How to Know If You’re Ready to Buy a Home

Kayla Albert Unison, Housing Market 0 Comments

How to know if you're ready to buy a house

You want to buy a home, but you’re not sure if you are financially ready. It’s a common situation — and one that I found myself in recently.

I currently live near Denver, Colorado, a city that has seen tremendous growth over the last few years. According to one study, rental prices in Denver have increased more than 5% every year since 2010, with a whopping 9% increase from 2014 to 2015 alone. However, real estate prices have seen a double-digit gain for the past three years as well, meaning that purchasing a home isn’t a clear cut alternative.

When I was faced with the “rent or buy” dilemma, I soon realized it was more complicated than I originally imagined it would be. It required careful consideration of not only home prices and rental prices, but also of my financial situation and my plan for staying in the home.

If you are trying to decide if you’re financially ready to buy a home, here are things you need to consider as you make your decision.

Get an Overview of Your Financial Situation

Obviously, a big part of the picture is your expected monthly mortgage payment – which consists of your principal and interest payment plus taxes, property insurance and, in some cases, mortgage insurance. It’s a good idea to get a quick read on whether you can afford the monthly mortgage payment from an online calculator.

Being able to afford a monthly mortgage payment is a great first step, but it’s just one small piece of the overall homeownership puzzle. Here are other things for you to consider:

Income stability: A mortgage is a longer term commitment than a lease agreement and carries greater financial implications. For example, if a job loss prevents you from making the payments, you could lose your home and any equity in it. Therefore, if your income isn’t stable or you are already concerned about your job stability, locking yourself into a mortgage might not be the best option.

Credit health: Have you checked into your credit lately? The items on your credit report and your resulting credit score could have a big impact on both loan approval and loan terms. While this is something lenders will look at on your behalf, taking a look for yourself beforehand will allow you to correct any misreported information and take steps to improve your score now. If your credit health is less than ideal, you may need to wait until financial changes you make can be reflected in your score. (You are entitled to one free credit report annually from each of the three credit reporting bureaus — Equifax, TransUnion, and Experian — at AnnualCreditReport.com.)

Savings: While some loans make it possible to purchase a home with less than 20% down, your monthly payment will be higher and you’ll likely have to pay mortgage insurance in that case. On the other hand, you might not want to lock up all your savings in the house just to get to a 20% down payment. Instead, you should consider programs like the Unison HomeBuyer program offered by Unison, which allows you to reap the benefits of a large down payment without putting all your cash into the home. The company invests alongside you in your home so that you can put down 20%.

Emergency fund: The need for a stable emergency fund (3-12 months’ worth of expenses, depending on your situation), becomes even more of a necessity when you have the responsibility of a mortgage. In addition, you’ll have to remember that repairs that used to be paid for by a landlord will now fall squarely on your shoulders. So having an emergency fund is a necessity.

Get Pre-Approved for a loan:  It doesn’t cost anything to talk to a loan officer and it is the surest way to find out who kind of home prices you can consider. When you talk to a loan officer, they will ask you about your income, current debts, cash available for a down payment and credit history. From this information, they will be able to tell you the amount of a loan and hence the home price you can consider. If you forward documents which verify the information such as copies of tax returns to verify your income, the loan officer will be able to give you a pre-approval. A pre-approval is a formal estimate of how much money you can borrow to buy a home. If and when you decide you want to buy a home, you’ll want to have a pre-approval in hand before looking at homes.

Think About Your Long-Term Plan

A few years ago, a friend of mine sold her single family home for a hefty profit after only living there for about two years. While these scenarios do happen, it’s not something any of us can count on. I know that I’ll need to be prepared for a variety of scenarios when buying a home.

That’s why part of the decision-making process should include taking a careful look at how long you plan to be in the home you purchase or rent. The plan you create should be based on fact, not assumptions – and not wishful thinking.

A down payment is a cost you essentially recoup because of the equity you gain right off the bat. But there are other costs — like real estate agent fees and closing costs — that you won’t be able to get back. That’s one reason why many suggest being prepared to stay in a home for 5-7 years, which should be long enough to build equity in the home to offset these costs.

The “right” amount of time, however, depends on your situation.

Evaluate Your Rent Costs vs. Mortgage Costs

Finally, you’ll need to look at the hard numbers associated with renting vs. buying.

As a renter, you probably have a few simple house-related costs to think about. These expenses probably include:

  • Rent
  • Water/sewage
  • Utilities

As a homeowner you will need to consider a few additional costs, such as:

  • Mortgage
  • Property tax
  • Homeowner’s insurance
  • Water/sewage
  • Utilities
  • Home repairs and maintenance

There may be some additional costs as well, including:

  • Homeowner’s Association dues
  • Private Mortgage Insurance (PMI) for conventional loans or Mortgage Insurance Premium (MIP) for FHA loans

You should know that PMI or MIP kicks in when you have less than 20% for a down payment. Programs like Unison HomeBuyer can eliminate the need for paying mortgage insurance altogether.

In order to understand the full cost implications between renting and buying, here are a few numbers you should evaluate:

  • Rental prices in your area (based on the size of home or apartment)
  • Home prices in your area (based on the size of home)
  • Current interest rates on a mortgage
  • Property taxes in your area (Here’s a resource to help.)
  • The average cost of homeowner’s insurance for your area

This comprehensive rent vs. buy calculator can shed some light on what these numbers might mean for you.

What’s Next?

In my case, after taking into consideration my current financial situation, the cost to purchase vs rent, as well as the long term outlook of the rental and real estate markets in my area, I made a decision to buy a home. This choice made the most sense for me right now and into the foreseeable future. In looking at the numbers, I felt that I wouldn’t be stretching myself financially by becoming a homeowner.

By completing all of the initial legwork, you too can make your decision with confidence, and end up with a new home that fits your needs. Even if homeownership isn’t the best choice right now, you will be well-equipped to make a thoughtful decision in the future.

About the Author

Kayla Albert

Staff Writer

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Kayla is a writer and editor who has written about many consumer finance topics, including credit, budgeting, retirement, and home-buying. She likes connecting readers with advice relevant to their life.

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