How to Decide When to Buy a House

There are two major factors in buying a house. One is the market and the other is whether or not you’re financially ready to make the leap. Interest rates on mortgages are at an all-time low, but no one wants a repeat of the subprime implosion of 2007.

Lenders are more stringent about evaluating applicants. Forget the “zero-down” payment options that were floated before the recession. The standard is 20%, though there is one government program to drop that down.

By the market’s standards, now is an excellent time to buy. It’s up to you to figure out if you’re ready…and if a lender would agree.

Debt to Income Ratio (DTI)

DTI is the first thing lenders look at when assessing your eligibility. The standard is debt to income ratio is 43% – your debt should not be more than 43% of your income. Regular debt payments include utilities, loans, credit cards, plus housing-related expenses.

For example, if your gross income is $6000 a month, you multiply that by .43 to determine how much debt you should carry. In this case, that’s $2,580. If you hit it, it’s good but not a guarantee. If you’re over, it’s a guarantee of a no.

Lenders have another way of assessing your application, called Front-End DTI. This is where they look at how much house you can afford. That number is much lower than 43% – the industry standard is 28%. Apply that to a monthly income of $6000, you would qualify for a mortgage payment of $1,680. That’s how a lender would evaluate it.

In terms of readiness to buy, these calculations let you look at your eligibility from a lender’s point of view.  Front End DTI should always be considered when you start your house search. Depending on the lender, there may be some wiggle room. High-earning professionals can get preferential treatment because of their projected income. Buying more house than you can afford (or need) is not a good strategy. Don’t spread yourself too thin.

Job History

Lenders feel more confident with applicants who have a consistent employment history. They prefer people who have been in the same job for at least two years, sometimes five. The lender wants reassurance you can hold a job and pay your bills. If you’re self-employed, they’ll want at least two years of tax returns and possibly more.

Due to excessive job loss during the pandemic, there may be some flexibility but don’t count on it.

Buying a House in 2021

house sale

Though everyone is talking about low interest rates, the number of cash buyers is on the rise. That has a major impact on first-time homebuyers who need to apply for down payment assistance. Cash is quick and government programs are notoriously slow to respond. Low interest rates won’t apply if you have bad credit.

The other issue is that home prices are rising fast. That may be pushing buyers out of the market, especially in competitive locations. A pre-approval letter is essential to stay in the game, since sellers may see several bids. Mortgage underwriters are assessing applicants carefully and the sales cycle is moving much faster.

The message? If you want to buy a house, do your homework. Know what you need, what you can and cannot afford, and prepare. Think of it from the seller’s – and lender’s – point of view.

(Read: Is Paying Cash Better Than Having a Mortgage?)

5 Steps to Buying A Home

Make sure you give some thought to how much you can afford to pay for a house. That’s important not just for the lender but for you and your family. Think carefully about how much house you need and don’t go overboard. Those huge, beautiful houses come with some ugly utility bills and maintenance costs. Don’t forget property taxes and HOA dues, if applicable.

1. Check your Credit Score

Your credit score will determine what type of rate you will get on a loan. The lower the credit score, the higher the rate. The higher the rate, the more interest you pay over the length of your loan. Most traditional lenders require at least a 620 score to qualify.

According to the calculator at myFICO.com, for a $180,000 house that score would get you an interest rate of 3.97%, (assuming you met other factors.) Over a 15-year, fixed-rate mortgage you’ll pay $52,594 in interest. Meanwhile, a credit score of 760 might net you a 1.972% rate. For the same house, the same term, you’d pay only $28,079 in interest. Almost half what the lower score costs you.

A mortgage is a simple loan – the interest is paid first and then the principle. The higher the interest rate, the higher your monthly payments. If you can push your credit score up – you can save some big bucks. Remember, a pre-approval isn’t a mortgage. If you take out a car loan or otherwise add to your DTI, underwriters can yank your approval right up to the closing.

There are a couple of government programs that work with people who have lower credit scores.

VA Home Loans

VA loans are backed by the U.S. Department of Veterans Affairs. Only active military families and veterans can apply. Lenders prefer a credit score of 620 but there’s no official standard. Interest rates are lower, and most eligibility requirements are related to military service.

USDA Loans

The U.S. Department of Agriculture offers a home mortgage program for low to middle-income home buyers. The program serves individuals and families who are buying homes in rural areas. The credit score for eligibility is 640, though sometimes allowances are made. There is no assistance with a down payment.

