Everywhere you look, people are becoming homeowners. It can be easy to feel pressured to follow the crowd. But are you ready to buy your first home? It’s something only you can decide.
Considerations When Buying a Home
There are two aspects to homebuying readiness. One is whether you, personally, are prepared for the responsibility that comes with owning property. You’ll have a mortgage that you’ll have to pay every month, as well as the burden of maintaining the property.
But it’s impossible to make the decision without taking your finances into consideration. As a rule of thumb, your debt should take up less than 43 percent of your income. This is your debt-to-income ratio, and a lender will use it, in part, to decide whether to give you a mortgage or not. So start by setting up a budget and crunching the numbers to see if your ratio is low enough.
Read More: Healthy Debt to Income Ratio
Gauging Your Economic Stability
When you take out a mortgage loan to buy a house, you’re making a commitment for at least a few years. That’s how long you’ll typically need to stay in a home to at least break even since you’ll have to pay off the balance due to get out of the loan. So it’s not just about whether you have enough money today.
Your source of income will likely impact your financial stability in the coming years. Would a sudden economic downturn lead to layoffs and cutbacks with your current employer? If you suddenly lost your job, how long could you make your mortgage payment? If you have the savings to cover it until you found something else, that could make a difference.
Monitoring the Real Estate Market
Some homebuyers start the search for a home without ever stopping to research how the market is doing. The problem is that if the supply of homes for sale is low, you’ll end up competing with many other buyers for the same house, which will drive prices up. This is known as a seller’s market.
If you’re still renting, the best time to buy a house is when the home supply is high and not many people are buying. This is known as a buyer’s market. As long as you have enough money and your finances are stable, you’ll have an advantage by buying in a buyer’s market.
Determine Your Mortgage Payment
It’s important not to assume that your monthly mortgage payment will be more than what you’re currently paying on rent. With rental costs rising in many markets, often the amount you’ll pay each month for a house you own will be less than what you’re paying in rent. Best of all, you won’t live with the risk that your landlord will bump the rent up each year.
Luckily, there are many calculators that can help you determine what your payment will be. Some real estate sites will even let you calculate your mortgage directly on property listing pages. You’ll input the amount you plan to put down and the purchase price, and the calculator will use current interest rates and property tax information to estimate what the payment will be.
Looking at Fluctuating Interest Rates
Many homebuyers jump when the interest rates drop because even a small savings on interest can add up over a 30-year mortgage. But there are a couple of reasons not to rush to buy when interest rates drop. One is that it simply might not be the best time financially for you to make that move.
But another reason to look at falling interest rates with caution is that the market tends to adjust for interest rate changes. When interest rates drop, the real estate market gets extremely active as buyers rush to get into a home before they increase. That means you may pay much more for a house than you would a few years down the line, when interest rates are higher and there are more homes for sale than interested buyers.
Read More: Is Now a Good Time to Buy a House?
Checking Your Credit Score
Homebuying means convincing a lender to give you hundreds of thousands of dollars. Any lender will want to make sure you will reliably pay the money back. This means that, in addition to looking at your debt-to-income ratio, lenders will pull your credit report and scrutinize your credit history.
Before you start thinking about buying a home, take a look at your credit score. You’re eligible for one free credit report a year from each of the three credit bureaus through AnnualCreditReport.com. This score is a reflection of your financial habits over the past seven years, including late payments, credit card debt and bankruptcies.
Credit Score Requirements for Mortgages
Each lender has the right to set its own baseline for credit score requirements. While you can get a conventional loan with a credit score as low as 620, most lenders will want to see a score of 660 or higher. But there is another option if your credit score is lower.
If you’re new to borrowing money to buy real estate, an FHA loan may be a great alternative to a conventional loan. If you can put down 10 percent of the home’s purchase price, you can get a mortgage with a credit score of only 500. With a score of 580, you’ll only have to put 3.5 percent down.
Requirements for Down Payments
Before you can buy a house, you’ll need to have enough money for the required down payment. If you’re going for a conventional loan, you’ll be able to get that loan for as little as 3 percent, but you’ll need to pay private mortgage insurance if you put down anything less than 20 percent of the purchase price at closing. This is a monthly cost that will be added to your mortgage that you can have removed once you’ve paid back 20 percent or more of the principal.
FHA loans are backed by the government, so lenders give a little more leniency. With an FHA loan, you’ll need at least 3.5 percent if your credit score is 580 or more. For credit scores below that, you’ll need to put down at least 10 percent.
