Buying a home can seem like a daunting process — it just may be the most expensive and emotionally charged purchase of your life. But even during a pandemic, with careful research and determination, the keys to that dream home can be yours. We’ll help you along your path toward homeownership.
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 factor to consider: The current housing market is one of the most competitive in decades, with record-high prices and record-low inventory.
That means buyers should be prepared to make multiple offers and be aware that they may have to pay more than a home is listed for — sometimes thousands of dollars more — in order to get their offer approved.
Still can’t decide if buying is for you? Check out The Times’s rent-versus-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 streaming services to your weekly restaurant takeout. The Consumer Financial Protection Bureau offers a spending tracker that can help you figure out where your money is going each month.
Because of the pandemic, homeownership is more affordable than ever. Interest rates on mortgages, near record-low territory, are around 3 percent. If you can qualify for a loan, these rates add up to significant savings over the course of a 30-year loan.
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.) Over all, 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. A mortgage calculator can help you determine what your monthly mortgage may be — don’t forget to adjust the slider to match current interest rates.
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.
The pandemic is also raising the financial stakes on these costs for new homeowners: Because the housing market is so competitive, many buyers, in a bid to get a leg up, are now choosing to waive contingencies in order to have their offers accepted. Contingencies offer buyers an out if something unforeseen arises.
They allow you to cancel a purchase if an inspector finds the need for significant home repairs, and to cancel or renegotiate deals if an independent home appraiser deems the home value to be significantly less than the purchase price. A mortgage contingency gives buyers the option of pulling out of the deal if they can’t obtain financing within a reasonable amount of time. And if you need to sell your current home to afford the new one, you should make your offer contingent on the sale of your own home.
By waiving them, buyers may get a leg up in the market but are also vulnerable to extra costs after the sale is completed. So proceed with extreme caution.
Have you decided to buy? Before you jump into the world of combing online home listings, attending open houses and vetting 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.
- 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.
- Decide if You Want to Go Digital or Analog…
Digital lending platforms like Better.com, Rocket Mortgage and LendingTree are growing rapidly in popularity, and for good reason: They not only allow potential buyers to apply for loans from home and on their own schedules, but also have the potential to remove biases from the loan industry. But applicants with spotty employment history, credit issues or those relying on a gift for their down payments might run into issues online, where their applications could trigger a more thorough inspection. In these cases, working with a traditional human lender might provide a smoother experience.
- 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.
- 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.