Making the leap from renting to buying is thrilling and liberating — for many, it signifies the realization of the American Dream.
But it’s also a big decision, both for your future and your finances.
It’s a long-term commitment that requires strong financial standing, and in many ways it’s about more than just money.
You have a low credit score
«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’re doing it as an investment
If someone asks why you want to buy a house and your first answer is something along the lines of «Because I’m wasting money on rent» or «Because it’s a good investment,» you might not be mentally prepared for all the responsibilities that come with home ownership.
«When you look at the average price increase of a home across the country over the last 100 years, it’s only about 3%,» says Eric Roberge, CFP and founder of Beyond Your Hammock. «If you take away extra costs plus inflation, you’re not really making any money on average on a single-family home.»
It’s smarter to look for a house that meets non-monetary goals: It’s in your dream neighborhood or it’s a good place to start a family. «A home is a utility, not an investment,» Roberge says.
You have to direct more than 30% of your income toward 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.
«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.»
«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 previously told Business Insider. «In addition, a quick sale is not always possible or equitable for a seller.»
You aren’t putting anything into savings
Even with a full emergency fund, you should still be able to continue putting money away for other goals.
«If you’re saving money every month, that means your cash flow is in good shape, which is a good sign you’re ready to buy a home,» Roberge says.
If you can’t spare anything more than the mortgage payment, consider putting off purchasing a home until your cash flow is more stable.
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, 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.»
You’re planning other big expenses in the next few years
It’s important to consider your housing budget within the context of your future goals. «Keep in mind the next couple of years down the road and what you have coming up,» Roberge says.
If you don’t have any other big expenses looming, it will be easier to make paying off your house a priority. Consider this: If you can afford mortgage payments of $1,000 a month right now, but you have a baby next year, will you still be able to afford the same amount? If not, it’s time to choose your priorities.
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 exorbitant on their own.
You won’t be able to keep up with other goals
Don’t feel like you need to have every penny worth of debt paid off before you can purchase a home. But do a deep dive into why you have debt and how you’re planning to deal with it, from student loans to credit card charges.
«Why do you have the credit card debt? Was it just a random occurrence where you had to put something on the credit card and you know you’re going to pay it off soon? Or have you been spending more than you make and it’s increasing over time?» Roberge says.
It’s okay to still be paying off your student loans or paying down past credit card debt. But if the added costs that come with buying a house — mortgage payments, taxes, and repairs — impede your ability to continue putting money toward those goals each month, you might want to hold off for now and let your other expenses take priority.
You’re deep in debt
While it’s okay to have some debt, if it’s a significant enough amount, it could hinder your ability to buy a house at all.
«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.»
Read up on all of the hidden costs that come with buying a home before making the leap.