If you’re tired of renting or living with your parents, buying your own place may sound like a good idea. You can enjoy full decorating control, build equity, plus ownership offers a sense of stability. But even if you have income and good credit to qualify for a mortgage, you shouldn’t jump into homeownership too soon.
Buying a house is one of the biggest decisions you’ll ever make. Before you fill out a mortgage application, ask yourself these questions to know if you’re financially ready.
1. Do I Have Stable Income?
Whether it’s a job or another income source like child support, alimony or disability, you need some sort of income to purchase a house—that’s a no-brainer. Getting a mortgage requires 24 months of steady employment, preferably in the same field; and if you’re self-employed, you have to provide two-years of profitable tax returns. But even if a bank approves your mortgage application based on the information you provide, only “you” can decide whether now’s the best time to buy a house.
It’s important to base this decision on logic, not emotions. You don’t want to jump into a mortgage if you doubt the long-term stability of your income. Maybe your employer has been talking about cutting back and you fear your job might be on the chopping block. Or maybe you’re thinking about going back to school or quitting your job to start your own business. Some might say it’s best to purchase before a major employment change takes place, and in some cases, it is. But if a change results in lower income, it might be easier to cope without a mortgage hanging over your head.
A mortgage is a big commitment. Sure, you’re mentally ready for this next step in your life. But it’s also important to have your financial house in order. If your income fluctuates, or if you think your income may decrease in the near future, now may not be the best time to purchase.
2. How Much Debt Do I Have?
Mortgage lenders will also consider your existing debts when reviewing your application. Debt doesn’t necessarily prevent a mortgage approval, but it can reduce affordability.
Your debt-to-income ratio can skyrocket if you’re juggling several maxed out credit cards, a car payment and student loans. This ratio compares your monthly debt payments to your monthly expenses, and lenders use this ratio to determine how much you can afford to spend on a house. Typically, your mortgage payment cannot exceed 31% of your gross income, and your total debt payments (including the mortgage) cannot exceed 36% to 45% of your gross income, depending on the type of mortgage.
The less debt you have, the better your odds of qualifying. But even if you can qualify for a mortgage with existing debt, it doesn’t hurt to pay off some of your debts before buying a place. Homeownership is expensive. It’s not just the mortgage payment you have to worry about, but also home repairs and maintenance. The cost of owning can be much higher than you anticipated. Paying off credit cards and other debts can increase your disposable income, providing extra cash flow to handle unexpected expenses.
3. How Much Do I Have in the Bank?
Unless you qualify for a home loan program that doesn’t require a down payment—such as a USDA or a VA loan—you’ll need cash to purchase a house.
Down payment requirements start as low as 3.5% for an FHA home loan, and between 3% and 5% for a conventional loan, depending on your credit score. You’ll also need cash for closing costs, which can range between 2% and 5% of the sale price. The good news is that you can ask the seller to pay all or a percentage of your closing costs, or you can include closing costs in your mortgage loan.
It takes a lot of cash to get your foot in the door. Even with cash in the bank for your down payment and closing expenses, it might not be enough to qualify for a loan. This is because some lenders require borrowers to maintain a cash reserve after paying mortgage-related expenses—perhaps two or three months’ worth of mortgage payments. Cash reserve requirements vary by lender, with some lenders only requiring reserves from self-employed borrowers.
Your bank may not impose this requirement, but this doesn’t mean you shouldn’t maintain a reserve. It’s never a good idea to completely drain your savings to buy a house. You need to leave a surplus or “just in case” funds. Unexpected expenses are going to pop up. It’s not a question of if, but when. If you spend all your cash buying the house, you might have to rely on a credit card.
Giving your landlord a check every month can feel like you’re flushing money down the toilet. But you shouldn’t let this frustration cloud your judgement. Although buying a home is a fulfilling and exciting milestone, you don’t want to make a hasty decision. Take a closer look at your finances, and then decide whether now’s the right time.
How did you financially prepare for a home purchase?