There’s a reason why most people associate home ownership with settling down. For most first home buyers, realizing this dream often indicates that your life is steady, your career is secure, and you are likely married or in a significant relationship. If you’ve reached this point, it shows you’ve decided what you want out of life. Ideally, it also indicates that your finances are in order.
However, as much as you want to quit renting and start owning, becoming a homebuyer is not for the faint of heart. Aside from that, home ownership comes with a slew of possible issues and costs that renters are unlikely to face. A home is also the most expensive investment most individuals make in their lives – are you prepared to make that type of commitment? In this article we’ll cover the six most important questions for first home buyers, which will help you determine if you’re indeed ready to become one of them.
1. Have You Achieved Financial Security?
Before you start binge-watching HGTV and collecting paint samples, consider the following: Do you have an emergency fund? If that’s the case then how many months could you afford to cover your ongoing bill payments? An emergency fund covers your expenses if you lose your job, require surgery, or need to fly to a family member’s funeral. It’s an important first step towards financial security.
Having a well-stocked emergency fund means you won’t miss a mortgage payment because you can’t work. It’s your last line of protection against losing your house due to events beyond your control. If you don’t have at least three to six months’ worth of expenses saved up you should work on that before becoming a homebuyer.
The next thing to think about is whether or not you have debt and how much you owe. You won’t be able to get a mortgage if you have too much debt. Loans for first home buyers have become a lot harder to get approved since the real estate crash in 2008. Lenders look at your debt-to-income ratio to see if you have enough money to pay them back every month. Do you know what your debt-to-income ratio is? You can calculate it by dividing the money you owe by the money you bring in every month. Ideally, this ratio should be as low as possible.
Becoming a first-time buyer is probably the right choice for you if your employment is consistent, you have enough funds, and you have low debt. If you’re still battling with money problems, prioritize tightening up your finances and adopting a more frugal lifestyle.
2. How Long Do You Intend to Live in the Area?
As many first home buyers know, purchasing a property costs more than just the price of the house itself. You have to pay many upfront expenses, including inspection fees, appraisal fees, and loan origination fees. These costs are likely to be in the thousands of dollars, if not more. This indicates that in order to break even you must stay in the home for at least five to seven years. If you sell your house before that time, the value may not have increased sufficiently to satisfy closing expenses.
Becoming a first-time buyer makes little sense if you need to move around for work. Your employer may transfer you to another place, leaving you to deal with your changing living situation.
Let’s take a look at one probable scenario: You purchase a property in March, and your employer informs you in November that the branch is closing and you will be relocated to another city. You may either refuse and look for a new job in your area or you can accept the offer.
Because you enjoy working at your job you accept the company’s offer. But now you have two weeks before your transfer, leaving you with little time to sell your house. Because the date is so near to Thanksgiving, there aren’t many people interested in your listing. In the end, it takes two months for your property to sell during which time you must pay both your old mortgage and your new rent.
This type of scenario is more common than you may imagine and it demonstrates why home ownership isn’t always the ideal option – even if you can afford it. As a homebuyer you need to be aware of this inherent risk.
3. Are You Prepared for Home Ownership?
On the surface, home ownership appears simple, but the reality is far from that of a Lowe’s ad. If you’ve lived in a rental home your entire life, you’ve always had a landlord to contact when there’s a problem with the property. You’ve never had to deal with leaking pipes or replacing a broken air conditioner. As a homebuyer, you are ultimately responsible.
According to experts, you should set aside 1% of your home’s purchase price for repairs each year, or $1 per square foot. This will cover both small issues, such as touch up paint for your doors, and big issues, such as a roof replacement.
It’s not only costly but also time-consuming to repair your home when something goes wrong. Instead of ringing up the landlord and delegating this task, it’s you who will need to call up contractors in your area, obtain several quotes, and take time from work to address the issue. Not to mention the added stress of dealing with it all. Experiencing this ordeal as a first-time buyer can be exhausting and it’s definitely something you should be aware of when becoming a home owner.
If your budget does not allow for an extra couple hundred dollars per month for repairs, or if you do not want to deal with home maintenance at all, you are probably not ready to buy a home just yet. In fact, some people prefer to rent their whole lives, directing the money they would have spent on a house to other assets. There is no law that says you have to be a homebuyer in order to be financially stable.
4. What Kind of House Do You Prefer?
Before you begin looking for a home, you should determine what you genuinely want in a house. While it’s easy to say, “I’ll know it when I see it,” such an approach can prolong your search process unnecessarily. When you’re ready to become a homeowner, you’re also ready to make a plan and get specific.
