Do you dream of buying a house? Do you find yourself scrolling Zillow more than Instagram? Do you dream about white marble kitchen counters or a beautiful open floor plan?
Well, it’s time to take the first step toward making that dream a reality: making sure you’re financially ready for the biggest purchase of your life: a house.
If you're wondering, “Am I ready to buy a house?” you're in luck, because today I’m going to walk you through three questions to help you figure that out.
Am I ready to buy a house?
Before you start calling up realtors or dropping by open houses, you need to ask yourself these three questions:
1. How is my financial health?
Buying a house is expensive, and I’ll explain that more in a minute, but because of that, you need to make sure that you’re in a good financial place before you buy a house. Think of it like going to the gym. If you haven’t worked out in a year or two, you aren’t going to walk in and try to lift the heaviest weight you can find. You want to warm up, stretch your muscles, and build up to the heavier weights.
A house is the biggest thing you’ll ever buy, and you shouldn’t just jump in before you’re warmed up and ready. Here are a few things that act as a thermometer to measure your financial health:
- What’s your Debt-to-Income Ratio (DTI)? Not only is this a key indicator of your financial health, but it is something that mortgage lenders will take a look at before granting you a loan. The 43% debt-to-income ratio standard is generally used by the Federal Housing Administration as a guideline for approving mortgages, but it’s generally recommended to have a DTI of 36% or less.
So how do you calculate your DTI? Your DTI is the percentage of your monthly income that is used to pay off debt. For example, if you earn $4,000 a month in income and every month $1,000 goes toward your student loans or credit card debt, then your DTI is $1000 / $4000 or 25%. Again, anything less than 36% is good.
If you have a high DTI, then you should probably spend some time lowering that percentage before you start scrolling through Zillow. If you need help paying down your credit card debt, sign up for our FREE mini-course, 5 Days to Debt Free.
- What’s your credit score? Again, this is both an indicator of your financial health and a crucial component that lenders will evaluate to decide if you qualify for a mortgage.
Most mortgage lenders require a score of at least 640. Need some help improving your credit score? Click here.
- How large is your emergency fund? Especially considering all of the things that can go wrong when you’re a homeowner – your washing machine breaks down, the roof needs to be replaced, you find mold in your walls – it’s important to have an emergency fund in place to handle any urgent, unexpected expenses.
There’s no set number for how big your emergency fund should be, but it should be enough to cover 6 weeks to 6 months of expenses. As a homeowner, you might want even more than that.
Questions about emergency funds? Click here.
- Are you saving at least 20% of your monthly income? Buying a house requires several hefty costs on the front end as well as multiple ongoing costs, which I’ll get into in a second. If you’re going to make your dream home a reality, you need to start saving now, both so you can afford those costs and so you can develop the habit of saving money so you aren’t struggling to pay your mortgage and any unexpected costs that arise.
Ok, now that you’ve evaluated those four areas to determine your financial health, the next step in figuring out if you’re ready to buy a house is…
2. How much will a house cost?
Of course when you’re buying a house you’ll be taking on a mortgage, and you should figure out exactly how big a mortgage you can afford and what you qualify for, but there are many more costs associated with buying a house that you also need to be aware of.
- Down payment: It's best to put down 20% of your home price to avoid paying private mortgage insurance.
- Closing costs: Before you can get the keys to your new home, you’ll have to pay closing costs. These typically range from 2-5% of the loan principal. The number of closing costs associated with a house will vary depending on the value of the property and the partners you work with, but they may include a credit check fee, appraisal fee, title insurance, and application fee, among other costs.
- Recurring costs: Being a homeowner is expensive. You can’t call up the landlord when the AC goes out or if the dishwasher breaks. In general, you should plan on home maintenance costing $1 per square foot per year.
You have to be prepared for repairs, but there are other recurring costs to be aware of as well, such as electricity and water. Depending on where you live, you may have to pay HOA fees or flood insurance. You may also have to spring for cable and Internet. Plus, you’ll have property taxes every year. Just be sure you sit down and evaluate all of the potential costs.
So, let’s say you’re buying a 2,000 square foot house for $300,000. A 20% down payment would be $60,000. Closing costs would be $6,000-15,000. You should also plan on $2,000 a year for home maintenance, about $3,500 for property tax, at least $1,400 for insurance, and $2,000 for utilities. Not to mention Internet and cable service, HOA fees, and other expenses you may incur to make your home more comfortable, like a pool or lawn service.
Altogether, that’s $66,000-75,000 you’ll have to pay up front and at minimum about $9,000 in annual recurring costs. Of course, all these costs may vary depending on your situation and where you live, but that’s a rough estimate based on a $300K home.
All right, now that you’ve done the math on how much a house will cost, it’s time to move onto the final question for determining if you should buy a house:
3. Is now the best time for me to buy?
I can’t answer this question for you. But just be aware of the current economic situation and housing market. Even if you’re prepared to take on the financial burden of a house, you do run the risk of buying at a bad time. Real estate is cyclical. There are times when the housing market is down and times when it’s high.
If the market is high, it isn’t necessarily the “wrong” time to buy; your house will almost definitely go up in value if you hold onto it. But it is something to be aware of.
Track the prices of real estate in your area. See if houses seem to be trending above asking price or high compared to a year or two ago. Track the supply and demand of houses in your price range. Is there much inventory? Are houses being snapped up quickly?
If the market is low and housing prices are depressed, it’s considered a buyer’s market. This is the best time to get a good deal on a house. But when the market is up, you may be paying more for a house.
We saw this in early 2022 when the housing market was red-hot. I have some friends who considered buying a house in 2020 for about $650k. Less than two years later, that same house was worth more than $900k.
Keep an eye on the economic outlook as well. The Fed has increased interest rates to combat inflation, which means that you will have to pay more interest on a new mortgage. To illustrate what that looks like, a 30-year mortgage (360 months) on a $100,000 loan at 3% interest will cost you $422 per month. At a 5% interest rate, it will cost you $537 per month. At 7%, it jumps to $665.
That isn’t to say you should or shouldn’t buy a house, but try to be smart about when you buy.
So…are you ready to buy a house?
Buying a house is a huge deal, and if you’re ready for it, congratulations!! And if you’re not, don’t worry. You’ll get there. The most important thing is to not rush into making the biggest financial decision of your life.