Wealthfront's Home Planning Guide

There's no place like home

Whether you're just browsing or ready to make a move, buying a home comes with a lot of questions.

To help you get to the essentials, we've created three tailored guides.

What stage are you in?

> 5 years out

Planning
ahead

< 5 years out

Thinking
it through

This year

Ready
to go

Or dive straight into the full guide below

With data from

Affordability

What are the all-in costs of home ownership?

Conventional wisdom may lead you to believe that the only costs of home ownership are the down payment and the monthly mortgage payment. However, if you budget with only these two factors in mind, you'll likely be caught off guard when the bills come rolling in.

Some additional costs to keep in mind:

This is not meant to discourage you from exploring homeownership, but rather to provide a comprehensive view into the costs you can expect when you become a homeowner. See the benefits of home ownership

What does it take to qualify for a mortgage?

When it comes to securing a mortgage, there are several financial factors at play. Here are a few things you can do to ensure you qualify for a mortgage with favorable terms:

Keep your credit score up

Mortgage lenders consider your credit score when determining how risky it is to give you a loan, which impacts the interest rate you can get. If your credit score is above 750, you are likely to get a mortgage interest rate that is 0.20% lower than someone with a credit score of 660 to 680. If your credit score is below 600, you should expect some challenges in qualifying for a mortgage and, if you do find one, it may have a much higher interest rate.

Keep your Debt-To-Income (DTI) ratio low

Your DTI is the sum of all of your monthly debt payments, including credit lines, credit card debt, auto loans, and your upcoming mortgage expenses, as a percentage of your monthly pre-tax income. Most mortgage lenders prefer to issue a mortgage that will keep your DTI below 33%. Once your DTI goes above 44%, it becomes much more difficult to secure a mortgage.

Make a healthy down payment

The size of your down payment, or the upfront payment you make on the house, impacts the size of your monthly mortgage payments. The standard rule of thumb for a down payment is 20%, however, the median down payment in the US is 15%. Mortgage lenders will often offer lower interest rates when a down payment of greater than 20% is made.

While these three inputs are common for most banks, mortgage approval standards vary regionally. In fact, our analysis shows that the median DTI ratio across states ranges from 32% in Kansas to 40% in Hawaii.

Your home budget is limited by the size of your mortgage, but other factors are at play as well when it comes to affordability. See more details

How big should my down payment be?

Before diving into the details, let's first define a few key terms:
  • Down payment refers to the upfront payment you make on the house.
  • Principal payments reduce the amount you owe on your mortgage.
  • Interest payments are what the bank charges for lending you the money.

The size of your down payment directly affects the overall costs of your home. The standard size of a down payment is 20% of what you pay for a home. If you put more down, you will have smaller monthly principal and interest payments.

If your down payment is lower than the standard 20%, not only will you have higher monthly principal and interest payments, but many mortgage lenders may require additional mortgage insurance, which can be up to 1% of your total mortgage value. Not to mention, if you put less than 10% down, you may have trouble qualifying for a mortgage at all.

Example

Larger down payment means lower monthly payments

The example assumes a home that costs $800,000 with a 30-year fixed rate mortgage.

Down payment 10% 20% 30%
Monthly principal and interest payment $2,429 $2,133 $1,839
Monthly mortgage insurance $600 $0 $0
Total monthly costs $3,029 $2,133 $1,839
Note: Assumes 4.05%, 4%, and 3.94% interest rate respectively for 10%, 20%, and 30% down payment scenarios.
Source: Wealthfront Research
Time & place

When is the best time to buy?

Timing the real estate market is just like trying to time the stock market – it's impossible. Home prices will go up and home prices will go down. Plus supply-and-demand varies regionally, making any attempt to time the market even more challenging.

As evident from the Case-Shiller Home Price Indices, the leading measures of U.S residential real estate prices, while home prices in the US have increased over time, real estate market volatility is hard to avoid.

Example

The real estate market is impossible to time

Group 2 Created with Sketch. 1990 100 500 Case-Shiller Index 2000 2010 2015 New York, NY San Francisco, CA Chicago, IL National Average Group 2 Created with Sketch. 1990 100 500 Case-Shiller Index 2000 2010 2015 New York San Francisco Chicago National Avg
Note: Data normalized to 100 in 1987
Source: S&P Dow Jones Indices LLC, S&P/Case-Shiller U.S. National Home Price Index retrieved from Federal Reserve Bank of St. Louis

Keep in mind there's actually an implicit cost to waiting. Even if you don't pull the trigger on buying a home, that doesn't mean you're not incurring housing expenses. For instance, waiting a year to buy a home means paying a year of rent to your landlord instead of towards a mortgage. Find out how to compare renting versus owning.

We believe that if you're confident in your reasons to buy a home, you shouldn't delay taking action. Curious what are the reasons to buy a home? Learn about the benefits of home ownership.

What if there's a market downturn?

