subject: How To Decide Whether You're Ready To Purchase A Home [print this page] Buying a home can be intimidating, even for veteran homeowners. Not only must you list your current property (if you're planning to sell it), but you'll need to sift through dozens, perhaps even hundreds, of homes for sale. And this is merely the beginning of a long process toward finally purchasing a new house for you and your family.
But prior to reaching that stage, it's important to decide whether you're even ready to do so. Much depends on your current financial situation; you'll need to determine how much you can afford to pay. In this article, we'll help you navigate this process. We'll show you how to calculate a manageable mortgage payment while factoring in additional, necessary expenses. You'll also learn how to choose a down payment that makes sense for your current circumstances.
Determine Your Mortgage Payment Ceiling
Mortgage lenders use front-end and back-end debt-to-income (DTI) ratios to determine how much you can afford to pay each month. The front-end DTI represents the portion of your income that can go toward a mortgage payment. The back-end DTI represents the portion of your income that can be allocated toward the front-end DTI plus all other recurring debts. These debts include child support and alimony payments, auto loans, credit cards, and other financial obligations.
Commercial lenders often use a 28%/36% combined DTI. This means your house payment (i.e. the front-end DTI) can represent 28% of your gross income. Your house payment plus all other debts cannot exceed 36% of your gross income. The Federal Housing Administration (FHA) uses a 31%/43% combined DTI.
The front-end and back-end debt-to-income (DTI) ratios provide a reliable way to calculate a mortgage payment you can afford.
Factor In Additional Expenses
Consider the nonessential bills you pay each month. This lies outside the scope of groceries, utilities, car insurance, and other necessary expenses. For example, are you a member of a gym? Do you attend concerts on a regular basis? Do you enjoy eating at expensive restaurants with your friends? How about hobbies for which you allow yourself a monthly stipend?
These and other nonessential outflows should be deducted from the mortgage payment you calculated using your combined debt-to-income ratios (ref. previous section).
Identify An Appropriate Down Payment
Ideally, you'll want to put a 20 percent down payment on your new home since doing so allows you to avoid paying PMI (private mortgage insurance). PMI payments can add an additional $100 or more to your mortgage. It initially seems a small amount, but it can become significant after paying it month after month.
If you lack the financial resources to put 20 percent down, you can use a small down payment. The downside to doing so is that your mortgage payment will be larger, and your interest rate on the loan may be higher. You'll need to weigh the benefits and drawbacks of reducing your down payment. Another option, of course, is to purchase a smaller home, or wait until you have a larger reserve.
Is There An Ideal Home-Buying Season?
Technically, no. Every local housing market is a little different, and each poses times during the year when it may be slightly more advantageous to buy. For example, homes for sale near elementary schools may be priced lower during the winter. Homes in areas that receive a lot of tourists during the summer may be priced lower during the fall.
It's worth noting that timing a real estate market is always dangerous. While waiting for home prices to decline, other factors may cause them to rise. Or, if demand is outpacing supply in the local market, a property that appeals to you may be purchased by another buyer.
First, decide whether you're truly ready to purchase a home by calculating the highest monthly payment and down payment you can manage. Then, set your sights on the neighborhoods that appeal to you and your family.
