Buying a house is a huge milestone, but are you financially prepared to take this step? We spoke to real estate experts to get their take on what’s most important when preparing your finances for homeownership.
How to know if you’re ready to buy a home
Ultimately, preparedness will vary by individual, so we advise working with a financial professional to help you determine whether you’re absolutely ready to buy a house.
Ask yourself these five questions to help determine if you’re ready to buy a house.
1. Are your finances in order?
Having a strong financial profile is one of the biggest factors when determining if you’re ready to buy a house. Not only should your debt-to-income ratio be low, you should have enough saved for a down payment and cash on hand for inspections, closing costs, and maintenance.
Lenders will look at your debt-to-income ratio to measure your ability to manage the monthly payments you make to repay the money you’ve borrowed. It’s recommended that your debt-to-income ratio be 43% to meet the requirements for a qualified mortgage. To calculate your debt-to-income ratio, divide your monthly debt payments by your gross (or pre-tax) monthly income.
For example, if you pay $1,000 a month for your mortgage and another $150 a month for an auto loan and $500 a month for the rest of your debts, your monthly debt payments are $1,650. If your gross monthly income is $5,000, then your debt-to-income ratio is 33%. ($1,650 is 33% of $5,000.)
According to April Palomino, realtor with Coldwell Banker Residential Real Estate, “You will want to get credit card bills and other debts paid down before trying to purchase a home. Lenders typically want your total debt to be less than 36% of your gross income. If it is not, you are not ready to buy a home.”
According to Randy Mintz of Mintz Homes, you should ask yourself if you can handle the mortgage alongside your existing expenses. “Does the bank think you can handle the expenses? In other words, are you paying your other bills on time, and what’s your debt-to-income ratio: do you have little enough debt and high enough income to qualify for a mortgage loan?” says Mintz.
A loan officer can help you estimate your monthly loan payments and expenses on the type of house you want. You could also use a mortgage calculator to get a general sense of what your mortgage payments will be.
Before buying a house, make sure that you can cover a down payment of at least 20% of the home’s list price. “If the amount of cash you have can cover the 20% down payment, broker’s commission, closing costs, as well as the inspection and appraisal fees, then chances are that you’re ready,” says Shane Lee, analyst at RealtyHop.
If you buy into a co-op, a corporation that owns real estate, you’ll need even a bigger down payment. When you buy into a co-op, you become a shareholder in the corporation that owns the property. “If you’re looking at purchasing in a co-op, you’ll need around one-third of your purchase price in order to have enough for a down payment, post-closing, and any small, miscellaneous co-op closing costs,” says Lucas Callejas, agent at Triplemint Real Estate. For example, with a $1,000,000 co-op, you should have somewhere around $350,000 in what a board would consider liquid assets.
“Inevitably owning a home means repairs, furnishings, and other items that may come up once you move in, so a healthy emergency fund goes a long way,” says Jen Nelson, a realtor at Realty Executives. Plan to have three to six months’ worth of living expenses saved up in cash.
“Another sign that you’re ready to buy is the investment mentality and beginning to understand that you’re either paying down your landlord’s mortgage or paying down your own,” says Priscilla May, operating broker at 21 Century CARE. “Once that is realized, it becomes a bit less fearful of an experience to buy. Being willing to manage an investment is also necessary to gauge how ready you are. You won’t have a landlord to call for all your repairs but the opportunity cost is that you aren’t building their wealth; you’re building your own.”