People have a lot of expectations when buying their first home. Most first time home buyers probably envision opening the doors to their dream house and triumphantly walking into their mansion. The culmination of their hard work and even harder saved dollars are embodied in this perfect piece of property.
While that is a great image to strive for, a more practical approach may be to buy a starter home like a fixer-upper or condo to tide you over as your first purchase. It isn't as pretty a setting as you'd like, but it could be a much smarter financial decision in the long run. In fact, it could help get you to that perfect home a little sooner.
Building Equity Toward Your Dream Home
There are actually several benefits to owning a starter home. Aside from a much smaller home mortgage to finance the purchase, prospective buyers can also ease their way into understanding the home purchasing and ownership process. But one of the best reasons to go for a smaller, less expensive home first is to build some equity that you can access when you upgrade your residence later.
If you're paying rent but aspire to one day be a homeowner, your best bet could be in buying a small home now versus taking on a large mortgage loan or paying rent until you save up enough money for a down payment on a large home. Here are some disadvantages to each approach:
- Renting: Unless you're paying a very low rate for rent, it doesn't necessarily make sense to fork over a sizable chunk of change every month to your landlord and try to save for a home purchase at the same time. While there are certain perks to renting over owning, the biggest drawback is that you build no equity despite all the money you're paying.
- Large Mortgage: Taking on a huge home loan to finance a property purchase is also a bad idea in most cases. You could end up smothering yourself under that weight of debt, and chances are that your mortgage loan is so huge, you won't be building any equity in the first few years of your housing payments anyway since it'll mostly just go to the interest costs.
You can use a mortgage calculator to see how long it'll take before you can start building up some serious equity in your property. Obviously, the larger the home loan amount, the longer it will take before your payments start making a real dent in the principal. This is why a smaller mortgage loan for a lower priced home is beneficial.
Small Home to Dream Home
Depending on your situation, buying a small house to build some equity and then flipping it to buy a larger home can be very effective in saving you money in the long run. Here are some factors to consider:
- Monthly Rent: If your rent payments are favorable, it may make sense to stick around and save up extra money. Depending on the size of your mortgage loan and the current housing prices versus the rent rates in your area, it could be quite a few years before buying makes more sense than renting.
- Time Horizon: A shorter mortgage allows you to keep more equity and pay less interest over time. Though the payments may be higher, you pay down the principal a lot quicker. However, keep in mind a shorter time horizon may not give you enough time to build any equity, which would defeat the purpose of buying a small home first.
- Housing Market: You also have to keep an eye on mortgage rates and housing prices. If low prices or interest rates are offering a great opportunity, you should jump on them if you can. If they're inflated, you can afford to wait before making your move. You also don't want to buy if prices are likely to drop further.
- Down Payment: How much cash you have available is also important to how much equity you can build right off the bat. Let's say you have $40,000 for a down payment. While that might not be enough to cover 20 percent on your dream house, it may be more than enough to do the trick for your smaller starter home.
- Additional Expenses: There are so many extra costs that go into buying and owning a home that people don't expect. There are closing costs, property taxes, homeowner association fees, maintenance and repairs–the list goes on. Make sure you factor these into your calculations when weighing the pros and cons of buying a home versus renting.
There are a lot of advantages for first-time home buyers when going small and more affordable first. By not overextending yourself with a mortgage you can barely afford and still building equity over time, you position yourself to be more financially flexible to buy that dream home without the added stress of a huge load of debt. Before making a commitment to a home loan, however, consult a financial professional and do your own due diligence to see if this strategy works for your end goal of homeownership.
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