What’s the Worst Mistake First-Time Buyers Make?

by Steve CookSeptember 14, 2018

In these times of stiff competition, rising costs of buying a first home, and short supplies of affordable houses, first-time buyers have little room for error. Buying and financing a first home is more complicated today than it has ever been.

Failing to find the right real estate agent, applying for a mortgage before your financial house is in order, missing out on the low down payment options available to you, or being unwilling to compromise on location or features− these are just some of the errors that can make buying a first home a miserable experience.

But the worst mistake first-timers make is overpaying for a home. This can keep hurting you for years after closing.

First-time Homebuyers

Overpaying for a Home

Too many first-time buyers are paying more for their homes than they can afford. A recent survey of 2,000 buyers by Homes.com found that only 40 percent of first-time homebuyers were very comfortable negotiating the purchase price of the property with their real estate agent. One in ten first-time buyers said they suffered buyer’s remorse and another 13 percent think they overpaid for their home.

“First-time homebuyers are often stressed and overwhelmed when making such a large purchase like a home. As a result, they are looking for guidance and assistance to help make the process easier and smoother,” said David Hoegerman, Senior Manager of Homes.com.

A new study by two economists at the Federal Housing Finance Agency confirmed that first-time buyers are paying more than their homes are worth. In 2016, first-time buyers overpaid an average of about $2,200 each, or 0.79 percent of the value for their homes. “The underlying reason for first-time home buyers’ overpayment likely is their inexperience,” the authors of the study said in a recent interview.

Soaring prices have made it especially difficult for today’s new buyers to stay within their budgets. Since 2016, when the FHFA study was conducted, the median national sales price for all homes has risen 10 percent. For smaller starter homes, which are in shorter supply than more expensive homes, prices are rising even faster than the average.

With affordable homes so scarce, first-time buyers are tempted to offer more than the listing price when they find a house they like. In hotter markets, they may find themselves in a bidding war and may bid more than they can afford. When they can’t find a home in their price range, many first-time buyers are looking at more expensive listings and stretching their budgets too far to make an offer.

The Perils of Overpaying

When buyers pay too much for a home, they may encounter serious problems that they did not anticipate, such as:

  • Becoming “house poor” and consigning their families to a lifestyle with so little discretionary income that they can’t afford to save for college, retirement and many of the finer things in life like travel, entertainment, and home furnishings
  • Skimping on home maintenance and repairs, which will reduce a property’s value over time
  • Paying a premium for their mortgage. Borrowers who stretch their income and increase their monthly mortgage payments can create a debt-to-income ratio high enough to trigger mortgage interest rates far above average
  • Making it more difficult to accumulate equity in their home. Overstretched owners may even find themselves “underwater” if they have paid more for the home than it is worth
  • Finding themselves without the financial reserves to weather a period of unemployment or an expensive medical bill

Overpaying for a home can also jeopardize the purchase itself (which may be a blessing in disguise for overstretched buyers). Should the home appraisal come in below the agreed-upon sales price, the buyer often must come up with the difference quickly. Low appraisals occur more frequently when local market prices are rising quickly, as they are now, and when buyers use low down payments, as most first-time buyers do today.

New Homeowners

How to Avoid Overpaying

The reason so many buyers are overpaying is simple. They have not taken the time to create an accurate budget for homeownership, or they ignore their budget when they fall in love with a house they really can’t afford.

Many assume that the amount for which a lender has pre-qualified or pre-approved them means they have a guarantee that they can borrow up to that amount. But this isn’t the case. A pre-qualification letter is an approximation — not a guarantee. This step does not include verifying any financial information, nor does it include a current review of the buyer’s credit. Also, borrowers who push the limit on their pre-approval will pay a high price. Even should a lender agree to lend the maximum stated in a pre-approval letter, they will do so only at a rate high enough to cover their risk.

Many buyers make offers on houses when they don’t have a good idea of their real value (as opposed to listing price) and overestimate its potential appreciation. Homes.com provides an estimated valuation right on the listing. Ask your real estate agent to weigh in with his or her expert opinion of local market price trends.

When thinking about a property’s future value, read up on housing economists’ forecasts. Home values typically rise about 3 percent per year but have been rising at about twice that rate over the past two years. Most experts predict appreciation will level off or even decline in the next two years. And, as homeowners who weathered the housing crash can attest, home values don’t always rise.

How to Create an Accurate Budget

Housing economists recommend householders pay no more than 30 percent of their gross income on housing. For homeowners, “housing” includes mortgage principal and interest, mortgage insurance, homeownership association dues, property taxes, homeowners’ insurance, and flood insurance.

For prospective buyers without access to some of these numbers, here’s another way to come up with a good estimate. Multiply your household’s annual gross income by 2.5 to get a rough idea of the price range where you should start. For example, if you make $74,000 a year and your spouse makes $50,500, you should be in the market for a $280k-$300k home.

Sticking to a budget in today’s housing markets can be hard and the pressure to raise the bar is hard to resist. Buyers should never forget that they may be living with the home buying decisions they make today for decades to come.

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About The Author
Steve Cook
Steve Cook is editor and co-publisher of Real Estate Economy Watch. He is a member of the board of the National Association of Real Estate Editors and writes for several leading Web sites, including Inman News. From 1999 to 2007 he was vice president for public affairs at the National Association of Realtors.