So you’ve finally decided to take the plunge on your dream home. But are you really ready to own it, or should you consider renting? Home ownership is often touted as a popular facet of the American Dream. But buying a home is not something you do on a whim. Rather, it’s a deliberate process that involves assessing your life to determine if buying a house is a financially sound step for you. Here are some signals that you might be ready for homeownership.
You Are Debt Free
You know you’re ready to buy a home when you are debt-free. Not only would paying a monthly mortgage seem like a herculean task, but getting a mortgage lender to finance your home could be difficult as well.
Lenders often decide to lend based on the debt-to-income ratio. The debt-to-income ratio is related to your total monthly debt to gross monthly income. The higher this number, the more difficult it is to receive financing. If a large portion of your income is going to pay off your pre-existing loans, you have to ask yourself if you can really afford to pay off another huge loan. If you are still paying off your auto loans, student loans, and credit card debts, or have a debt-to-income ratio of more than 43%, now might not be a good time to buy a house.
You Can Afford a Down Payment
A down payment is a percentage of the total price of the home that you pay up-front. The number one hurdle that potential house-buyers face is this initial investment.
How much should you put down as down payment? The standard amount is 20% of the asking price of the house. This is the ideal percentage to keep your monthly mortgage check low and manageable. A 20% or higher down payment will also allow you to refinance your future home at a lower interest rate.
Being able to afford a healthy down payment shows your lenders that you are capable of saving, and that you are serious about your investment. This payment negates the need for private mortgage insurance (PMI), which gives your lender protection in an event where the buyer stops paying their mortgage.
The 5-Year Rule
If you’re planning to stay in one place for at least 5 years, that’s a great time to buy a home. The reason is that this long-term commitment helps build equity.
Equity is the difference between the appraised value of your house and the balance left to pay as mortgage. One thing to be aware of is mortgage amortization, which is how mortgage payments are calculated: how much goes toward paying off the principal amount, and how much goes toward paying the interest.
At the beginning, more of your payment goes towards paying interest than principal balance. But after making enough payments, as you get closer to paying off the remaining balance on your loan, more money will go to pay the principal amount rather than interest. Each month, equity on the house increases. Five years is a good benchmark to develop enough equity to sell your house for a profit, which may be used to make a bigger down payment on your next house.
You Have an Emergency Fund
Life is full of curve balls, and you should be prepared for those, especially financially. Another great indication that you’re ready to purchase a home is that you have an emergency fund reserved for unexpected events like lay-offs, car repairs, renovations, emergency medical expenses, etc. It’s a good idea to build a safety net before investing in a house. A good benchmark is to have 6 months’ worth of income saved up in a savings account. This gives you a healthy blanket of financial security to handle any financial setbacks that might come your way. Emergency funds should be kept separate from your down payment.
You Can Afford the Associated Fees of Buying a Home
Buying a home requires more than just being able to afford the sticker price. There are several costs that may not be mentioned up-front that most new buyers don’t consider. Educating yourself about all these fees, which can add up to a substantial expense, will put you in a better position to tackle what many new buyers might consider as an unexpected blow to their home-buying plans.
Home Inspections, closing costs (an umbrella term that includes several costs like lender fees, title fees, home appraisal, and Escrow fees, etc.), moving costs, property taxes, home insurance, higher monthly utility bills, homeowner’s association (HOA) fees, along with maintenance, furnishing, and renovation expenses are all costs that many potential home-buyers overlook. Make sure that you have enough savings stacked up to cover these expenses.