How Do You Know When You’re Financially Ready To Buy A Home?
Recently I got the question: How does one know they are ready to buy a home, in financial terms? Pretty good question, I think, and considering that we are getting ready to buy a home, very timely. Here are the four steps I would recommend you take to make sure you are financially ready to buy a home.
Step One: Have A Fully Stocked E-fund
This is incredibly important. You need to have an emergency fund that is entirely separate from any funds you are using to buy the home. Why? Because life can suck.
Real example: You have the funds for the house and all is well until your car gets totaled in an accident. You’re mostly fine thanks to wearing your seatbelt and the airbag deploying, but now you need a car. Can’t go to work without one. There goes the house down payment. It sucks royally to be in this position. An e-fund can make your life so much easier.
Step Two: Have Funds For A Down Payment
You’II need to have the funds for a down payment. This can vary based on the type of loan you are going to get.
Some loans like USDA or VA have 0% down payments. This means you don’t have a down payment on these loans. All you’ll need to have are the funds for your closing costs. Closing costs typically run anywhere from 2- 6% of the loan amount depending on where you are and what kind of loan you are doing.
FHA loans require a down payment equal to 3.5% of the purchase price. So you would be paying this amount in addition to any closing costs you have.
Conventional loans can go as low as a 3 % down payment, but they are harder to qualify for. It is worth noting that if you put 20% down. you will not have to pay mortgage insurance which would decrease your monthly payment.
These are just the most common loan options. Some lenders will have their own unique programs, and some counties may have special bond loan options available so best to shop around and see your options.
Step Three: Get Pre-qualified For A Mortgage
Now that you have money and emergency money we are ready to see what you qualify for.
When I say pre-qualified, I do not mean that letter you get in the mail from your bank saying that you are pre-qualified for × amount. This is you actually completing a loan application, the lender running your credit, you supplying documentation (tax returns, last few paystubs, bank statements, etc), and the lender submitting everything for review via a process called underwriting. Underwriting is when the lender verifies all the information you sent in and assesses how risky it would be to give you a loan. Things like low credit, high debt, late payments, and low income make giving you a loan riskier and could lead to a denial or being approved for a lower amount. They may also ask for more information or documentation as well. This process can be frustrating, but they are trying to decide whether to loan you hundreds of thousands of dollars. They will be doing their due diligence. If your application gets approved, they will let you know how much you are approved for.
If the lender doesn’t automatically tell you, be sure to ask what the monthly payment would be on the amount you are approved for. Also, keep in mind that the monthly number they give will typically only include principal and interest on the load (also the mortgage insurance if your loan requires it). You will still have to factor in real estate taxes and insurance. If you have an idea of the area you’ll be looking in, they may be able to give you a rough estimate, but until they have a specific home they are qualifying you for, it’s just educated speculation.
If your application is denied, they will go over why it was denied and whether it is something that can be fixed. If it can, they try to come up with an action plan to get you to where you need to be. However, some things just need time to pass before you can qualify. These are things like multiple late payments (past 30 days overdue), bankruptcies, or being self-employed/making the majority of your income via commissions or bonuses.
Fun Fact: Most lenders want at least two years of income as a self-employed or commissioned/bonused person before they’ll approve you for a loan.
Now that you know what you’re qualified for, it’s time for the final step.
Step Four: Figure Out What’s A Comfortable Monthly Payment
This is super important. At the end of the day, you have to decide how much you are willing to spend every month on a mortgage. The lender can say that you qualify for a $5000 mortgage, but is that actually feasible for your life? Just because you can qualify for a $5000 mortgage doesn’t mean that you should have one.
Some questions you may want to consider:
- Are you wanting to be able to go on a yearly vacation?
- How much is that?
- What do you need to save monthly to get that?
- Do you have hobbies or past times that you love that you want to still afford to do?
After you take everything into account you may find that while you may be approved for $5000, you are only comfortable with a $3000 mortgage.
Once you know how much you’re comfortable with, you need to ask the lender what that translates to in a house price. Just keep in mind that taxes and insurance will vary. From here, you have to find out if that house price is feasible where you are looking.
If it is not feasible then you have some questions you need the answers to and some choices to make. Some questions you may need to find the answers to:
- How close are you to where you want to be?
- Are you able to put more money down to get the payment lower?
- Is buying down the rate an option?
- Are you able to pay the mortgage insurance upfront (an option for conventional loans) to reduce the payment?
- Are you willing to give up or scale back something to allow your payment to be higher?
The answers to these questions will determine your best options and whether or not buying a house is the right move for you.
If it is, then awesome! Find a real estate agent and go get your home.
And that’s that. Four steps that you should take to make sure you are financially ready to buy a home. If you have all of this under your belt, then you’ll be financially ready to buy a home or know where you stand on your path to buying one. I hope that was helpful for someone out there especially with the market being the way it is. 😊
Feature Photo by Sean Kinnear on Unsplash
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