These are some of the fundamental questions that will help first home buyers contain their search:
- How many bedrooms you actually need?
- What kind of neighborhoods do you prefer?
- What type of yard best suits your lifestyle?
Getting into the specifics can mean that things get a little more complex:
- Do you need to live near your workplace or do accept a longer commute?
- Do you have or want children, and therefore need to purchase a home in a certain school district?
- Do you have a preference for a certain architectural style?
If you’re married or in a committed relationship, talk to your spouse about the type of house they want. Decide on whether you want a starter home or a forever home. The answers to these questions will help you narrow down your search and speed up the process to becoming a first-time buyer.
5. Can You Save Enough Money for a Down Payment?
When you apply for a mortgage, you must make a down payment that serves as a deposit. The down payment provides you with immediate equity in the property you’re about to purchase and demonstrates to the mortgage lender that you are capable of saving.
The lowest needed down payment for a home depends on the type of mortgage you want to apply for. Most lenders will have similar down payment requirements for first home buyers as well as established homeowners.
- 0% downpayment: VA loans, which are guaranteed by the United States Department of Veterans Affairs, often do not need a down payment at all. VA loans are available to current and former military service members, as well as their surviving spouses. USDA loans, which are supported by the USDA’s Rural Development program, also have no down payment requirements. USDA loans are available to every homebuyer who fulfills the program’s income limits and other non-monetary requirements.
- As low as 3%: Some traditional mortgages only demand a 3% down payment. Conventional loans are not government-backed, but they adhere to the down payment requirements set by the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
- As low as 3.5%: If you have a credit score of at least 580, FHA loans, named this way because they are underwritten by the Federal Housing Administration, need as low as 3.5% down. The down payment requirements rise to 10% if your credit score is between 500 and 579.
- As low as 10%: Home loans that don’t adhere to the loan requirements established by the Federal Housing Finance Agency (FHFA) are known as Jumbo loans. Because these large loans cannot be guaranteed by the GSEs, lenders will typically demand a larger down payment to mitigate some of the risk.
In addition to the down payment, you must also pay the loan’s closing costs, which are typically between 2 and 5% of your home’s purchasing price. When you apply for a mortgage, the money to cover both your down payment and any additional fees must be in your bank account. A loan from your parents, relatives or friends cannot be used as a down payment, since the lender would consider it debt. However, depending on your family’s financial background, your parents may be able and willing to support your dream of becoming a first-time buyer with a sizable contribution that you don’t have to pay back. After all, you are their favorite child, right?
If you can’t save enough money for a down payment, you’re unlikely to qualify for a mortgage. If you don’t qualify for the loans that require no down payment, such as VA or USDA loans, there are also several assistance programs available to first home buyers. Some of them will assist you in saving for a down payment, others may even provide you a grant if you meet the program’s requirements. So look into those if you’re having difficulty.
6. What Credit Score Do You Have?
Having a good credit score is crucial for purchasing a home and being accepted for a mortgage. A traditional loan requires a minimum credit score of 620. However, some lenders want a score of 700 or higher. FHA loans require a credit score of at least 580. If you are an aspiring homebuyer with a low credit score, a debt that is actively being collected, or a recent bankruptcy, you may not be able to apply at all.
Check your credit report at AnnualCreditReport.com before attending an open house or signing up for Zillow alerts. The report will list your whole credit history and will highlight any abnormalities a lender may view as red flags, such as late payments or overdrawn accounts.
If your credit score is below 700, make sure you investigate the potential reasons for it being this low:
- Do you use more than 25% of your credit card limit each month? Even if you’re staying well below your maximum allowed credit limit, anything above 25% may negatively impact your credit score.
- Did you have a lot of hard inquiries recently? Hard inquiries will stay on your credit report for two years.
- Is your credit history not long enough yet? Becoming an authorized user on another person’s longstanding credit card account can help you lighten the impact of a short credit history.
A good credit score may improve the likelihood of first home buyers to secure a reduced interest rate on their mortgage. Locking in a low interest rate can save you thousands of dollars over the life of the loan.
Buying a house is one of the most significant financial decisions you will ever make. For that reason, you need to make sure it’s the right one. Don’t do anything just because all your friends are doing it and don’t let your parents talk you into becoming a first-time buyer when you still feel unsure about it. If you ask yourself these six important questions, you’ll be able to tell when the time has come to be a homebuyer. Until then, enjoy the stress-free life of a being a renter for a little while longer.