Much like getting married and becoming a parent, buying a home is one of life’s great milestones. And, as with any other major life event, it can be tricky knowing when is the right time to take the leap.
When buying your first home, one of the most prominent unknowns is whether or not you’re financially stable enough to take on a mortgage. Here we’ll take a look at the top four factors to consider when determining if you’re on a solid enough financial footing to make such an important purchase.
How good (or bad) is your credit?
Knowing your FICO or credit score is a great first step in assessing your financial health. There are several online resources you can utilize to run a free credit check, including annualcreditreport.com which pulls reports from the three major credit bureaus.
The higher your score, the better your outlook for securing a loan. Any score of 740 or higher is widely considered excellent. Additionally, a higher credit score can help with private mortgage insurance (PMI). PMI is nearly always required on any conventional loan where the down payment is less than 20% of the final sales price. Generally speaking, a higher credit score will afford you a lower PMI payment.
If your credit score is too low for a conventional loan, you aren’t out of the running yet. Loans through the Federal Housing Administration, commonly known as FHA loans, are available to first-time homebuyers with scores typically considered too low for traditional funding. They also allow for down payments as low as 3.5%.
There are additional options for funding a loan if your credit is in bad shape. However, bad credit is a good indicator you may want to continue renting while you work on improving your credit.
Is your income stable?
How Americans earn money has become more widely varied over the last couple of decades. What hasn’t changed is the necessity of a steady and consistent income stream in order to qualify for a home loan.
The more traditional view of a stable income would be a paycheck from the same employer for two or more years with no erratic changes in total earnings — anything over a 25% fluctuation within a given year.
If, however, you’re self-employed, enjoy alternative sources of capital, or have changed employers a number of times over the years, there’s still a clear path to a mortgage. What’s important is to show your career is progressing within your chosen field and that your yearly income is either relatively steady or, even better, growing.
Of course, how much you earn comes into play. A widely accepted rule of thumb is that your total monthly housing costs (mortgage, taxes, insurance) should account for no more than 28% of your gross monthly income.
What’s your debt-to-income ratio?
While income is important, another critical factor of financial stability is the amount of debt you’re carrying, and your debt-to-income ratio.
You can calculate your debt-to-income ratio fairly simply by adding up all your recurring monthly payments — student loans, car, credit card, etc. — then dividing them by your gross monthly income.
An ideal debt-to-income ratio would be somewhere around 36% or lower. However, a borrower can still qualify for a loan with up to a ratio up into the 40% range.
Do you have adequate savings?
A downpayment is often the biggest hurdle for first-time homebuyers. As mentioned earlier, a downpayment of 20% will save you money in the long run by allowing you to opt-out of PMI.
With government loan programs such as FHA, U.S. Department of Veterans Affairs (VA), and U.S. Department of Agriculture (USDA), borrowers can secure home loans with as little as zero money down. However, taking on such debt without making an initial investment is a risky bet and leaves you vulnerable to fluctuations in the housing market — meaning you could end up owing more than your home is worth.
Remember: your down payment is not the only money you should plan on bringing to the table. As discussed in our blog on how long you should stay in your home before selling, closing costs for buyers can vary, though they typically fall anywhere between 2% to 5% of the overall purchase price.
Add to that moving costs, which can vary wildly depending on how much stuff you have, how far you need to move it, and how you plan on moving it. Not to mention what additional items you’ll need to purchase to appoint your new home.
Given all those considerations, we would recommend setting aside at least 25% of your target home price, above and beyond emergency funds and other dedicated savings allotments.
Calculating your future mortgage.
Check all the boxes and feel ready to start down the path of buying your first home? Get a clear projection of monthly housing costs at different price points with our mortgage calculator. And, as always, our mortgage specialists are standing by to help with your first steps toward achieving your homeownership dreams.
This is not a commitment to lend. Information deemed reliable but subject to change.