If you have a steady income, a good credit score, manageable debt and some money in savings and you want to put down some roots, you may be ready to buy a house.
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How’s your job? Love your work and see yourself staying put for the next five years or so? Oh, and how’s your love life?
It may seem personal, but those are the types of things to ask yourself that help answer the big question you may considering: “Should I buy a house?” Before buying, you’ve got to take a serious self-inventory, including asking yourself some not-so-obvious questions about not only your financial readiness, but also your life readiness to buy a home.
Am I emotionally ready to buy a house?
When you’re ready to put down roots and can’t imagine living anywhere else — that’s when you realize wanting a house is not just a financial decision, but an emotional one as well.
Money and emotion are often married, whether you are or not. For example, buying a house as an unmarried couple requires a bit of planning. So does home shopping when one spouse has a much higher salary or much lower credit score than the other. Or maybe you’re happily single but you have a goal of buying a home before you’re 35. You might be pleased to learn that doing just that can trigger something called “housing wealth.”
Does your career path mean you need to maintain a bit of mobility? Depending on where you live, it can take anywhere from a little over a year to nearly four years to break even on the purchase of a house compared with renting an identical home, according to 2018 Zillow research. Could a promotion or career advancement in the next five years mean you’ll have to relocate? If yes, then maybe you’d better keep on renting.
It’s all about determining your first home’s shelf life — and how long you think you’ll be there.
Are you planning to start a family? If so, you might outgrow a starter home before you know it. You might consider looking for something bigger — and check out the school district, too, before buying.
It’s all about determining your first home’s shelf life — and how long you think you’ll be there. Also worth thinking about: Your starter home may serve as a passive income provider in the future. Consider how the property might work as a rental unit.
Another “life readiness” consideration to buying a house: Do you have the time and desire to handle maintenance, such as yardwork, repair and upkeep? If yes, then owning a home can give you plenty to do on weekends!
Am I financially ready to buy a house?
To assess your financial readiness for homeownership, you’ll want to consider three components that determine your home loan worthiness: credit score, debt load and down payment.
Your credit score not only determines what kind of loan you may qualify for, but it’s a major factor influencing the interest rate you’ll pay on a mortgage.
You can get an FHA loan with a credit score around 580, but you’ll have more choices in loan products with a FICO of 620 and up. Typically, the lowest mortgage rates come with having a high credit score of 760 or better.
Many lenders use the following debt load formula to determine how much house you can afford: Your house-related payments (principal and interest, taxes, insurance) shouldn’t exceed 28% of your pretax income, and your total monthly debt obligation shouldn’t exceed 36% of your monthly pretax income. (Government-backed loans tend to be a bit more flexible.)
The formula’s called the debt-to-income ratio, or DTI. It looks like this:
Total debt / Gross income = Debt-to-income ratio
Say you have total minimum payments of $7,200 toward all your debt each year; that’s $600 a month. If you make $60,000 per year, or $5,000 per month, your debt-to-income ratio is 12%. As we mentioned above, conventional lenders generally want to see an all-in DTI of 36% of your gross income or below — including your house note — but some lenders will allow for wiggle room on this, and if they determine you have the ability to repay, they may go above this watermark.
In the above scenario, that leaves 24% of your annual salary available for your housing expenses (36% minus 12%), or $14,400. Your mortgage budget would need to be around $1,200 per month.
Before you rush to a mortgage calculator to see how much house your target monthly payment will buy, remember to consider more than just principal and interest — there are also property taxes, homeowners insurance and other expenses that will have to be accounted for.
There are ongoing — and maybe increasing — life expenses to think about, too. Building a family can mean adding the cost of day care to your budget. That’s not a minor expense.
You’ll probably want to start a college savings plan for that wet-bottomed bundle of joy, as well.
And you’re likely to see rising property taxes now that you’re a tax-paying property owner. All in all, it is essential to have a solid income with fair expectations that cash flow will continue.
This is the high hurdle that you probably already know about. At some point you’ll need to have a nice plump savings account to tap for the down payment and closing costs. Mortgage closing costs run from 2% to 5% of the loan cost, including property taxes, mortgage insurance and more.
There are no-down-payment loans available; you’ll want to understand the pros and cons of each option. And it’s certainly important to find out if you qualify for first-time home buyer down payment assistance programs. But here’s the lay of the land: While zero-to-the-traditional-20% down is the typical spread, for first-time buyers who financed their home the median down payment was 6%, according to a 2019 report by the National Association of Realtors.
Knowing you’re ready
All of this may seem overwhelming. That’s a natural reaction when you first begin considering buying a home. But as you dig down into the numbers and begin laying the financial foundation to homeownership, you’ll realize that with a bit of effort, it can be within your reach.
As you become financially ready, your emotional readiness will likely follow.
By HAL M. BUNDRICK, CFP