Financing

How to Know if You Are Financially Ready to Buy a Home

If you’re interested in taking the plunge into home ownership, consider the following factors before you commit yourself to a property or talk yourself out of it.

Purchasing your first home is one of the biggest accomplishments of your life. For many people, signing the closing papers on their first home feels like their official entry into adulthood. However, millions of potential homebuyers approach the market with trepidation every year based on the fear that they simply aren’t ready financially to commit to a 20 or 30 year mortgage. If you’re interested in taking the plunge into home ownership, consider the following factors before you commit yourself to a property or talk yourself out of it. Owning your own home may be closer than you think!

Debt to Income Ratio

One of the first things that a mortgage officer will look at is your debt-to-income ratio. If you are planning to pay cash for a home, this obviously doesn’t apply, but if you plan on using a mortgage to buy your first home, you should get a good understanding of how your current debt compares to your annual income. The Federal Housing Administration (FHA) generally uses a 43% debt-to-income (DTI) standard. This standard means that your existing debt payments plus your home-related expenses (mortgage, HOA fees, mortgage insurance, homeowner’s insurance, property taxes, etc.) shouldn’t be greater than 43% of your monthly gross income.

For instance, let’s assume that your monthly gross income is $6,000, meaning that you gross $1,500 per week. To determine your DTI, multiple $6,000 by .43 which gives you $2,580. This means that $2,580 is the maximum amount that you should spend each month on debt. If your current monthly debt commitments total $2,000, that would mean that you would only have $580 to cover a mortgage (including interest), home insurance, HOA fees and the other expenses associated with owning a home. To determine where your current DTI stands, simply divide your amount of debt by your gross monthly income. If you’re below 43%, you may be well on your way to owning your own home. You may be interested to know that most mortgage lenders look for a DTI of around 28% when approving or denying mortgage applications.

Down Payment

Before we dive into how much you need for a down payment, it’s important to note that there are several variables to the down payment equation. The type of loan that you’re applying for may have different down payment requirements, and it’s even possible for different lenders to charge different down payments. In most cases, a 20% down payment does prevent you from being responsible for private mortgage insurance (PMI). In most cases, PMI costs somewhere between $30 and $70. While that may sound like a minimal amount, paying $70 extra per month over the course of a 30-year mortgage costs an extra $25,200. 

However, you may be hesitant to put 20% down on your home. Perhaps you don’t plan on living in the home very long or you’ve got plans in place to flip the home into a rental property in the future. If that’s the case, 20% down may seem like a heavy ask. However, the more that you are able to pay up front, the smaller your monthly mortgage payments will be. If you only have 5% down, you may be able to apply for certain types of loans, but your monthly mortgage payments will reflect the low amount. Generally speaking, industry experts encourage you to be able to afford at least 10% down when looking for a new home.

Interest Rates

Interest rates are a constantly evolving part of the home-buying equation. As a potential home buyer, you should try to take out a home loan when interest rates are at their lowest. If you are able to get approved for a fixed-rate mortgage, this would help ensure that you aren’t spending too much money on interest every month. Lower interest rates generally lead to a higher mortgage approval amount, so you can get a much nicer home if you’re able to wait for interest rates to drop. If you’re in a position where money isn’t a primary concern, this isn’t as important. However, if you’re looking to buy your first home, you probably want to get the best possible deal.

Understanding the Housing Market

This is the type of thing that you can’t really determine on your own. However, if you choose to work with a real estate agent, he or she will be able to give you good insight into the housing market in the area that you’re considering. One of the best ways to determine if you’re ready to buy a home in a particular neighborhood is determining whether it is cheaper to rent a home there or buy one. 

You should also look for opportunities to take advantage of a “buyer’s market.” For instance, during the economic recession of 2007, the housing market bottomed out. Many sellers were selling homes for far less than they would’ve been worth much more than their final purchase price. Don’t feel bad about taking advantage of a housing market that favors sellers! Your job is to get the best deal possible to protect your personal financial interests. 

If you have all of your other finances under control and you can purchase a home for a comparable price to renting one, it’s always a good idea to buy. Additionally, if you can find a home with “motivated sellers” who are willing to take less than a property is actually worth, it’s a great time to put in an offer.

There are several factors that go into determining whether or not you’re ready to buy a home, and some of them are under your control while others are not. If you find yourself on the fence about whether or not you are financially ready to purchase a home, consider setting up a meeting with a mortgage officer. He or she will be able to take a look at your current financial state and the housing market to give you a better understanding of where you stand on your journey to home ownership.

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