Are You Ready to Buy Your First Home?
Are You Ready to Buy Your First Home?
Many renters opt to remain renters for a long time for different reasons. Some of them value the flexibility of having a landlord take care of some of the headaches that come with living in a house or apartment. Others find it convenient to be able to relocate to another place with a 30-day notice.
For some, renting gives them easier and less expensive access to areas in a desirable school district, commercial or business area. For renters in cities such as New York, San Francisco, or Chicago, they can reside in apartment buildings and condominiums that offer unique amenities and features.
There are many reasons that would drive people to try and purchase their first home. For instance, even when property values take a dive, you will still have a place of your own. Once you’re done paying the mortgage, it’s all yours. You won’t have to worry about having to set aside money from your regular salary just to make sure that your family will have a place to sleep in for the night.
A lot of younger couples fail to realize that buying property is less difficult than what they imagine it to be. However, having your own home means taking a big responsibility but it also provides the excitement to first-time homebuyers to work toward a notable achievement in their lives. Knowing when to buy a home – that perfect time to do it – is one of the more important parts of the process.
Check out these 7 signs to see if are ready to buy your first home:
You have enough saving for the down payment (even more than the minimum amount the bank requires)
If you are planning to take money out of your 401(k) or Individual Retirement Account to cover the down payment of your home (as many Americans do), think through it. Doing this could be an expensive blunder that would severely affect your retirement. By getting money from your 401(k) or IRA, you forfeit years of compounding interest and you’d still need to pay it back with post-tax money. A better strategy would be to build up a savings account for your down payment – it’s more liquid and won’t mess up your finances later.
Even if you have a neat budget for buying a home, unforeseen expenses will always come knocking on the door. For example, closing costs may come with inspection fees and title insurance that can add an extra 5% to the final cost of the home. So, it’s a good idea to provide some financial buffers on your down payment.
First-time home buyers would often overshoot their budget when buying a home. Add to this the complexities involved in the process of buying. Therefore, it is a wise move to build your savings at an amount much, much higher than the minimum amount of the down payment of the home you plan to buy.
You do not plan to move in the next 3-5 years
This three-year rule is not a matter of life and death but it will tremendously help you to know if you are at the right stage in life to buy your first home. Why do we say 3-5 years and not 5-7 years? As you already know, as you keep paying your mortgage month in and month out, you are effectively reducing your interest payments. Now, it takes about three to five years before the amount that you will save on shrinking interest will be on par with the rent you’ll be saving on. Whatever amount you’ll save can go to cover your closing costs for the investment. This way, you can truly say you’ve broken even.
One other important reason is that if you sell your house in less than 2 years, you’d more likely not realize a true real estate profit from the transaction.
Let’s not forget the tax implications of selling your house too early.
The good thing is that the IRS will not collect capital gains tax for profit from the sale of a home up to $500,000 on a jointly-filed tax return, or $250,000 on a single-person filing.
However, this is dependent on the fact that you’ve used the home as your primary residence for at least 2 out of the immediately preceding 5 years. If that is the case, you can claim the capital gains exemption from the sale of real estate.
Selling your house earlier than 2 years means setting yourself up to paying additional federal income taxes. So be sure to consult your tax advisor before making any decisions that could have an impact on your personal taxes.
You should know what type of mortgage you need and want
There are different types of mortgages and each one will differ from the others in the interest rates, fees, terms, flexibility, etc. Each feature will be a factor in determining how much the loan will eventually cost and how long it’s going to take for the borrower to pay it off. An interest rate can fall under the category of fixed, floating or a mix of the two. Even the repayment structures offer many different variations. For a new buyer, it can be overwhelming just trying to understand all of these things, so let’s try to unpack these features.
As you choose your mortgage, you have to take into account your own financial situation and all the options that you have at the moment. Only after you have selected the type of loan that you need can you compare lenders and their offers. By being able to relate the features with your needs and understanding some basic loan terminologies, you can make a more intelligent decision about the loan offers.
Your credit score should be high enough
Perhaps the most important credential you can present to get a bank loan is your credit score. It will determine whether a lender will lend you money and at what rate. If you have a bad or low credit score, you may be able to get a loan but with higher monthly repayments which will not be very easy on the pockets. Your credit score does not remain stagnant for a long time so be sure to check it early during the home buying process. If it’s less than ideal, you’d better put some work into it first to build it up and raise it higher.
Banks and other lenders would try to see if you are trustworthy and can pay your loan back so they would take a close look at your credit score. The credit bureaus review your past borrowings and timely repayment activity to compute for your credit score. Typically, credit score ranges from 300 to 850 although some versions can go as high as 900. In the financial world, a score of 720 and above merits you an excellent status. If at this point, you don’t know what your credit score is, you can check online using one of the many credit score apps and websites.
You have job security
The other important consideration is if you have a consistent stream of income with a stable degree of regularity and predictability. It follows that you should be able to generate enough monthly income to cover the monthly mortgage payments. You might think that paying your mortgage every month would be the same as paying a monthly rent but there’s more to it than just the regular amount. At some point, you’ll need to pay property taxes and higher insurance costs. The advantage of the monthly mortgage payment is the tax deduction it allows you to have. Because of the larger tax deduction, there’s less money that you need to take from your budget to pay for your income taxes.
Aside from this, if you are confident that your career is heading the right way, purchasing a home is a practical decision. The pride that comes with the achievement – that of being able to purchase a home at a young age is motivational. It can boost your confidence and inspire you to reach better heights and success in your career.
Your debts are under control
If you have many debts, it will affect your ability to repay your mortgage and it will not sit well with prospective lenders especially, on their decision to take their chance with you. If you have multiple credit cards, it might be a good move to consolidate your debts. Also, if you have a high credit limit but you’ve not availed of, you can probably ask your lender to lower your limit. If you have some personal loans, you can consolidate them or incorporate them into your proposed home loan. These things will show your lender that you will have no trouble repaying your home loan, even if your situation undergoes some changes.
Lenders will evaluate your ability to repay by examining your monthly debt-to-income ratio (DTI) in two ways. The first one is through the front-end DTI which limits the ratio to just the housing debts and expenses. The second one is the back-end DTI that considers all debts such as auto loans, credit cards, and other loans. Lenders will follow their own guidelines but on average, the upper end is 35% for a front-end DTI and 43% for a back-end DTI.
For example, if your total debt payments for each month is $1,500 and your monthly income is $6,000, you will have a ratio of 25%. Generally, lenders want to see a DTI of less than 43% before they will give a thumbs up to your mortgage application. In case your present DTI is over that benchmark, you should find ways to bring it down first.
If you are not having any difficulty paying off your student loans, it’s a sign that you can take on a bigger purchase like a house. But if your credit card debts are mounting or you are still struggling to pay off a big personal loan, take that as a red flag. You might want to put off buying a house in the meantime.
Baruch Silvermann is a personal finance expert, investor for more than 15 years, digital marketer and founder of The Smart Investor. But above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.