Can You Afford to Buy A Home Yet?
How much are you paying in rent today? Have you considered what it would feel like to put that kind of cash towards buying your own home? Well, maybe you can.
How much are you paying in rent today?
According to a recent report, in 2016 Americans paid an average of $1,210 in rent every month. That’s a lot of money.
Have you ever considered what it would feel like to put that kind of cash towards a real home? Something you own — and have equity in?
Trading in a world of rent and landlords for a mortgage and a house doesn’t have to be complicated. The first (and easiest) step you can take is figuring out what it actually costs to buy a home — and whether or not you can afford one right now.
You might be surprised.
4 Financial Factors that Determine What You Can Afford
Let’s kick this off by examining aspects of your financial life that affect your ability to purchase a home. Determining how much home you can afford comes down to four financial factors: Income, Savings, Expenses, and Credit.
Income: How Much Do You Make?
Basically, your recurring income establishes a baseline for how much you can afford to pay on a mortgage each month. This includes your salary and any additional payouts you receive from investments. Remember, a mortgage is a long-term commitment (usually 15-30 years), so you’ll want to be confident that your income won’t fluctuate for a few years while planning.
Savings: How Big Will Your Down Payment Be?
Your savings can be defined as the amount of money you have built up that can be applied to a down payment, closing costs, and other expenses.
NOTE: While you’re likely to deplete the bulk of your savings with a big down payment, it’s really important to not completely tap your savings. Because most mortgage lenders will want to see you have enough saved up to cover purchasing costs while still leaving some cash in an emergency fund to cover unexpected repairs or lifestyle changes.
Debts & Expenses: What Are Your Other Obligations?
What are your financial obligations each month? Are you actively paying off one or more loans?
Whether it’s a monthly car payment, student loans, or your health insurance premiums, you need to tabulate exactly how much you’re obligated to shell out each month before the addition of a mortgage. To assess how your mortgage might stack up against the rest of your finances, lenders like to determine your debt-to-income ratio using the 28/36 rule.
The 28/36 Rule
To be clear, this isn’t a hard-and-fast rule. It’s more of a guideline lenders use to evaluate the breakdown of a person’s monthly financial obligations.
The 28/36 rule suggests any home-related expenses should never account for more than 28% of your monthly income. And, factoring in everything else, your combined debts and expenses should never exceed 36% of your pretax income.
Credit: Impacting Your Loan Rate
Without question, your credit score will impact your loan rate. The amount of money you can borrow (and the rate at which you do) to buy a home is primarily affected by your combined debts and credit score. Using a sliding scale of 300 – 850, lenders typically look for a minimum qualifying score in the mid-600’s. But, as your score breaks into the mid-700’s, your chances of locking in a lower interest rate increase dramatically.
Costs Associated with Purchasing A Home
Comparing renting to owning is not as simple as comparing rent payments to a mortgage. A lot of money changes hands while you’re signing papers for a home purchase. And, if you’re considering buying your first home, you need to understand a down payment is only one part of the total upfront cost. There are a handful of smaller expenses you need to be prepared for, including:
One-Time Homebuying Expenses
1. Down Payment
This is your biggest financial hurdle from a savings perspective. And, while some modern lending programs will accept down payments as low as 3% of the home’s purchase price, the traditional standard down payment is 20%. Put simply, if you’d like to buy a $200,000 home, a 20% down payment would be $40,000. Again, your down payment can be less than 20%, but you’ll likely have to pay “private mortgage insurance” (PMI) on top of your monthly mortgage until you cover the difference and gain equity.
Don’t have 20% laying around? The option to put up a smaller down payment works for those who need a home soon, have stable income, but haven’t yet had the chance to save up a nest egg for a big down payment.
2. Closing Costs
Expect to pay about 3% of the home’s purchase price at closing. That $200,000 home with a full 20% down payment of $40,000 will cost an additional $6,000 with closing costs. With inspection fees for pre-owned homes and property taxes, you might need to budget upwards of 5% of your home’s total purchase price.
3. Moving Expenses
It’s easy to forget this part, but you’re going to need to do three things when moving: get there, furnish it, and decorate. Remember, you don’t have to do this all at once. A new home doesn’t mean you need all new furniture.
Ongoing Homebuying Expenses
4. Mortgage Payments
Back to savings — make sure you have a few months of mortgage payments stashed away before closing on a new home. You never know what could happen to your employment status.
Another piece of advice is to shop around for home loans. Nearly half of Americans don’t, and data suggests that comparing just three different loans almost guarantees you a lower rate, saving you a ton of money compared to if you had settled for option 1.
5. Property Taxes
Taxes vary across the board. They’re set by your local county government and are based on the county’s assessment of your new property. The difficult part about property taxes is they’re subject to fluctuation, either by re-assessment or your local government boosting tax rates.
6. Utilities & Repairs
Unlike some apartment setups, utilities are all on you. That’s a given. Where you need to pay attention is the unexpected nature of things … breaking. It’s a good idea to keep a rainy day fund for bigger repair jobs. In fact, some lenders will check to see you have enough in savings AFTER purchasing the home to cover potential repairs.
Are You Ready to Buy?
Or should you just keep renting?
Most would be surprised to learn that owning a home is absolutely within their grasp. But, if you’re planning a career move away from home, keep renting. Those leases typically only last a year — but, in order to avoid losing money on a home, you’ll need to live in it for 2-5 years, or just long enough to regain some equity.
Also, if you map your finances, find your dream home, and determine you have “just enough” money to make it work … wait a little while longer. You’ll want a cushion of cash even after the keys are yours.