Unfortunately, if the real estate market declines, so will the value of your home. On the other hand, if the real estate market is on the rise, homeowners will benefit from the appreciation of their home value. Just like the financial markets in general, the only sure thing in the real estate market is that it will go up and it will go down.

The market is unpredictable

The impact of volatility in the real estate market is unavoidable, even if you're not a homeowner. If you rent and the real estate market is on the rise, you can surely expect your rent to increase. But rent prices do not always increase one-to-one with home prices. According to Redfin data, between Jan 2010 and Dec 2017, average home prices have increased by around 53%, but average rents have increased by around 26%.

In the event of a downturn, if you have a fixed-rate mortgage your monthly mortgage payments should not be affected by any market volatility. However, you are at risk if there's a significant drop in real estate prices and you have a sudden need to sell your home, say for a job opportunity in a new location. In this case, you may be forced to sell your home at a loss. If the value of your home has decreased significantly, you may not have enough to repay the remaining balance on the mortgage.

Don't be discouraged by uncertainty

It's wise to understand what can potentially go wrong. But in the face of certain uncertainty, our advice is the same advice we give investors: The risk of a downturn is a part of life. Having a long-term time horizon and staying the course is your best path forward. Consider the benefits of owning a home.

How does location factor in?

Deciding where to buy is often almost as big of a decision as which home to buy. For those living in urban areas like New York or San Francisco, a fairly common question that arises is whether or not to make the move to the suburbs.

A huge draw of the suburbs is you can often get a larger home for the same budget. But, on the other hand, there are many perks and conveniences of city life that can't be easily replaced when you move away.

Aside from size of home you can get for your money, there are a number of other factors to consider and trade-offs to think through when deciding on the location to buy that's right for you:

Property taxes

Property taxes can vary dramatically by city or county. For example, Manhattan's property tax rate is 0.51%. While in Fort Lee, NJ, just 10 miles across the bridge, property taxes are are about 1.94% of home prices. However, the price of homes in Fort Lee is much lower, so it's important to to assess your all-in costs.

Mortgage rates

The location you choose could even affect the mortgage and its interest rate. When issuing mortgages, lenders often factor in the difficulty or ease of selling a home given its location, in case of foreclosure.

School

If you are planning on starting a family or have kids now, school districts are another major factor in deciding where to live. Great public school districts often increase home prices in a specific area, which means you may have to pay a premium for access to better education.

Commuting

If your job is in the city, moving to the suburbs will mean increased time and money spent traveling every day.

Living costs

The cost for groceries, utilities, and other services can also vary widely between urban and suburban areas.

Value

What are the benefits to owning a home?

Practical

Even if you don't buy a home, you still need to pay something for lodging. For most people, this is in the form of monthly rent. When you buy a home and pay a mortgage, you're actually saving into a permanent asset. Plus, you get the automatic protection against rising rent costs. See how to value a home as an asset

Economical

There are a few concrete financial benefits to owning a home, namely a potentially significant tax break. Renters don't get a tax deduction from the rent they pay. But as a homeowner, you can deduct up to $10,000 paid in property taxes and interest paid on mortgages with balances of up to $750,000 from their federal taxes. When it comes time to sell your home, you may even exclude the capital gain, up to a certain limit.

Emotional

The most significant benefits to owning a home are likely not financial. You want to buy a home because you want a place to call your own, a place that gives you freedom to live the life you want. Your reasons are often justifiably emotional, which is why the case for buying a home can't simply be rationalized by a financial model.

In fact, in a recent National Housing Survey by Fannie Mae, when survey respondents were asked to choose their top reasons for buying a home, the top four were non-financial.

How should I value my home as an asset?

The costs of homeownership can be a huge portion of your monthly expenses. But over time your house could also become one of your largest assets. As you start paying down the principal on your mortgage, you also start building home equity, or the amount of ownership of your home. If you decide to sell your home in the future, you will likely have cash on hand to spend on something else.

A useful formula to remember:
Home equity = current home value - current mortgage balance

Example

Home equity builds over time

On day 1, you make a $100,000 down payment on a $500,000 home.

In year 5, you've paid down $85,000 in principal, so now you owe just $315,000. And guess what else? The value of your home has appreciated to $564,000.

Group 5 Created with Sketch. Day 1 Year 5 Mortgage balance Home equity $500K $400K $300K $200K $100K $0K $600K Home value $315K $249K $400K $100K You've paid $185k, but your home equity is now worth $249k. Not bad! Group 5 Copy Created with Sketch. Day 1 Year 5 Mortgage balance Home equity $500K $400K $300K $200K $100K $0K $600K Home value $315K $249K $400K $100K
Source: Wealthfront Research
A few risks to keep in mind

While a home has value, there are a few considerations to keep in mind that may affect the amount of cash you can expect from a future sale of the home. First, the real estate market fluctuates and is unpredictable. If the market goes up, so does the value of your home. Of course, if the market goes down, your home value will also decrease. See more on how to think about the real estate market.

