How to Know If You Should Buy a House
How to Know If You Should Buy a House
The right time to buy a home is different for everyone. Are you ready to take the leap?
TARA MASTROENI October 2, 2020
Our goal here at Credible Operations, Inc., NMLS Number 1681276, referred to as “Credible” below, is to give you the tools and confidence you need to improve your finances. Although we do promote products from our partner lenders, all opinions are our own.
There’s not just one answer to the question of when to buy a house. Instead, the decision of when to buy a home is a personal one that depends on multiple factors.
This article will help you get a sense of how close you are to being ready for homeownership. We’ll help you figure out whether buying the home in the near future is a smart move or whether you might be better off waiting.
Here are five signs that buying a house makes sense (and two you should wait):
You have a stable employment history
You have a handle on your debt
You have a decent amount of savings
You’re happy with your credit score
The market is working in your favor
You’re not ready to settle down
You have other big expenses on the horizon
1. You have a stable employment history
If you’ve worked at the same job for at least two years, you might be ready to buy a house.
Before they approve you for a home loan, lenders want reassurance that you have enough money coming in to cover the cost of the mortgage and will continue to do so for the foreseeable future. To them, that proof comes in the form of stable employment history.
To verify your employment history, lenders will typically ask for your last two years of W-2s. If you’re self-employed, be prepared to present your tax returns for the last two years instead. You’ll also need to be able to show any 1099s that you’ve received during that time.
2. You have a handle on your debt
If your DTI is less than or equal to 45%, you might be ready to buy a house.
The next thing that lenders take into account before approving you for a mortgage is your debt-to-income ratio (DTI). Your debt-to-income ratio is a measure of how likely you are to be able to afford another loan, given your current debt obligations and how much money you have coming in each month.
To find your current DTI, all you have to do is add up all of your recurring monthly debts, including credit card debt, car payments, and student loans, etc. Then, divide that number by your total monthly income and multiply it by 100 to get your percentage.
(Total monthly payments ÷ monthly income) x 100 = DTI
These days, lenders are looking for a DTI ratio that’s less than or equal to 45%. If your current DTI is higher than that, it may be worth focusing on getting a better handle on your debt before jumping into the real estate market.
3. You have a decent amount of savings
If you’ve saved over 5% of the average cost of a home in your price range, you might be ready to buy a house.
In addition to making sure that you have enough money to cover your mortgage payment each month, your lender will also want to verify that you have a sufficient amount of savings to shoulder the upfront costs of buying a home. In particular, you should save enough to pay for the following:
Down payment: Typically, you want to have a 20% down payment saved (though there are cases where you might need less of a down payment).
Closing costs: Closing costs account for any fees required to close on a home. They’re typically split between the buyer and the seller and usually amount to an additional 2% to 5% of the home’s purchase price.
Reserves: Reserves are the funds that you have left in the bank after paying your down payment and closing costs. Lenders prefer that you have enough in your accounts to cover at least two months of mortgage payments — but an even bigger buffer than that might be a good idea.
4. You’re happy with your credit score
If your credit score is over 500, you might be ready to buy a house.
The final financial component that lenders consider before giving you a mortgage pre-approval is your credit score. The exact score you’ll need to be approved will depend on the type of loan that you’re considering. As a rule of thumb, getting approved for a conventional loan will require a credit score of at least 620. However, it’s possible to be approved for an FHA loan, which is a program used by many first-time homebuyers, with a score as low as 500.
That said, it’s in your best interest to try and improve your credit score as much as possible before you start looking for a house. Put simply, borrowers with excellent credit scores are given the best interest rates. On the other hand, if you have a lower score, you’ll likely end up paying more for your home over time.
5. The market is working in your favor
If mortgage rates are going down, it’s probably a good time to buy a house.
Beyond the strength of your financial profile, you should also take market conditions into account when deciding on the best time for you to buy. In particular, you should take a look at current interest rates. When mortgage rates are low or trending downward, you’ll pay less overall when you borrow money.
You’ll also want to consider whether your area is currently in a buyer’s or seller’s market. Qualified real estate agents can help you make that determination, but as the name suggests, you’re hoping for a buyer’s market. During buyer’s markets, there is generally more inventory for prospective buyers to choose from, which makes sellers more willing to negotiate on price.
6. You’re not ready to settle down
If you plan to move within the next four years, you might NOT be ready to buy a house.
Conventional wisdom states that you should plan on staying in your house for at least five years for the purchase to make sense. A recent study by Betterment also backs up that figure. The company found that it takes new homeowners four years, on average, to break even on the cost of buying a home, meaning that you would have to stay put for at least five years for buying to become a smart financial investment.
The truth is that only you know when you’re ready to settle down. However, if your career is still up in the air or you’re not satisfied with the area in which you’re living, buying may not be the best decision. Instead, it might be better to wait until you’re ready to settle down long enough for your investment to pay off.
7. You have other big expenses on the horizon
If you have other big expenses to pay for in the near future, you might NOT be ready to buy a house.
By now, it should be clear that buying a home is a huge financial decision. If you know that you have other big expenses coming up, such as a wedding, a new baby, or education costs, now may not be the ideal time to buy.
Instead, it’s best to wait to buy a home until you feel stable in your current financial situation and you feel comfortable taking on the additional expense. That way, ideally, you’ll be able to handle the added upfront costs of buying a house without having to sacrifice in other areas of your life.