Owning a home has long been considered to be part of the Canadian Dream, but as the huge tidal wave of foreclosures has taught us in recent years, it can also be a major disaster if you buy a house you cannot afford – or if you buy a home before you are ready for home ownership.
Purchasing a home is a major investment, and as with any investment, it is important to be educated before you dive in. Once you have a basic understanding of what home ownership entails, you must carefully consider whether you are truly ready to buy.
When determining whether you are ready to buy your first house, there are six key factors to consider.
Am I Ready to Buy a House?
1. The Current State of Your Finances
The current state of your finances is perhaps the single most important factor to consider when determining whether you are ready to delve into home ownership. When examining your current financial state, you must answer two questions:
- Do I Have Cash Set Aside for a Down Payment? Ideally, you need to be able to put down at least 20% of the cost of the home to avoid having to pay private mortgage insurance (PMI). PMI is a huge waste of money, since it essentially just protects the bank’s investment in case you default on the loan. Buying a house without a down payment is risky for the bank and for you, since you could end up owing more than the home is worth if property values fall. PMI protects the bank, but you won’t have a safety net if you haven’t put money down on the home.
- Can I Afford the Cost of a Mortgage? This question seems obvious, but it is important to think about future mortgage payments, as well as current payments. If you take a fixed-rate mortgage, your payments will not change over the life of the loan, and it will be easier to predict whether you will be able to afford future payments. However, if you take an adjustable rate mortgage, you may be able to afford the payments now, but not when they adjust upward in the future. This is a significant risk, and these types of adjustable rate mortgages have been a major contributing factor in the ongoing mortgage crisis in the U.S.
So, why have people taken adjustable rate mortgages? Usually it is because their initial interest rate was lower – making it seem like they could afford the mortgage when they really could not. Don’t fall into this trap. If you need some type of creative financing to afford your house, then you simply can’t afford it.
2. The Stability of Your Financial Future
This is another important factor when determining whether you should buy a house now or wait until the future. If you have recently changed jobs, if you are thinking about changing jobs, or if you are expecting any major changes to your income, it is not a good idea to buy a house until you are on more solid footing. Banks and mortgage lenders typically require you to have been with your employer for at least a year or two before they will consider you for a loan.
Furthermore, you need to have a plan to pay your mortgage in the event that something does go wrong in the future, such as a layoff or a medical problem. Typically, this means you should have an emergency fund – at least a few months’ worth of living expenses – set aside before you buy a home.
An emergency fund can also come in handy to help you to bear all of the unexpected costs that come along with being a homeowner. For instance, having cash set aside for repairs is essential, since you will not have a landlord to call when something goes wrong.
3. Your Credit Score
The state of your credit is just as important as the state of your finances when it comes to deciding whether you are ready to buy a home. Your credit score determines whether a mortgage lender will give you a loan at all, as well as the rate. A low credit score can result in a significantly higher interest rate, which means that you will pay thousands (or hundreds of thousands) more over the life of the loan.
Typically, you need a credit score above 650 in order to get the most advantageous rates. If your score is lower, consider waiting a while to buy a house as you try to improve it. You can do this by:
- Paying down debt
- Having inaccuracies removed from your credit report
- Making payments on time every month
- Avoiding opening new types of credit or applying for new loans
Over time, with responsible borrowing behavior, old negatives on your report will have less of an impact, your score will go up, and you will be ready to purchase a home at a better rate.
Buying a house entails a large initial expense. First, you must pay the closing costs associated with your mortgage, which can total several thousand dollars. Once you are in the home, most of the initial mortgage payments go toward paying interest on the loan, rather than paying down the loan balance. Keep in mind too that selling your home in the future may also be expensive, as you typically must pay commission to a real estate agent.
With all of these costs, it is very difficult – if not impossible – to make money on a home unless you plan to stay in it for a while. Until recently, many experts recommended that you plan to stay put for at least two years if you are going to buy a home. However, because of an uncertain real estate market and uncertain property values, this estimate has been revised to suggest that you refrain from buying unless you plan to stay put for at least three to five years. If you aren’t committed to staying in one place for that duration, now is not the time to buy.
5. The Current Real Estate and Credit Market
While this factor may not be as crucial as the other considerations, you still need to consider it. Look at the current interest rates, and consider the experts’ opinions as to whether property values are on the rise, or are likely to fall.
- If interest rates are at record lows, it may be a good time to buy, as you will pay a reduced cost for the privilege of borrowing money.
- If property values are on the decline, it may be a good time to wait as you could end up getting a better deal on the same type of home in just a few months’ time.
It can be very hard to accurately predict what interest rates or property values will do, so these shouldn’t be deciding factors – but they are worth considering.
6. Your Commitment to Home Ownership
Being a homeowner is different than being a renter. You need to take care of all of your own home repairs and maintenance, rather than counting on someone else to do it. You may have more yard work, as well as additional responsibilities (such as shoveling snow and cleaning out gutters) that renters don’t have to worry about. While some people don’t mind such chores, others don’t want the hassle. Consider whether you are ready to take on these added responsibilities of home ownership before you make your decision.
All of these factors need to be weighed and considered when deciding if now is the right time to buy a home. Make sure everyone in your family is on board and that you think with your head, not your heart. If you don’t carefully consider every aspect of this important financial decision, you could find yourself struggling to make mortgage payments you can barely afford – or worse, you could find yourself in foreclosure