In addition, when it comes to selling a home, keep in mind that real estate commissions, home improvement efforts, transfer tax, and moving costs can add up to over 6% of total sale price.

How do I compare buying versus renting?

When it comes to home ownership, it's tempting to compare your monthly rent with your potential monthly mortgage. While this is a logical way to evaluate costs on a monthly basis, it actually ignores a number of significant considerations.

The right monthly costs comparison

To make an accurate comparison between renting and owning, you should understand the full costs of homeownership. In addition to monthly mortgage payments, there are a number of additional monthly home expenses to consider, such as property taxes, insurance, and HOA fees. These other expenses can add up to 26% of what you spend each month on your home Review the all-in costs of homeownership.

Home requires upfront payment

In addition, in order to be approved for a home purchase, you will need to make a down payment. This amount is usually at least 20% of the total home cost. In addition, the amount of down payment you make affects the terms of your mortgage. See what you should know about the down payment.

Equity in your home

While buying requires more upfront costs, you also own the house outright, albeit with debt from the mortgage. Over time, the monthly mortgage payments you make will start increasing your home equity. The money you pay on rent, on the other hand, is money you'll never get back. See how to value a home as an asset.

Thinking ahead

What can I do today to be prepared?

If a home purchase isn't in your immediate future, there are a few things you can do to better prepare far in advance.

  1. Pay down any debt

    When you pay down your debt, you decrease your debt-to-income ratio. This is a key input in determining the terms and interest rate for your mortgage. The rule of thumb is that your total monthly debt payments should be less than 33% of your monthly pre-tax income. See more details about mortgage.

  2. Improve your credit score

    Lenders use your credit score to assess the risk they take on when giving you a loan. They use it to determine whether you qualify for a mortgage and what interest rate you'll pay. A healthy credit score is 740 or higher. To increase your score, monitor it via credit reports, set up bill payment reminders and pay down any debt. Source: My FICO

  3. Budget wisely

    This might seem like a no-brainer, but everyday expenses can get in the way of proactively saving for larger goals. By defining a monthly amount to put towards a home and depositing it in an appropriate savings or investment account, your future won't become an afterthought. Learn more about how to invest home savings.

Time can be your friend. A longer time horizon means more time to save for your down payment and build up your credit score. However, just because you're buying more time to save for a home purchase doesn't mean you don't have living expenses. Be sure to factor in rent and other household expenses into your savings plan.

How does a home fit in with my other goals?

The right home is one that still allows you to meet your other financial priorities with confidence. This means understanding how much home you can afford, and also having a clear sense of your other goals — both short and long term.

Start on the right foot
  1. Before you start saving for a home, you should put money towards paying down high interest loan. We define this as loans with interest rates greater than 6%, such as credit card loans or student loans.
  2. Next, you should contribute to your company-sponsored 401(k), but only if your employer offers a matching contribution. An employer match is basically free money, making it much more attractive to participate.
Map out your priorities

After you pay down debt and put money towards your 401(k), it's time to understand what your financial priorities are. Do you want to cover your children's college education costs in full? What about having a comfortable lifestyle in retirement? Do you need to buy a home sooner than later? Once you've decided the relative importance and timing of these priorities, you can then determine how much of your savings to allot to each goal.

Understanding the trade-offs

The reality is you only have so much money to work with, so prioritizing one goal will have an impact on the others. To demonstrate how to consider trade-offs, let's walk through an example. Let's say you're deciding between buying a larger home that costs $800,000 or a more modest home that costs $500,000

What's your Path forward?

It's important to have a comprehensive plan that accounts for all your financial goals. But arriving at that plan takes careful research, calculations, and projections. That's why we built Path, our comprehensive planning solution that does it for you. Get started with Path.

How should I invest my home savings?

There are several ways to invest in the funds you've set aside for a future home purchase. The right option for you, depends on your time horizon.

Within five years

Markets can be volatile from year to year. In fact, our analysis shows that there could be a 22% probability of loss for investments with a time horizon of less than five years. For near term purchases, it's more prudent to stay out of the markets to avoid a potential downturn.

If your home purchase is in the next five years, we recommend investing funds for a down payment in a low-risk option, such as a high-yield savings account, certificates of deposit (CDs), or a money market account.

More than 5 years away

If your time horizon is longer, your savings can afford to take on more risk. For home purchases that are over 5 years away, we recommend investing your money in a long-term diversified investment portfolio, which can deliver higher returns than short-term savings options.

As you get closer to purchasing a home, we suggest moving that money from your investment account to a safer, low-risk option, as mentioned above. Consider investing your long-term savings with Wealthfront.

It's a lot to keep in mind.
That's why we built Path to do it for you.

Wealthfront uses your financial data to determine what you can afford and helps you plan for a home that fits with your other financial goals.

iPhone X Copy 2 Created with Sketch. Explore places to live Edit 9:41 Home purchase in 3 years is comfortable …and doesn’t hurt your long-term plans. Tell me more $1,100,000 In 3 years, you can comfortably afford up to $1.1M. Buying a home for