Finally becoming a homeowner is something that is on everyone’s list of goals. It is something that most people look forwards to in their life. When you are able to buy a house, you get to make it your own. From the paint to the furniture and appliances, you are finally free to pick exactly what you want. The process of buying a home is very complex and there are many considerations you will need to think about. This is especially true because a home is most likely going to be the biggest purchase you make in your life. Here, we detail the top financial factors to consider when buying a house.
Current Debt Load
One of the first things that a potential lender will look at when you go to apply for a mortgage is how much debt you currently have. Not only will they look at your debt, but they will also look at the amount of a coborrower. If you are purchasing a house with someone, they will also consider the amount of debt that person has.
The figure that a lender will look at specifically is your debt to income ratio. The debt to income ratio is not simply the amount of debt you have divided by your total annual income. Instead, it is the percentage of your gross monthly income that goes to paying your monthly debt payments. Gross monthly income is the total amount you make in a month before paying taxes and other deductions.
A lower debt to income ratio shows potential lenders that you are not highly leveraged. It can also display that you have a strong financial stranding can afford a new mortgage. Lenders prefer that your debt to income ratio is lower than 36%. No more than 28% going towards paying for your mortgage.
No matter what, the lower your debt to income ratio the better. Any debt that you take on will affect this figure. This is why you may want to hold off on getting a new car until after you get approval for a mortgage and buy your house. Also, be sure not to apply for a new auto loan after getting approved for a mortgage before purchasing your house. This can be a huge red flag for lenders.
One of the most important financial factors to consider when buying a house is the health of your credit history. When you apply for a loan, or in this case a mortgage, the first thing a lender will do is pull your credit history. This is a report that shows many different parts of your financial past. For instance, it will detail your outstanding loans plus show some loans that have paid off. A credit report can also show the amount of outstanding credit card balances. One part of a credit report lenders will be keen to is your payment history. They will check to see if you have ever defaulted on a loan.
All of these pieces of a credit report can impact your credit score. If you have a strong credit score, like 650+, then you should not have any issues getting mortgage approval. Also, you will be able to get a more competitive rate if it is closer to 800. If you have a low credit score, then you should consider all of the ways to improve your credit score. Having a low credit score and a poor credit history can lead to higher mortgage rates. While 1% not seem like a big deal, it can end up costing tens of thousands of dollars over the life of a mortgage.
Job Security and History
Not only will lenders look at your credit history, but they might also be interested in your job history. If you have had sporadic employment in the years leading up to your mortgage application, a lender may see this as a red flag. Number of months at your current job will be one of the factors to consider when buying a house.
If you just started a new job, you may find it difficult to get approved for a mortgage. This may be different if you are applying for the mortgage with a coborrower like a spouse.
Before even applying for a mortgage, you should ask your self a similar question. Do you have a high enough level of job security? If you lose your job, how will you pay for your mortgage? Do you have an emergency fund built up to support you? If you just started a new job, it may be in your best interest to wait it out 6 months to see how things go. This way, you will have a better understanding about your future at this company.
One of the hardest parts about being able to afford a house is having enough money to put as a down payment. While many people know about the basics of a down payment, they do not realize how much of an impact it can have on your mortgage.
First, some lenders require a specific amount be put to a down payment. Banks and other financial institutions will only finance up to a certain percent of the home’s value. The down payment not only reduces the amount you have to get a mortgage for. It also shows lenders how much you are financially invested in the property. Because of this, it can affect the interest rate on your loan. Many lenders and financial professionals suggest a 20% down payment. This means that your down payment should be around 20% of the closing price of the house.
Another reason why a down payment is one of the factors to consider when buying a house is because of something called private mortgage insurance. Another name for this is PMI, or lenders mortgage insurance. If you do not put down a certain amount for your down payment, your lender may require you to buy PMI. PMI is an insurance policy that protects the lender, not you, in case you fail to make mortgage payments. The reason this is tied to your down payment is because if you put more down, the lender will think you a more trustworthy borrower. If you only put a small down payment on your house, you have less risk invested, therefore need PMI.
The most common way to pay for PMI is through a monthly insurance premium. This can range anywhere from $100-$300 depending on the price of your house, as well as your down payment. The only way you won’t need PMI anymore is if you refinance your mortgage after you have enough equity in your home.
Home equity is also something to think about when deciding how much to put down on your home. The more you put down upfront, the sooner you will have a larger amount of equity in your home. Home equity is very important for a couple reasons. First, you can use the ownership percentage you have in your home to get a loan. This loan can be in the form of a simple home equity loan, or a home equity line of credit.
When it comes to your down payment, there are many factors to consider. You need to take into consideration your personal financial situation. If you are paying a ton in rent every month, it may make sense to put less money down. This means that you can start building equity in your own house even though you may have to pay for PMI.
Thus far, we have just covered the factors that are you can control when buying a house. These include your credit history, as well as the amount of your down payment. However, one of the factors to considering when buying a house outside of your control is the overall conditions of the real estate market.
If you have been saving up for a down payment for several years, and finally have your goal achieved, this is great. However, if the housing market has increased significantly, you may not be able to afford the house you were originally looking for.
Additionally, market conditions such as supply and demand will affect overall prices of houses on the market. This is something that is very prominent now after the COVID pandemic. The housing market post COVID is drastically different than a few years ago. During this time, and even in the year following, house building was slowed down. Some reasons for this include the fact people couldn’t work. Another reasons for halted home building is due to supply constraints. It has been harder and harder to get lumber, foundation materials like rebar, and even the simple screws and nails that are a necessity.
Because of this, people may be staying in their homes longer because they can’t move into a house that fits their current needs. This is creating a supply issue. If they do want to list their home, even though a new home isn’t ready, they may be asking more than the house is currently worth. These factors combined and inflating prices of homes, making it harder for the normal buyer. Additionally, demand is at very high levels. Many people are trying to move out of densely populated areas. These people may have higher incomes than those in the areas they are looking to move. Because of this, they may be able to afford these homes, making it harder again for normal people to make a home purchase.
So, what should you do if you are stuck because you are not sure if you should buy due to current market conditions? The best thing to do is work with a realtor, accountant, or financial advisor. The realtor should be able to negotiate prices down to a true value, and give insight into what the market will look like in the future. An accountant or financial advisor can help you determine the type of home you can afford. They will also be able to help put together a budget, and see if putting down a smaller down payment just to get into a new house so you don’t have to pay rent anymore, despite having to pay PMI, will be beneficial in the long run. At the end of the day, it may be worth it to just wait until the market corrects itself.
Factors to Consider When Buying a House – Summary
If you are a prospective home buyer, there are many financial considerations to think about. First, make sure you credit history is strong, and your debt levels are low. Also, think about your job history, down payment amount, as well as the overall broader market conditions. These are all financial factors to consider when buying a house.
If you still have questions, reach out to a financial advisor, realtor, or accountant. They will be able to lead you in the right direction.