The Decision to Buy…
Before taking the plunge into the buyer pool, it’s important to consider whether homeownership is right for you.
Rent Vs. Buy?
When looking for a new place to live, the first question you ask yourself will help drive the rest of your decision-making. Should you rent or buy? Buying may seem appealing because you will put an end to escalating rent and can build equity. But the reality of routine home maintenance and repairs can quickly drain a bank account.
In general, whether renting or buying is better for you largely depends on your specific circumstances.
Here are some basic questions to consider when thinking about buying a home:
How long do you plan to stay there? If you expect to relocate in just a couple of years, renting is likely a better option.
How much home can you afford? If you can’t afford a home large enough to fit your family in a few years, it may be worth it to rent while you save a bit more.
What’s on the market? If you can’t find a home you like, it’s likely not worth tying yourself to something you’re unhappy with.
Another consideration: Stretching your budget for that dream home may actually make you miserable, as a growing body of research suggests.
Still can’t decide if buying is for you? Check out The Times’s rent vs buy calculator to dig deeper into the difference in expenses.
If both your lifestyle and the hard numbers point toward buying, the next step is to determine how much home you can afford.
Can I Afford to Buy a Home?
Buying a home is the biggest financial decision most people will make, with many factors going into that decision.
How Much House Can I Afford?
To determine how much you can spend on a home, take a close look at your budget. Review your bank statements and spending habits for the last couple of months to figure out how much you are spending on everything from cellphone bills to restaurants.
The Consumer Financial Protection Bureau offers a spending tracker that can help you figure out where your money is going each month.
Once you have a better picture of your spending habits, determine how much you want to allocate toward a monthly home payment. This figure includes your principal, interest, tax and insurance payment, which add up to your monthly mortgage sum.
The Federal Housing Administration formula, used by many lenders, recommends allocating no more than 31 percent of your monthly income to your housing payment. This figure will change based on your amount of debt. Buyers with no other debt may be able to budget as much as 40 percent of monthly income to housing. (But remember that the rest of your budget is going to have to go toward heat, water, electricity, routine home maintenance and food.) Overall, your total debt-to-income ratio, including car payments and credit card bills, should not exceed 43 percent.
So, for example, if you make $50,000 in annual gross income, your monthly gross income is $4,167. That should leave you with $1,292, or 31 percent to devote to your monthly mortgage, provided your overall debt does not exceed $1,792 a month. Our mortgage calculator can help you determine what your monthly mortgage may be.
But remember that besides the mortgage, buying a home includes additional one-time payments that can quickly add up, including closing costs, legal fees and other expenses associated with buying, such as a house inspection. And don’t forget about moving fees or home improvements.
Organize Your Finances…
It’s time to assess your spending, clean up your credit and figure out what you can afford.
Count Your Pennies…
Have you decided to buy? Before you jump into the world of open houses and real estate agents, take the time to get your finances in order. It will help you once it’s time to apply for the mortgage. It will also help you get some financial perspective before you fall in love with that perfect center-hall colonial or the studio with views of the park.
1. Check Your Credit Score:
Lenders use credit scores, also known as FICO scores, to evaluate the potential risk of lending to you. The higher the number, which runs from 300 to 850, the better your score. The best mortgage rates go to borrowers with credit scores in the mid- to high-700s or above, according to the Consumer Financial Protection Bureau.
To find out where you stand, go to annualcreditreport.com, which offers a free report annually. Be aware that the three major credit-reporting bureaus, Equifax, Experian and TransUnion, generate their own FICO scores based on the data they collect; you’ll be able to find out all three here.
Is your FICO score low? You can improve your score by paying down high credit card debt, and by cleaning up any financial mistakes, like errors resulting from identity theft or mixed-up files belonging to another person with the same or similar name. Be aware that it takes time for these changes to be reflected in your credit score, from months for an inaccurate bill to years if you’ve had tax liens or bankruptcies. But if you can clear up your credit, it can make a big difference in your mortgage rate.
2. Get A Mortgage Preapproval:
A preapproval letter is a written estimate from a lender of how much you will likely be able to borrow from them. This letter will help you determine how much you can afford, and help demonstrate that you can secure a home loan when you are ready to make an offer on a house.
Getting preapproved for a mortgage is different from getting prequalified for a loan, which is essentially a back-of-the envelope calculation of how much of a loan you may qualify for based on unverified information. The preapproval application for a mortgage often requires submitting pay stubs, bank statements, tax returns and other financial documents. Take the time to get one now, so you’re ready to make an offer as soon as you find a home you love.
How Do Down Payments Work?
There’s a reason why people talk about saving to buy a house. Your savings will go into your down payment.
3. Line Up Cash:
The more cash you can pay up front toward your home, the less you will have to borrow. A bigger down payment means your monthly payments will be lower and you will pay less interest over the course of your mortgage. If you can afford to put down 20 percent or more of the total home price, you typically won’t have to pay for mortgage insurance, a premium that protects the lender in case you default on the loan.
But don’t use all your money toward a hefty down payment. Lenders will want to see that you have some reserves in the bank. Closing costs typically add up to thousands of dollars, according to Bankrate.com, which conducts a survey of closing costs nationwide and offers a fee breakdown of the average costs by state. You’ll also need cash on hand for moving, renovations and other incidentals.