2. Pull Together Your Down Payment

As noted above, a traditional down payment is 20%. Using our 180,000 house, you need $36,000 just to get in the game. The national median price of a house in 2020 was $295,300, according to fool.com. They have a great map here to see the average price by state. West Virginia wins most affordable while Hawaii will give you sticker shock.

You need to get a letter from your bank saying you have the funds immediately available. If you plan on selling stock or other assets – get the job down before you find a house to buy. In this market, you can’t wait even two or three days to pull the cash together.

There’s a government program that can lower your down payment, even with a poor credit score.

FHA Loans

A Federal Housing Administration mortgage is the solution for a down payment discount if you have poor credit. If you’re eligible for the loan and have a credit score of at least 580 – you may only need to pull together 3.5% of the home value. The one caveat is that you have to pay FHA mortgage insurance. There is an upfront charge you can roll into your loan and a monthly amount based on the term of your loan.

One note of caution. Getting around a down payment sounds great. But if the market tumbles, you can end up underwater on your mortgage. Granted you can ride it out, but if you’re trying to sell – it’s a problem.

Make sure you have a pre-approval letter from your lender. Do not start shopping until you know who will be handling your mortgage.

3. Start Looking at Houses

Finding the right house takes some time. Be prepared. Think about what you and your family need. A couple with 2 young kids probably doesn’t need 4 full baths, but they will want a good school district. Sit down and talk about how much space you need and what amenities are critical. Granite countertops can be added later, not so easy for a two-car garage or a first-floor master bedroom.

Look around online before you contact a realtor or real estate agent. Location should be a key factor in your browsing. You can fix up a house, but you can’t move it. Write down the zip codes you like with the houses in your price range. Be on the same page about what constitutes a deal-breaker, i.e., no garage, no go.

Then meet with a realtor or real estate agent. Provide the parameters and be polite but firm about sticking to them. Like any other salesperson, agents lean toward showing you houses that are a bit over the budget. If you don’t want to get sucked into a house you can’t afford, don’t go look at them. If the agent understands you aren’t budging – he or she won’t waste anyone’s time.

4. Make an offer

If you found the house you want, work with the realtor to make the seller an offer. To prove that you’re serious about buying the house, the seller may require “earnest money” up front. The amount will vary based on the purchase price and length of time on the market, but don’t undercut yourself here. The money is held in escrow and applied to your purchase price.

Your lender will require an appraisal of the house before signing off on the mortgage. When you make your offer, give some thought to any contingencies that could make you pull back. For example, if there’s a crack in the foundation or an easement or lien on the property.

Contingencies aren’t for cosmetic issues – like replacing some windows. You can negotiate those with the seller. Think of expensive structural or legal issues that could cost you a fortune. Get the appraisal done as quickly as possible so the seller can move forward and accept your offer.

(Read: Closing Costs: The Money to Finalize a Mortgage)

5. On to the Closing

signing off on house

At the closing, you need to take care of all the professionals involved in the deal. The real estate agent, the lawyers, the lender’s representative – all of them have a fee or commission. The average closing costs for the buyer range between 2% and 5% of the purchase price. A more expensive property will have lower closing costs. A $1M home would never sell with that high of a percentage.

Your lender provides a Loan Estimate that includes their best guess on closing costs when they approve your loan. They are required to provide a final Closing Disclosure form 3 days before you close. That should tell you how much you’re going to pay.

If a house has been sitting on the market too long, the sellers may opt to pay the closing costs. But don’t count on it – sellers have closing costs of their own. Plus, most homes are selling pretty quickly in this market. So bring the money for the closing costs and a cashier’s check for the purchase price. Sit through a long and boring read-through of the mortgage and the keys are yours.

When Should You Buy a House

You should buy a house when you’re ready to establish a stable household for a minimum of 5 years. That’s the minimum expectation when you buy a house.

You should buy a house when you have stable employment and a high credit score. If your credit is bad, step back for a bit and clean it up. It will save you thousands when you do buy.

Buy a house when you have a decent down payment. It may take some time but it will reduce your payments and keep your mortgage above water.

The time to buy is a house is when you’ve thought it through. When you know where you want to buy and how much you can afford to pay.

That’s when you should buy a house.

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