This 5-question quiz can help determine whether you’re ready to buy a home
Taking the leap from renting to buying is one of the biggest financial decisions most people ever make. Before you jump into home ownership, asking yourself these five questions can help answer the really tough one — are you ready to buy a home?
1 What is your credit score?
Check your credit rating if you’re even thinking about thinking about buying. Credit scores range from 300 (very poor) to 850 (excellent). Most basically, a higher credit score indicates you are likely to meet all your financial obligations. A lower credit score serves as a red flag for financiers.
Even in the case of renting, credit counts.
A credit score of at least 620 may be required to qualify for a lease without contingencies (such as a higher deposit or a co-signer).
A conventional home loan also will require a score of 620 or higher. As a general rule, the higher your credit score, the lower the home loan interest rate that you will be offered by lenders. A larger down payment (20 percent of the home price or more) can also help you qualify for a lower rate.
If your credit score is low, work on raising it. Closely examine your credit history for errors. If you find any, contact the lenders who have reported incorrect information and request corrections. Pay your bills on time and pay down credit card balances to no more than 30 percent of the maximum credit that you are allowed. Such steps can raise your score significantly over time.
2 Do you have enough money saved?
Assess your finances. Whether you are renting or buying, it’s best to have an emergency fund of three to six months of living expenses saved up to cover unexpected issues, such as a car breakdown or a job layoff.
Beyond your emergency fund, do you have money saved for a down payment on a home?
Renters are familiar with security deposits, which typically require one month’s rent, with additional money required for pets and, in some cases, parking.
When buying a home, the required down payment typically ranges from 5 to 20 percent of the purchase price. Making a down payment of less than 20 percent is likely to be costly in the long run. Most often, you will be required to pay for mortgage insurance as part of a total monthly mortgage payment.
3 How much can you afford to spend on housing?
In general, aim to keep housing costs — rent or mortgage payments plus homeowner’s or renter’s insurance and, if you own, property taxes — to less than 30 percent of your gross, or pre-tax, monthly income.
The advice offered in a New York Times article titled “With Eyes Bigger Than Their Wallets, Homebuyers Are Forced to Revisit Old Rules” in 2009, after the housing bust, remains true as the housing market recovers:
“Several financial advisers recommend reverting to an old standard known as the 28/36 rule.
“Using that rule, households should spend no more than 28 percent of their gross income on housing costs — including mortgage payments, property taxes and insurance — and less than 36 percent on all debt. The total includes obligations like car payments, student loans, credit cards and medical debt.”
Joseph R. Birkofer, a financial planner and principal of Legacy Asset Management in Houston, told the Times: “I want people to have more than a house, I want them to have a life, too. The application of the 28/36 rule can be an eye opener and a ‘go slow’ or ‘reform now’ sign.”
Remember also that the true cost of owning a home includes both fixed monthly payments and money for ongoing repairs and maintenance. For those accustomed to renting, there is suddenly no landlord to call. If a pipe clogs, an air conditioner breaks or paint starts to peel — and such things will inevitably happen — making the situation right is all up to you.
As Jennifer Hartman, a Los Angeles financial planner interviewed by the Times, puts it: “If you can’t afford a new roof or a water heater, then you can’t afford the house.”
Just getting in the door of a newly purchased home often comes with extra costs. You may need to purchase big-ticket items such as appliances, a lawn mower or window treatments, for example.
4 How long do you plan to stay?
As a general rule, the longer you plan to stay in a home, the more sense it makes to buy. It takes time to build enough equity to get back what you put into it. If you suspect you may be in the area only a year or two or even three, renting is very likely the better option. Think long term.
5 What’s the local housing market like?
A local real estate agent can tell you whether home prices are up or down from where they were last year. They can also provide projections for the coming months. You can also check local newspapers, the Internet, and the county tax appraiser’s office for a record of recent sales prices.
Another way to determine whether the local economy is growing is to take note of the infrastructure. Vacant buildings and overgrown, empty lots may indicate decline. New roads, new housing developments and schools going up are all signs of healthy economic growth.