Are You Ready to Buy a House?
Are you ready to buy a house? This simple answer: Only if you can afford it.
There’s a lot that goes into buying a house. Being a first-time homebuyer can be intimidating. Lots of big words that you may have never heard before.
Here’s our guide to knowing when you’re ready to make the biggest purchase of your life.
Nearly everything that I advise begins with having a budget. You need a good handle on your finances to know whether or not you can afford to purchase a house. If you don’t have the money to buy a house, you’re certainly not ready.
That’s not to say you need $200,000 in your bank account. Most first-time homebuyers don’t. That is where a mortgage comes in.
A mortgage is a fancy name for a loan used to purchase a building; in this case, to buy a house. Since they are loans, you’ll need to find a bank to work with.
Banks take into account several factors when determining if you qualify for a mortgage. Each bank is different but you can count on these constant factors with nearly every lender.
Mortgages are loans just like an auto loan or a personal loan. Therefore banks are going to pull your credit report to see if they can take the risk of lending you money.
The better credit you have, the better the interest rate you’ll qualify for. Purchasing a house is a lengthy investment. A typical mortgage is set up to be paid in full after 30 years. 30 years of interest is a scary thought. So it’s important you have your credit in order before applying for a mortgage.
Related: How to Repair Bad Credit
Your debt-to-income ratio (DTI) is how mortgage lenders determine whether or not you can afford the house you want. They look at all your sources of income and compare it to all the debt you have, including the house you’re looking to purchase.
The Federal Housing Administration’s guidelines state that a borrower should have a DTI ratio of no higher than 43%. This means that all of your current debt, including the mortgage you’re applying for and any accompanying expenses like mortgage insurance, homeowner’s insurance, property taxes, and homeowner’s association fees should all add up to less than 43% of your gross income. This is your back-end DTI or your full DTI.
But banks also look at your front-end debt-to-income ratio. This takes into account only the mortgage and related expenses in comparison to your income. Most lenders required this DTI ratio to be under 31% or even lower.
Part of determining the risk in approving you for a loan is how much wiggle room you have in your budget for other expenses. Banks want you to be able to pay back your mortgage, even if some other major expense comes up. If you can just barely make your mortgage payment, then you can’t really afford it.
The Housing Market
If you’ve made it this far, you likely have a good handle on your finances. So what’s next? Now we want to look at the housing market. This can vary from state to state or even city to city.
The housing market for the most part abides by the economic principle of supply and demand. If there are more buyers searching for a house than there are houses to meet their demand, then it’s a seller’s market. Seller’s markets mean that prices are higher than average. Sellers can charge more buy leveraging your desire to purchase their house because you have very few options.
Conversely, if there are more houses available than there are potential buyers, it’s a buyer’s market. This is the kind of market you want to look for. Low prices mean lower mortgage payments, which means less interest you’ll have to pay overall.
Time of Year
The time of year you’re looking to buy can also affect the price you’ll have to pay.
If you’re looking for a good deal, aim to purchase a house in the late fall through the winter. The upside is that fewer houses go up for sale this time of year, meaning the seller might be more flexible with the price. It’s unlikely they’ll be receiving multiple offers for their home this time of year. And most people looking to sell in the winter need to sell quickly.
The downside of house hunting in the winter is also that fewer houses go up for sale this time of year. You don’t have much to choose from. If selection is an issue and you require a wide variety of homes, shoot for the spring. You’ll find “For Sale” signs popping up like spring flowers. Most families wait to move until the school year is over, so Spring is the best time to start searching for buyers.
What About Your Future?
Buying a home costs a lot of money. And with a typical mortgage priced out for 30 years, odds are you’ll be staying there for a long time. So figure out where you want to be in 10 years.
10 Years? Really?
Yes, if you don’t intend to stay in the same place for 10 years, you might not be ready to buy a house. Settling down can be hard. If you’re still in the phase of life where you bounce from city to city and job to job and can’t envision staying in one place for more than a couple years, reconsider your house hunt.
You don’t want to get stuck having to move to a new city and need to make a quick sale on your current home. If the fair market value of your home is more than what you owe, you could get stuck with a huge bill for the balance of the mortgage while still trying to buy a new one.
If you insist on buying a house without a 10 year plan or can’t guarantee you’ll stay in one place for long, look for houses that are well below what you can afford. Your down payment can stay the same on the cheaper house, which will put you in a better position to sell down the road. You can also save money in the process by not maxing out your budget.
I Have a 10 Year Plan, Now What?
Great! Does your plan involve creating or expanding your family?
You’ll want to plan ahead so you and your family can grow into your house rather than grow out of it. It might just be you right now, but what if you have kids? A lot can happen in 10 years. Is there going to be space for your hypothetical unborn children?
What about the school district the house is in? Will your kids get a good education? And to add to it, what about the school taxes on your property?
Alright so you’ve made your decision. You still want to buy a house. How much money you have for a down payment can seriously affect your future.
You’re going to want to dip into your savings here. You’ve been diligently putting money away for a reason. This is it.
If you want to avoid having to pay for private mortgage insurance (PMI), which you should, you’ll need to fork up 20% of the purchase price of the house for your down payment. A PMI can add any where from $50 – $100 to your monthly payment.
But not everyone has that kind of money in their savings. For example, in my area the average house price hovers around $250,000. A 20% down payment would cost me $50,000. That’s a lot of money.
Fear not, you don’t need a 20% down payment. There are mortgages out there that only require 3.5% down. I could dig up $8,750 for a down payment. But just because you only have to put down 3.5% doesn’t mean that’s all you should put down. The larger the down payment, the smaller your monthly payment will be, and the less interest you’ll have to pay over the life of your mortgage.
So What’s My Next Step for Buying a Home?
If you’re committed to purchasing a new house, you’ve got a couple things to add to your to-do list.
Stop down at your local bank and get pre-qualified. Pre-qualifications are great when you’re just starting your house hunt. Give the bank some basic information and they’ll tell you roughly how much you’re willing to let you borrow. There’s nothing worse than finding your dream home only to find out that it’s outside your price limit.
Now that you’ve got that pre-qualification in your hands, get shopping. Go to open houses, check Zillow, or connect with a real estate agent. Find the house of your dreams within your budget.