House hunting can be a very time-consuming and emotional process but it’s also one of the largest financial decisions most people make. It’s important to avoid potential mistakes that could leave you in a bad financial position for years to come. Understanding how much house you can afford, what loan is right for you and whether or not this is the right time to buy can help you make a smarter overall financial decision. Speak with a financial advisor if you’re trying to determine how your next house will play into your long-term financial plan.
Determine If Now Is the Right Time to Buy a Home
Although your home can be a significant asset, it is also a responsibility. Even in the best market, buying a home can be expensive and painstaking. It’s important to make sure that both the market and your personal readiness are aligned before deciding to move forward with buying a home. By taking the following factors into account, you can gauge your readiness to purchase a home.
Your debt-to-income ratio (DTI) helps lenders decide if you can afford a mortgage. By dividing your minimum monthly debt by your pre-tax monthly income, lenders calculate your ability to make a mortgage payment each month.
For example, say your monthly payments on debt amount to $1,500. Your gross monthly income is $4,500, so $1,500/$4,500 equals 33%. This figure meets the industry benchmark of 43% or less to be eligible for most mortgage variants. However, most lenders want to see DTIs below 36%.
Your credit score is vital to qualifying for a home loan and getting a low-interest rate. Lenders use your credit score to help determine how risky it is to loan you money. If your credit score is lackluster, you can take action to improve it. A good credit score will help you in more areas than a mortgage, so you’ll do yourself a favor by addressing lingering debts.
With the exception of VA loans and USDA loans, you’ll need to put money down on the home you want to purchase. Therefore, you will need some liquidity if you want to buy a home, even if you have an excellent credit score and little debt.
You’ll need a minimum of 3% of the home’s appraised value as a down payment for a conventional mortgage or 3.5% on a Federal Housing Administration (FHA) loan. Another 3-6% will be due in closing costs. The more you can put into the down payment, the better off you’ll be. You will lower the loan’s principal balance, reducing the interest you will pay over the years to come. Furthermore, if you put 20% down at closing, you can eliminate private mortgage insurance (PMI) from your monthly payment, saving you even more.
Without consistent income, paying a mortgage is difficult. Lenders scrutinize your monthly income when establishing the amount they will loan you. Your monthly income affects your DTI, an indicator lenders take seriously when deliberating whether to provide you with a mortgage.
Market conditions are something to account for rather than wait to reach an ideal. The housing market is constantly changing and is rarely 100% favorable for anyone, whether you’re a buyer or a seller. As a buyer, a favorable market is one with a plentiful supply of homes and low-interest rates. These factors help a homebuyer find a house at an affordable price and get good terms for their loan.
Sellers want the kind of market we’ve had for the past few years: low supply and higher demand, which drives up the prices of homes. If a small number of homes continue to sell rapidly to an increasing proportion of buyers, sellers will continue to benefit from higher prices.
Calculate How Much You Can Afford
Homeownership is more than a mortgage. Whether your house was built last year or one hundred years ago, it will need maintenance and repairs as you live in it. If you’re wondering what kind of mortgage you can afford, calculating your DTI ratio is an excellent first step. Want help crunching the numbers? Use our home affordability calculator to see how much house you could afford.
Pinpoint the Right Type of Mortgage
Different mortgages meet the needs of homebuyers in a variety of situations. Some might be best if you have less down payment while others might provide a better overall interest rate and lower monthly payments over the course of the mortgage. Depending on your circumstances, one or more of these loans may be right for you.
- Conventional Loans: Conventional loans are mortgage loans from a non-government lender such as a bank or other private financial institution. Many conventional loans are held by Fannie Mae and Freddie Mac. Loans owned by these institutions are called conforming loans. Conventional loans are widespread among borrowers and require a down payment of at least 3%.
- FHA Loans: Federal Housing Administration (FHA) loans have less stringent credit score requirements because the federal government insures the loans. However, borrowers must put down at least 3.5% of the loan value to get an FHA loan.
- VA Loans: VA loans are exclusive to veterans, active-duty military members, National Guard members and some surviving spouses. Borrowers taking out this loan do not need a down payment. Credit requirements for a VA loan vary by lender.
- USDA Loans: United States Department of Agriculture (USDA) loans help those living in rural regions with low incomes get a mortgage. USDA loans have minuscule interest rates and require borrowers to pay closing costs but no down payment.
5 Home Hunting Tips
The housing market has been more competitive than ever over the last two years. Finding a house will take more than writing a basic offer letter and houses rarely go for below the asking price. Use these five common strategies to get a leg up on the competition and successfully purchase a home in a way that doesn’t put you in a bad financial position:
Avoid Unnecessary Contingencies
As discussed previously, a contingency for the appraisal or inspection can protect you from committing to a house that isn’t up to snuff. However, contingencies can also take you out of the running if multiple buyers make offers (and in today’s market, this is usually the case).
Instead of a contingency, you can offer to buy the home no matter what the inspection reveals. Additionally, if the seller performs an inspection before listing, that can provide the information you need to make a decision on the home. For peace of mind, you can still have your own inspection; just make it clear to the seller that you won’t try to negotiate based on the results.
Keep an Open Mind
In our current market, sellers are essentially comparing the best, highest offers among several buyers and choosing what appeals to them. If you’re fortunate enough to have your offer accepted, keep an open mind when you start negotiating with the seller. Keep a short list of non-negotiables and be open to change when it comes to anything else. A long list of demands will cause the seller to jump ship and choose a more easygoing buyer.
Cash Is King
It’s not unusual for buyers in today’s market to have extra cash for an appraisal gap. Gaps are occurring more often because appraisals are lagging behind the rising price of homes. As a result, buyers are taking the initiative by paying the seller the difference between the asking price and appraisal in straight cash.
You can also go a step further and make an all-cash offer if you have the funds available. Cash offers are more competitive because they eliminate the hoop-jumping brought on by getting traditional financing through a lender.
If you have the money available but are uncomfortable with parting with that much cash, you can take advantage of delayed financing. Delayed financing allows you to get a mortgage on a home you recently purchased for cash. This tool allows you to retain your liquidity while making a competitive cash offer on a house.
If you’re having a hard time finding a home or having your offer accepted, you’re not alone. One way around this challenging market is to ask friends and family if their neighbors are moving out soon. By getting the inside scoop on homes going up for sale, you can contact the owners, tour the home and make an offer before anyone else.
Work With an Experienced Realtor
Currently, many home sales turn almost into auctions, with the seller waiting for the highest bid and cashing out on the hot market. Working with an experienced realtor can give you the edge you need for the seller to accept your offer.
Having a knowledgeable, skilled advocate marshaling your negotiations and working behind the scenes can make the difference between finally landing a home or going back to the drawing board. Therefore, be selective when choosing your real estate agent. You’re looking for a tenacious, enterprising professional with years, if not decades, of experience.
Buying a home is a large financial decision that can often be driven by emotions. However, you can land a home you’ll love by taking the process one step at a time, acquiring financing and making smart financial decisions for both the short and long-term. If you need help with the process, consult a financial advisor who can provide additional guidance.
Tips for House Hunting
- Purchasing a home is one of the most significant investments you’ll ever make, which is why the guidance of a financial advisor can be crucial for you and your family during this process. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- House hunting starts with a mortgage preapproval, which requires extensive documentation and research. Therefore, it always pays to have a mortgage preapproval checklist by your side.
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