While buying a home is a big milestone, it’s one that should be carefully considered beforehand. Investing in a home can be a great way to build equity and wealth, but it also comes with a lot of responsibility, which can make you question whether you're ready to take on homeownership.
If you’ve found yourself searching for the answers to questions like, “Should I buy a house?” or, “Should I buy a house now?” — the eight simple steps listed below will help you determine whether you’re ready to become a homeowner.
1. Take a Look at Your Debt-to-Income Ratio
Your debt-to-income (DTI) ratio compares how much you owe from debt each month to how much you earn. Your DTI is a way to gauge your overall financial health.
Lenders use your DTI to determine whether you can borrow money to purchase a home — and if so, the maximum amount you can borrow. The lower your DTI, the less risky you are to lenders, and the higher the chances your loan will be approved.
Most lenders look for a DTI of 36% or lower to approve your loan or offer you the best rates. Lenders may allow a higher DTI ratio depending on your credit score, savings and other factors. In some cases, a higher DTI could mean a higher interest rate, which can add a significant amount to what you pay over the life of the loan.
To calculate your DTI, start by adding up your debt payments, which may include:
- Monthly rent or house payment
- Monthly alimony or child support payments
- Student, auto, and other monthly loan payments
- Credit card monthly minimum payments
- Other debts (not including monthly expenses such as groceries or gas)
Next, you’ll divide the total amount of your monthly debt by your gross monthly income, which is your income before taxes. The result of that calculation is your DTI.
2. Check Your Credit Score
Your credit score will also be a consideration for any mortgage lender, so it’s important to know what your credit score is. The higher the credit score, the higher the chances you’ll secure a lower rate and be approved for the home loan.
In most cases, having around a 640 FICO score is the minimum you’ll need to get approved for a home loan. There is no standard credit score minimum, and lenders are free to set their own credit qualifications.
If you have a low or no credit score, you may still qualify for a mortgage. Several loan options are available, including a number of government-backed loans, which can make it easier to buy a home with less-than-perfect credit.
3. Make Sure You Can Afford a Down Payment
Many mortgages require you to put at least some money down on your home. While a 20% down payment on a conventional mortgage will let you avoid paying for private mortgage insurance (PMI), you may be able to put as little as 3% down at closing.
However, some mortgage products, such as the VA loan and USDA loan, don’t require a downpayment - at all!
Whether you decide to put 3% or 20% down on your home, you will need to come up with a substantial sum of cash for the down payment. For example, if you want to put 3% down on a purchase of a $250,000 home, you will need about $7,500 at closing for your down payment. On the other hand, if you put 20% down on a $250,000 home, you will need to come up with $50,000.
4. Make Sure You Can Afford the Monthly Payment
Most lenders rely on the 28/36 rule to calculate what your maximum monthly mortgage payment should be. This rule suggests that the maximum monthly payment for your home loan should not exceed 28% of your gross monthly income and that your DTI should not exceed more than 36% of your monthly income before taxes.
Let’s say you earn about $5,000 per month before taxes. According to the 28/36 rule, your maximum monthly mortgage payment should be no more than $1,400. Now let’s say you earn about $3,000 each month before taxes. In that case, your maximum monthly mortgage payment should not exceed $840, which is 28% of your monthly income.
While the 28/36 rule is a good guideline for determining the maximum amount you can spend on your mortgage payment each month, it’s important to factor in the additional home-related costs, like lawn care and utilities, as well. These costs can add up and need to be factored into your monthly budget.
5. Do You Have Stable Employment?
Having stable employment is crucial for being approved for a mortgage. You will have to show evidence of having a stable employment history with few or no employment gaps or significant decreases in income. A stable employment history signals that you will be able to repay your mortgage loan on time without stretching your budget too thin. In turn, your chances of being approved for your loan are much higher.
As part of this process, your lender will want to see your recent tax returns, W-2s, and pay stubs as proof of your income. Your current and prior employment will also be verified.
Proving stable employment can be tough for borrowers that are self-employed or have variable income, such as part-time or commission-based income. For self employment, you must demonstrate earnings with your 1099s, and some lenders will require you to provide further documentation as part of the loan process. If your pay fluctuates due to the number of hours you work or the number of commissions you receive, it’s common for lenders to use a two-year average to calculate your income.
If you cannot prove that you have had stable employment over the last two years, you may not be ready to buy a home.
6. Do You Plan to Live There Long-Term?
If you aren’t planning to stay in your home for at least five years, you may want to wait to buy a home. houses can be risky short-term investments, as it costs money to both buy and sell a home.
When you buy a home, you are responsible for lender fees, closing costs, down payment, title insurance, mortgage insurance, taxes, and other costs. When you sell a home, you are responsible for some of these fees, and you are also paying your agent a commission.
The average commission is typically between 5-6% of the home’s selling price, and the buyer and seller’s agent share the commission.
Even if you sell your home for more than you owe on it, commissions and other costs can cut down on the profit you make. The longer you stay in your home, the more likely you will recoup what you spent when buying and selling your home.
7. Understand the Upkeep
One of the benefits of renting is that the upkeep and maintenance are the landlord’s responsibility.
This is not the case when you own a home, so be ready to hone in on your handyman skills. When you are a homeowner, you are responsible for the cost of any upkeep of your home. The bills for all home repairs or maintenance, from the lawn to the plumbing and the exterior facade, are going to come out of your budget.
The cost of upkeep and repairs will vary from year to year, but a good rule is to save between 1% and 4% of your home's value annually to spend on maintenance. If you plan to spend $250,000 on a home, it’s a good idea to save between $2,500 to $10,000 to allocate toward upkeep and repairs.
Make sure that savings goal is possible with your budget before buying a home, or you could struggle to cover the costs of upkeep.
8. Understand the Sacrifices
Owning a home can be a great investment, but if you’re on a tight budget or live in an area with high housing costs, you may also have to sacrifice some of what you want and like to do.
For example, do you like to take expensive annual vacations or have weekly dinners out with friends? Do you spend lots of money on a hobby or pastime? Are you planning to start a family or a home business in the near future? If so, does buying a home fit in with these plans?
If you are going to be forced to make significant changes to your lifestyle to buy a home, make sure you are willing to do so before moving forward.
The Right Time to Buy
Each person who’s considering homeownership should determine for themselves whether they’re ready, but the eight key factors above can help you decide. An investment in a home is a big commitment, one that requires time, energy, and most importantly, money — and if this isn’t the right time for you, the opportunity will still be there when you’re ready.