Buying a home is a big decision that you shouldn’t make lightly. Between all the costs and fees you’re responsible for, real estate transactions get expensive. And the upfront exchange of money is only the beginning.
Houses aren’t cheap and there are a lot of pieces and parts you need to keep well maintained and in working order. When something goes wrong, it’s your responsibility to fix — and pay for — it.
That’s not to say buying a home is a bad idea — far from it for many people! But you should be prepared and fully understand your financial situation so you can make an educated decision on whether or not this purchase makes good sense for you. Use this checklist to help you determine if you’re prepared for homeownership.
Understand What You Can Truly Afford Before Buying a Homebuying
If you go online and use a mortgage calculator — or call up a lender to talk with a mortgage specialist — you’ll find that what these tools say you “can afford” is likely far outside a reasonable, realistic budget. Only you know all the ins and outs of your financial situation, and the other financial goals you want to hit.
While you may be able to “afford” the monthly payments on a $500,000 house, you’ll likely be house-poor and unable to do anything but funnel your earnings to that mortgage each month. Choosing a house that’s $250,000 or less will allow you to focus on other goals, including saving and investing, and it allows you more financial flexibility.
Don’t forget to take into account expenses that you’re not responsible for when you rent, but you will need to pay as a homeowner. You’ll need to consider the impact of yearly property taxes, homeowner’s insurance, and regular maintenance and repairs.
Look for the Best Interest Rate
The interest rate you can get for your new home loan will depend on a number of factors, but the biggest one within your power to control is your credit score. The better your score, the lower your interest rate. If your score is not outstanding, it’s worth shopping around and looking for quotes from various lenders to see who can provide you the best rate.
(You should also get pre-approved while going through this process to have a better understanding of whether or not a lender will actually process your loan — a bank or credit union may quote you a great interest rate but end up denying your loan because of other financial factors.)
And while you should shop around for the best rate you can secure, you need to plan ahead. Getting a quote for the insurance rate on a mortgage is considered a hard inquiry on your credit report, and having too many inquiries can ding your credit. However, if all the inquiries are made within a 14-day period, they’ll count as one instead of multiples.
Plan to get quotes from lenders you’re most interested in working with within that timeframe so you don’t risk negatively affecting your credit.
Work to Improve Your Credit Score (and Pay Down Debt)
If you shopped around for interest rates and couldn’t get the rate you wanted because of your credit score, you may want to consider stepping back from your house search to focus on improving your credit score first.
A better score may mean a better interest rate — and that means saving tens of thousands of dollars in interest payments over the lifetime of your loan.
Improving your credit score starts with paying your balances on time and in full. Keep older accounts open, even if you don’t use the lines of credit anymore. And ensure you’re not running balances up to the limit each month on your credit cards. Even if you pay them off in full and on time, utilizing all your available credit all the time damages your score.
You’ll also want to work to pay down any consumer debts and make sure your student loan debt is manageable before you take on another financial obligation. Houses can be assets, but your primary residence is not an investment. It’s a big expense and you need to make sure you have the cash flow to handle the mortgage payment each month on top of all the other costs associated with homeownership.
Aim to Save 20% for Your Down Payment
Yes, 20% of a home’s purchase price is a lot of money. But it’s well worth taking the time and making the effort to save this amount before you buy. 20% is a common rule of thumb largely because putting down anything less means taking on private mortgage insurance, an additional monthly charge that you can avoid by putting down more cash up front.
Your monthly mortgage payments will also be less the more you put down, and you could secure a better interest rate as well.
This isn’t a hard and fast rule, and it may make sense to put less cash down depending on your financial situation. This is an excellent question to review with a fee-only financial advisor who can look at the big picture and help you determine the smartest money move to make when buying your home.