Gathering the Down Payment
Don’t have the money for a down payment? Your first step should be to look into whether you qualify for a USDA loan. These loans are available to homebuyers who are willing to purchase outside major cities. With a USDA loan, no down payment is required.
Otherwise, you’ll have to come up with at least 3 percent, which is $9,000 on a $300,000 loan. You can sometimes find government-funded down payment assistance programs, or you can take the money as a gift from a parent or other loved one. Setting aside a little money every month can help you get where you want to go, as long as you have some patience.
Gaining Equity in Your Home
Homeownership is a fairly sizable commitment. You’ll be putting at least 3 percent down, but there are also closing costs, which cover the fees associated with processing the loan and property transfer. Closing costs typically run between 2 and 6 percent of a home’s price, so all in all, you’d pay $15,000 to get into a $300,000 home.
Once you’ve moved in, you’ll start paying a monthly mortgage that includes interest, property taxes, homeowners insurance and the loan amount you borrowed, divided into small monthly payments. During those early months, the majority of your payment will go toward interest, so it will take a while before you start making a dent in your loan principal.
When you finally sell your home, you’ll need to be able to make enough on the sale to pay back your lender. That means you’ll have to sell it for more than you owe. As your home’s value rises and you owe less than your house is worth, you’ll have something called equity. Home equity is the difference between what you owe on your home and what it’s worth.
Determining Location Stability
While there’s no guaranteed time when you’ll recoup your closing costs and gain equity in your house, plan for five years. This is a general rule of thumb since it can vary widely based on how the real estate market and overall economy are performing. If you’re buying a new house, too, keep in mind that when it’s a seller’s market and you can make more on your current home, you’ll have a tougher time getting a good deal on a home purchase.
The best thing about renting is that it does give you the flexibility to move every year or two if necessary. You’ll renew your lease every year, so you can reevaluate and change locations if you want. If you think your career might lead you to relocate in the next few years, or you simply don’t like to be tied to one place for several years at a time, it might not be the right time to buy.
Getting Out of Debt
You can still buy a house if you have debt, but you’ll be at an advantage if you improve your debt-to-income ratio. If your monthly budget is packed with expenses like car payments, you may want to try to pay off those items. But you could simply strike a balance between getting that debt-to-income ratio below 43 percent and having the money necessary for a down payment.
In the months and years leading up to homebuying, the financial decisions you make will be vital. Here are a few tips to help you keep your chances of getting a loan strong.
- Make all payments on time. This may seem obvious, but even one late payment can make the difference when you’re trying to get a mortgage application approved.
- Pay as much of your credit card balance as possible. Lenders look at your credit utilization ratio. If your balance is $200, but your credit limit is $20,000, your score will usually be higher than if you retained a $2,000 balance with a $10,000 limit.
- Paying off your debt completely is typically good since it decreases your credit utilization, which is a huge part of your credit score. But paying off debts completely can shorten your credit history, which can also hurt you. Try to keep at least a small balance on any credit cards you pay down until you get into your new home.
- Avoid job changes. Lenders look at your employment situation very closely. Lenders prefer to see borrowers who have been with the same employer for at least two years, but there are exceptions to that. If you’re self-employed or run your own business, though, you may need to have a bigger down payment than someone who has a more traditional work situation.
Setting Money Aside in Savings
Before deciding definitively, "Are you ready to buy a house?" make sure you have a little cushion in your finances. This includes setting aside the money for a down payment and then making sure you have an emergency fund to handle unexpected emergencies like an HVAC unit failure or a serious pest control issue.
How much will you need? A small emergency fund of a couple of thousand dollars or so could be enough for small homeowner emergencies. However, if you can set aside enough money to handle multiple months of mortgage payments, you’ll have peace of mind.
Extra savings will also put you in good standing with lenders. They look at the assets you have, including any money you have in checking and savings. You may find that having extra money gives you a loan approval when you wouldn’t have gotten one otherwise.
Homebuying is a personal decision, so it’s important to wait until the time is right for you to make the move. If you’re perfectly happy as a renter, don’t feel pressured to buy a home. Simply continue to crunch the numbers occasionally to determine how much you could save on a mortgage, especially if your rent costs keep increasing.
- CFPB: What Is a Debt-To-Income Ratio? Why Is the 43% Debt-To-Income Ratio Important?
- HUD.gov: Buying a Home
- FTC.gov: Free Credit Reports
- Experian: When Does the 7 Year Rule Begin for Delinquent Accounts?
- Experian: What Is a Conventional Loan?
- USDA.gov: Welcome To the Usda Income and Property Eligibility Site
- CFPB: Credit Score Myths That Might Be Holding You Back From Improving Your Credit
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.