Can You Afford A Mortgage? Review These 7 Signs Before You Buy
The thought of buying a home is exciting and can get you wrapped up in the dreams of your dream home. But owning is a long-term commitment, and one that requires strong financial standing.
If any of these signs strike a chord, you may want to delay taking on a mortgage in the near future.
You have a low credit score
Before considering home ownership, you’ll want to check your credit score, which you can do through free sites like Credit Karma, Credit.com, or Credit Sesame.
“The higher your score, the better the interest rate on your mortgage will be,” writes personal finance expert Ramit Sethi in “I Will Teach You To Be Rich.” Good credit can mean significantly lower monthly payments, so if your score is not great, consider delaying this big purchase until you’ve built up your credit.
You have to direct more than 30% of your income towards monthly payments
Personal finance experts say a good rule of thumb is to make sure the total monthly payment doesn’t consume more than 30% of your take-home pay.
“Any more than that, and your finances are going to be tight, leaving you financially vulnerable when something inevitably goes wrong,” write Harold Pollack and Helaine Olen in their book, “The Index Card.” “To be fair, this isn’t always possible. In some places such as New York and San Francisco, it can be all but impossible.”
While there are a few exceptions, aim to spend no more than one-third of your take-home pay on housing.
You don’t have a fully funded emergency savings account
And no, your emergency fund is not your down payment.
As Pollack and Olen write,
We all receive unexpected financial setbacks. Someone gets sick. The insurance company denies a medical claim. A job is suddenly lost. However life intrudes, the bank still expects to receive our monthly mortgage payments … Finance your emergency fund. Then think about purchasing a home. If you don’t have an emergency fund and do own a house, chances are good you will someday find yourself in financial turmoil.
Certified financial planner Jonathan Meaney recommends having the equivalent of a few years’ worth of living expenses set aside in case there is a job loss or other surprise. “Unlike a rental arrangement with a one or two year contract and known termination clauses, defaulting on a mortgage can do major damage to your credit report,” he tells Business Insider. “In addition, a quick sale is not always possible or equitable for a seller.”
You can’t afford a 10% down payment
Technically, you don’t always have to put any money down when financing a home today, but if you can’t afford to put at least 10% down, you may want to reconsider buying, says Sethi.
Ideally, you’ll be able to put 20% down – anything lower and you will have to pay for private mortgage insurance (PMI), which is a safety net for the bank in case you fail to make your payments. PMI can cost between 0.5% and 1.50% of mortgage, depending on the size of your down payment and your credit score – that’s an additional $1,000 a year on a $200,000 home.
“The more money you can put down toward the initial purchase of a home, the lower your monthly mortgage payment,” Pollack and Olen explain. “That’s because you will need to borrow less money to finance the home. This can save you tens of thousands of dollars over the life of the loan.”
To get an idea of the savings you’ll have to put away, check out how much you need to save each day to put a down payment on a house in major US cities.
You plan on moving within the next five years
“Home ownership, like stock investing, works best as a long-term proposition,” Pollack and Olen explain. “It takes at least five years to have a reasonable chance of breaking even on a housing purchase. For the first few years, your mortgage payments mostly pay off the interest and not the principal.”
Sethi recommends staying put for at least 10 years. “The longer you stay in your house, the more you save,” he writes. “If you sell through a traditional realtor, you pay that person a huge fee – usually 6% of the selling price. Divide that by just a few years, and it hits you a lot harder than if you had held the house for ten or twenty years.”
Not to mention, moving costs can be insanely high.
You’re deep in debt
“If your debt is high, home ownership is going to be a stretch,” Pollack and Olen write.
When you apply for a mortgage, you’ll be asked about everything you owe – from car and student loans to credit card debt. “If the combination of that debt with the amount you want to borrow exceeds 43% of your income, you will have a hard time getting a mortgage,” they explain. “Your ‘debt-to-income ratio’ will be deemed too high, and mortgage issuers will consider you at high risk for a future default.”
You’ve only considered the sticker price
You have to look at much more than just the sticker price of the home. There are a mountain of hidden costs – from closing fees to taxes – that can add up to more than $9,000 each year, real estate marketplace Zillow estimates. And that number will only jump if you live in a major US city.
You’ll have to consider things such as property tax, insurance, utilities, moving costs, renovations, and perhaps the most overlooked expense: maintenance.
“The actual purchase price is not the most important cost,” says Alison Bernstein, founder and president of Suburban Jungle Realty Group, an agency that assists suburb-bound movers. “What’s important is how much it’s going to cost to maintain that house,” she tells Business Insider.