly basis for an indefinite period of time to cover the shortfall between market rent and carrying cost.
From this perspective, some real estate markets are difficult to justify buying a house in because the monthly carrying cost exceeds what you could rent it for. In these market, buyers rely on home price appreciation (increase in the value of the house) which is not guaranteed.
Step 4: Get Pre-Qualified For A Mortgage Loan
Once you are ready to buy a house, if you plan on using a mortgage loan, you will need a pre-approval or pre-qualification letter from a reputable lender. Getting pre-approved typically takes less than 24 hours and can be done online through most local or national mortgage lenders. Just because you get your pre-approval from one lender doesn't mean you need to use them for your loan.
Step 5: Submit Offer(s)
Use a mortgage calculator to understand what you can afford and set your maximum budget. Avoid the natural tendency to compete for a property, don't let your desire to win or an emotional connection to a given house cause you to behave irrationally. It's better to start off with a low offer and be willing to place low-end offers on multiple houses.
Understand Your Levers
You don't need a real estate agent ("buyers agent") to submit an offer. In fact, you can actually save money by choosing to not be represented by an agent. If you are making an offer on a house that is listed by a real estate agent ("listing agent"), you can request that the portion of the brokerage commission that would otherwise be paid to the buyers agent -- usually a 50/50 split, therefore typically 2.5% to 3% -- be waived, so the seller only pays 50% of the commission (2.5% or 3%) to the listing agent. In exchange, you can submit a lower offer that factors in the savings the seller is receiving from the reduced commission.
If you have the means, you can offer a higher earnest money deposit ("EMD") and/or offer to close on an accelerated timeline -- say 30 days instead of 45 days. These deal points can make your offer significantly more attractive.
If you are confident in the condition of the property, you can make your offer AS IS and waive your inspection contingency. This avoid frustrating post-inspection negotiations that can sour a home sale. If you choose to go this route, we recommend touring the property with a trusted licensed contractor before submitting your offer.
Step 6: Make Vendors Compete, Avoid Unnecessary Expenses
Most lenders are not going to quote you their lowest rate off the bat. Make lenders compete, request rate quotes from multiple lenders and use quotes as negotiating leverage to get the best rate.
Be mindful of unnecessary fees, and fees that can be shopped and negotiated. These line items include title insurance, loan origination fees, home inspection, homeowners insurance.
Step 7: Be Vigilant About Maintenance Requirements
It's important to protect your investment. Whether you're buying a primary residence or an investment property, it is always a best practice to fix small issues before they become major issues. This means fixing a roof leak before it worsens and you need to replace the entire roof and associated water damage and mold.
Always keep enough cash on hand to cover periodic maintenance. Don't cut corners in your maintenance, get to the root cause of any issue and fix it. Make sure your contractors are licensed and insured. You can join local real estate investment associations and local Facebook groups to network with real estate professionals, get contractor referrals and get second opinions before spending considerable sums on maintenance and renovation work.
Step 8: Enjoy Home Ownership
Home ownership can be stressful at times, but it is something you can truly be proud of. Real estate is a wonderful long-term investment and when bought correctly, a powerful vehicle to build wealth for you and your family. Enjoy the process of buying a house. If you follow this guide, you will not regret it.
Questions or comments? Feel free to contact us!