Does buying a home make sense for you financially? It may or may not, depending on some financial, career, and lifestyle factors. Your savings, your credit, your salary, your level of disposable income, and your housing preferences all count.
If you are serious about becoming a homeowner, you should have three priorities: keeping your credit score above 700, saving up the down payment, and getting pre-approved for a mortgage.
How can you calculate how much home you can afford? The rules of thumb are fairly simple. If you intend to assume a 30-year fixed rate mortgage, your monthly housing expenses should amount to no more than 28% of your monthly gross income. For Federal Housing Administration (FHA) loans, the general rule is that the mortgage payment should be less than 31% of the buyer’s gross monthly income. For Veterans Administration (VA) loans, the rule is that the debt-to-income ratio should not exceed 41% of gross monthly income.
How can you accumulate enough for a down payment? If you are serious about home buying, you should be saving money each month for that goal. Most people aim to put 20% down, so they can avoid paying private mortgage insurance, but many buyers do purchase a home with 10% or 5% down, while assuming the bill for PMI. With a standard FHA loan, all you need to put down is 3.5% of the purchase price. VA loans require no down payment whatsoever (and their interest rates compare to those of the best conventional home loans).
In many real estate markets, VA and FHA financing limits on conventional home loans make it easier for buyers to afford a nice house: they top out at $417,000 in most metro areas, but rise to $625,500 in more expensive areas.
Hesitant about assuming a 30-year loan? Many homebuyers who think they will eventually move up or move on choose a 15-year mortgage or an adjustable-rate mortgage. The argument for 15-year mortgages and ARMs is simply stated: while you will borrow the same amount either way, you will borrow it for twice as long at a higher interest rate with a 30-year loan. So if you don’t see yourself living in the home you buy when you are retired, the shorter-duration loan may be worth considering.
How do you know if you are NOT ready to buy? Look for some telltale signs. Do you suspect you will live somewhere else in five years? Are you having a hard time deciding whether you want to live in a single-family home, townhome, or condo? These are signals to refrain from buying.
Typically, lenders want your total debt load (mortgage + consumer debts) to be less than 36% of your gross income. Is yours higher than that? Then reconsider committing to a home loan. Your household income might be too low to buy – while you may have enough money for a down payment and closing costs, you may not earn enough to handle continuing costs like mortgage payments, homeowner insurance, association fees, and property taxes. Properly furnishing and maintaining a home may take more money than you think. There is also the cost of a home inspection, a highly recommended move before buying.
If you have a credit score of 650 or less, a mortgage lender may demand a larger down payment or larger fees than you anticipate. If your score is underneath 600, you may be out of the running for a loan. (FHA loans are an exception: buyers with FICO scores below 600 have qualified for them.) If you have spent less than two years at your job, that could also discourage a lender from issuing a mortgage to you.
Is buying a home the key to moving up economically? For some people, it is an important step. Some real estate investors urge people to buy, if at all possible, rather than rent. Your decision to buy should not be made lightly, or simply to keep up with your peers. Do the math and think about how the commitment of home ownership aligns with your life and financial goals.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.