With mortgage rates as favorable as they are right now, you may be thinking it’s time to stop paying rent to a landlord and start paying a mortgage on your own home. Or maybe you’ve settled into a stable job and are ready to put down roots, or need more space for a growing family.
Whatever your reason for buying a house, it’s important to know that it requires more than just being able to afford the monthly payment. You’ll need to plan for a down payment, closing costs, insurance, maintenance and other expenses.
Here are some important factors in determining whether you can afford to buy a home:
Check your credit
Mortgage lenders want to know that you’ve handled your finances responsibly in the past. They don’t want to take the risk that you may default on your mortgage. You’re also more likely to get the best possible interest rate if you have good credit. So before you even begin house-hunting, check your credit report.
Once a year you can get a free credit report from each of the three credit-reporting agencies — Equifax, Experian and TransUnion. It’s simple – just visit annualcreditreport.com and click on “Request yours now!” and follow the steps outlined. Review your report for errors and follow the steps outlined for fixing them.
A note on scores: You may have to purchase your official FICO® credit score separately from your free credit report. Depending upon your credit score, you might realize that you are not ready to buy a home. A low score is a signal that you may need more time to work on paying your debts off and on time.
If you try to apply for a home loan with a low credit score, you may be considered a “sub-prime” borrower, which means any lender who approves you for a loan — and some will not — may charge you a hefty interest-rate premium in exchange for taking you on as a potentially risky customer.
Know what you can afford
Another step before you start going to open houses: Get preapproved for a mortgage. Talk with several different lenders and find out what they’ll charge in rates and fees. Once you find a lender with which you’re comfortable, complete their preapproval process. You’ll learn how much you can borrow for a mortgage, and what your monthly payment might be.
Although your lender might approve you for a more expensive home than you were considering, it’s important to decide what you can realistically afford. A good guideline to follow: Your gross (before-tax) monthly housing costs, comprised of your mortgage payment (both principal and interest), property taxes and homeowners insurance premiums, should not exceed 28% of your gross monthly income. Also, typically, your gross monthly housing costs plus total monthly payments on debts such as car loans, credit cards and other debts should not exceed 35%.
Decide on your down payment
The more you can pay upfront for your home (your “down payment”), the less you’ll pay in interest over the life of your loan. There are some special government programs that may allow you to buy a home with very little down. However, most lenders require at least 10% of the property’s price as a down payment. If you can afford to put down 20% or more, you’ll avoid an extra monthly fee known as private mortgage insurance (PMI).
A generous down payment is smart, but so is keeping enough cash on hand to cover things like moving expenses, furnishings for the new home and any repairs or remodeling you might want to do. You will also need to be able to cover all closing costs required by the lender (see next section), plus property taxes, pro-rated portion of the first month's interest, and other fees. Ideally, you should also have an emergency fund of 6 to 12 months’ worth of living expenses in the event of a financial hardship.
Keep cash for closing costs
When you “close” on a home–that is, when you sign papers to take ownership of the property–the lender requires you to pay a set of fees known as closing costs. Your closing costs may include one or more mortgage “points,” which are basically prepaid interest charged by the lender in return for the interest rate they have agreed to charge you for the loan. Each point equals 1% of the loan amount. For example, on a $250,000 loan, one point equals $2,500.
Other closing costs may include fees for loan processing, the loan application, credit reports, home appraisal, title insurance, surveys and the lender’s attorney. Your total closing costs will typically add up to between 2% and 7% of the value of the property you’re purchasing.
Appreciate home ownership benefits
Although buying a home can be costly, there could be benefits. You may be able to deduct interest you pay on your mortgage loan each month and even your property tax payments. Consult with your tax advisor for more information.
If you have questions about whether buying a home fits into your financial plan, call your current loan officer, or talk to a TIAA Direct® loan officer or TIAA-CREF advisor.
The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons.
TIAA-CREF Individual & Institutional Services, LLC, Teachers Personal Investors Services, Inc., and Nuveen Securities, LLC, Members FINRA and SIPC, distribute securities products.
TIAA Direct® is a division of TIAA-CREF Trust Company, FSB. Member FDIC. Equal Housing Lender
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