Owning a home is still many people’s idea of the American dream. Historic-low mortgage rates over the past several years have helped more consumers realize this dream. Yet purchasing a home still requires a major financial investment and a long-term commitment. During this, the last week of Financial Literacy Month, here are five signs to help you determine whether you are ready to buy a place to call your own.
1. You are budget-savvy. Your monthly finances -- how much money is coming in and how much is going out -- are key to figuring what you can afford to spend on a new home. Keep in mind that home ownership comes with a slew of new expenses. There are moving costs, utilities, homeowners insurance and real estate taxes. You may need to purchase household items such as curtains, lighting fixtures or furniture. Before you buy, you should have an established emergency fund. This fund will prove helpful when you encounter costly, unexpected expenses, which could range from replacing a hot water heater to repairing a leaky roof.
2. You have saved for a down payment. Lenders may expect you to have a down payment worth at least 20 percent of the home’s cost. That means you would need a $30,000 down payment to buy a home priced at $150,000. Some first-time homebuyers qualify for government-backed loans that require a lower down payment. For example, Federal Housing Administration (FHA) loans fall into this category (currently requiring a 3.5 percent down payment). For those who are just starting a career or have a lower credit score, these loans might be easier to obtain than a conventional loan. Regardless, though, unless you put at least 20 percent down, you will likely have to purchase private mortgage insurance (PMI). PMI protects lenders in case you default on a loan. However, PMI adds extra fees to your monthly mortgage payments.
3. Your debt-to-income ratio is good. As a general rule of thumb, your total monthly debt payments (including mortgage, credit cards, student loans and auto loans) should not exceed 40 percent of your income. Lenders prefer that your monthly housing costs, including principal, interest, taxes and insurance consume no more than a third of your monthly gross income. It is a good idea to pay down large outstanding debts before applying for a mortgage. In addition, it is wise to put off making any substantial purchases like a new car until after you have secured a home loan.
4. You have a plan for the future. Simply because you can afford to buy a bigger, more expensive home does not mean you will be able to stay in that home if circumstances change. For instance, you may think your household will always have two incomes to cover the mortgage payment. But what if someone is laid off, falls ill, gets injured or stays home to raise a family? An emergency fund will only tide you over for so long. Carefully consider what really is the right size home for your budget.
5. You are ready to put down roots. In most cases, you will need to be in a home for at least three to five years in order for its value to appreciate enough for you to recoup buying and selling costs. You may lose money if you sell earlier. Even if you do turn a profit, you should be prepared to pay capital gains taxes if you lived in the house less than two years.
Home ownership has many benefits. For one, you can deduct mortgage interest from your federal income taxes, which helps many home owners itemize deductions to save even more. Unlike rent, which can be unpredictable, a fixed monthly mortgage payment will not increase. And even though you are borrowing money to purchase a home, it can be a good investment if your house appreciates in value and you eventually sell it for a profit. Still, if one or more of the above points does not apply to you, it may be best to work on getting your financial house in order before you purchase a physical home.
Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.
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