Updated June 4, 2021
Reading time: 6 minutes
Buying a home is the American dream. That’s because homeownership is an attractive opportunity for financial stability, security, and investment. Are you and your friends growing up and starting new chapters? Or have you been renting for a long time and are ready to lay down some roots? There could be a beautiful home on your block, with all the bells and whistles of your ideal dream home. But before you submit an offer on a new home, there are essential details to consider.
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There is so much to consider before signing on the dotted line. Think through these vital questions when considering purchasing a house.
Sometimes, it’s a matter of when and not if you should buy a home. Maybe you’re a recent grad or newlywed, and the idea of homeownership seems like the next obvious step. But how do you know when you’re truly ready to put down a hefty chunk of change on a home purchase? Homeownership is the most significant financial decision of your life. Consider the following and whether you are prepared for each step. Then, you may be on your way to homeownership.
For first-time homebuyers, putting a down payment on your first significant investment is a big deal. Maybe your parents gifted you money toward the down payment of your first home. Or perhaps you’ve experienced some windfall that put you in the position to put down a down payment. But if you’re like most people, you’ll have to save your hard-earned money on a down payment for a home. The rule of thumb is to put down 20 percent of the home price. This percentage is standard if you want to avoid paying private mortgage insurance ( PMI ). Typically, you can expect PMI to annually cost between 0.5 and 1 percent of the entire mortgage loan amount.
If you don’t have 20 percent saved up, that doesn’t mean your home-buying dreams are impossible. You can purchase a Federal Housing Administration ( FHA ) loan for as little as 3.5 percent down. But a larger down payment does equate to smaller mortgage payments. Let’s say you purchase a home with a $300,000 mortgage and a four percent fixed-rate mortgage interest rate for a 30-year term. You’d then pay $1,432.25 a month for 30 years. If your mortgage were $280,000, then you’d pay $1,336.76 a month for 30 years. Also, be aware that some mortgage lenders won’t approve you for a mortgage unless you put at least 5 to 10 percent down.
Overall, it’s best to know if you can afford your home over the long haul. And it’s never worth it to sacrifice your emergency fund for the down payment on your home. If anything unexpected comes up, you could be in a pinch, needing to pay extra costs without those funds.
You might have the financial means to purchase a home for cash, which is rare these days. But if you’re like most people, you will have to take out a home loan. Before applying for a home loan through a mortgage lender, it’s always necessary to consider your debt-to-income ratio (DTI).
The FHA uses the debt-to-income ratio standard. Think of it as a general guideline for mortgage approvals. They use this ratio to determine if a borrower will make their mortgage payment each month. DTI considers your housing expenses like mortgage payments, mortgage insurance, home insurance, and property taxes. Having a DTI at 43 percent is generally acceptable, but economic conditions may make lenders more or less flexible about this number.
Let’s say your gross monthly income (the amount before taxes and other deductions) is $3,000. Multiply this amount by 0.43, and you get $1,290. That $1,290 is the maximum amount you should be spending on debt payments. But, like many others, you may also have student loans, a car payment, and credit cards. Let’s say these debt payments total around $440 a month combined. That means you could theoretically afford $850 in additional debt on a monthly mortgage payment. So, if you’re going back and forth on deciding whether you should buy a house, try to pay down your debt as much as you can.
When you own a home, you can expect to pay property taxes. Your local government will base your tax on the local tax rate and the assessed value of your property. To calculate the amount you’ll pay in taxes, you should take the assessed value and multiply it by the property tax rate. Let’s say you own a home with an assessed value of $200,000, and your county tax rate is one percent. Your annual property tax will be $2,000 per year. But some mortgage lenders will bake property taxes into your mortgage payment. And if that’s the case, you may be paying taxes monthly.
Expect to pay between two and five percent of the purchase price of your new home in closing costs. Let’s say your new home costs $200,000; you could pay between $4,000 and $10,000 in closing costs. Have that money ready to go for the final closing of your home. Pretty soon, you’ll officially be a homeowner!
Let’s say you have the money for a down payment on a home, and your debt-to-income ratio is no problem for lenders. Now is the time to find a real estate agent and find the right property in the right housing market for you. If your area is cheaper to rent than buy, then it may be worth waiting until the housing market is in a different place. Buying a home may be less expensive than renting in your real estate market. Then, by all means, go ahead and plan your home purchase.
Think about the long term with your financial investment. Maybe now a home value is $200,000, but in 30 years, your home could be worth several times more when you go to sell. But also think about financial situations —another Great Recession or frequent natural disasters that may lower home value.
An important factor you cannot afford to overlook is the economy. In early 2020, the coronavirus pandemic swept the world. The economy suffered as layoffs and furloughs were on the rise. But economists started to see a housing boom with low inventory and housing prices on the rise. What you could likely see is a competitive market while house hunting. No one could predict the economic implications of these events. But it’s always wise to think about the long term before buying. Do you think your employer could eliminate your job? If you are worried about your salary, it’s best to hold off until your personal finances are more stable.
If you do buy there may be housing costs to fix up the place that you may not be able to afford. Always make sure to factor in interest payment costs on your mortgage, taxes, and closing costs. And think about ongoing upgrades and routine maintenance when calculating how much you can afford on a home.
When your realtor takes you to look at homes, you should always compare home prices. Think about the home’s square footage, updates, and other property features that may be worth the cost. Let’s say one property is 2,000 square feet at $2 per square foot. Then, you find another with the same square footage and more upgrades that costs $1.80 per square foot. Which would you choose? When you look at the numbers for comparison, you can see a clear choice.
Most first-time homebuyers don’t factor in homeowners insurance, but most mortgage lenders require you to have it. That’s because home insurance protects your home from damage and loss from weather events, fire, vandalism, and theft. You can purchase additional insurance for other expensive stuff, too. Your electronics, antique, and jewelry can have riders. And most insurers will give you discounts for having things like a security system and fire alarms installed in your home. You could even save when you combine your home insurance with auto insurance or life insurance. This practice is known as bundling. And most insurance companies offer discounts when you buy multiple insurance products.
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It depends. On the one hand, low interest rates will not last very long, making home buying an obvious choice. On the other, some lenders are tightening their policies, making it harder to secure a home loan. But as long as your job is stable, you have a higher chance of home loan approval. If you’re in the right place financially, it never hurts to explore options with lenders.
Many people who enter the home-buying process go in with student loan debt. It’s entirely possible to get a home loan with student loans. Just make sure you can pay your debts on time. Also, make sure you have fewer debts overall to please lenders in the approval process.
Your credit score is a factor in homeownership. Lenders want to make sure you can make your housing payments on time each month. Lenders use a baseline credit score for loan approval of around 700 or above. Having an “excellent” credit score can also get you a home loan with a lower interest rate than a “good” credit score.
By now, you should’ve considered everything from how much money you can put toward a down payment to your debt-to-income ratio. And you factored in your long-term financial outlook. If everything is looking green and you still have that emergency fund, then, by all means, buy that dream home. But what if your debt is too much to handle? And what if you want a home right now to keep up with the Joneses? Then, you could be on the path to a financial burden. Either way, you should have a clearer picture now. And, as always, don’t forget to protect your home—whether you rent or own.
Stephanie Shaykin is a seasoned writer and marketing professional with experience in real estate. With a true passion for brand storytelling and SEO, she breaks down the most complex copy into a pleasant experience for the reader. In her spare time, she enjoys creating art and cooking in her home base of Chicago, Illinois.Learn More